What Is WTI Actually Worth in Canada?

Transcription

1 What Is WTI Actually Worth in Canada? Samantha Foster, P.Eng, Intermediate Engineer Mark Lenko, P.Eng, Engineering Director May 25, 2017 Many factors go into calculating the actual price of a barrel of oil for Canadian producers based on WTI. N/A Fluid(s) Oil Area North America Operator(s) N/A Bo r Exc der C han ros si ge Ra ng te Tra n Tar spor t iff Charge Commodity Chest y nt alit Qu ustme j d A Play(s) digest.canadiandiscovery.com Feature Article Demystifying Crude Oil Marketing

2 West Texas Intermediate, better known by its acronym WTI, is probably the most recognized oil field term out there. The media plasters it on headlines like a harbinger of death, and indeed many in the oil patch have died a slow and terrible death at its hands. But what exactly is WTI, and what is it worth to Canadian oil producers? It turns out that crude oil trading and marketing is more convoluted than merely selling a barrel of oil for the price a group in the Middle East have seemingly set at random. This article will attempt to de-convolve some of the mysteries around the price of crude oil and relate it back to the actual worth at the wellhead for a Canadian producer. The article is not a comprehensive analysis of the crude oil marketing system, but rather a high-level review relating the most familiar benchmark price for oil (WTI) to the actual price of a barrel produced from five different areas in western Canada. Image Overleaf The price of a barrel of Canadian oil is a game with many factors on the path to WTI value. Image by Paul Patton (With apologies to Parker Brothers.) Benchmark Pricing In general, crude oil will sell for whatever a buyer is willing to pay for it. Like any traded commodity, many different factors come into play when determining the value of crude oil, including supply and demand, crude quality, location, government regulations and financial markets. While all these factors play a role in setting the price, the main drivers are the quality of crude and the cost of transporting it to market. As petroleum producers are aware, not all oil is created equal. The actual composition of the oil flowing from the wellhead differs widely depending on where it is produced and even differs within the same producing zone. While many factors come into play when describing a crude oil, the main components used to determine quality, and therefore price, are sulphur content and API gravity. Sulphur is an undesirable component or contaminant of crude oil as it corrodes pipelines, and once it is refined out and becomes a by-product, there is not much market for it. Crude oil with more than 0.5 wt% sulphur is termed sour, while those with less than 0.5 wt% are deemed sweet. Sour crudes are worth less than sweet crudes due to the additional steps needed to extract the sulphur during the refining process. API gravity is the second identifier of crude quality. It is the inverse measure of an oil s specific gravity. The formula for calculating API is: API = Specific Gravity (Gatlin, 1960). Higher density crudes have a lower API gravity. Oil is also grouped into weight categories according to API gravity: API > 31.1 Medium API Heavy API Extra Heavy API < 10 (Petroleum UK, 2015). In general, lighter crudes are more desirable because they are easier to produce as they have lower viscosity and therefore flow better, and they 2 Discovery Digest Volume 3, 2017

3 1 Characteristics of Main Benchmark Crudes WTI Edmonton Brent API Gravity (degrees) Hardisty Dubai WCS Sulphur Content (wt%) Modified from Wikipedia, 2017 produce a higher yield of gasoline when refined, which is worth more than other refined products. Every crude oil that is produced could be classified according to sulphur content and API gravity. However, to make things more manageable, crudes are generally grouped into streams that consist of oils produced in the same geographic area with similar sulphur content and API gravity. The Energy Intelligence Group publishes a World Crude Oil Data handbook that has identified 177 main crude streams throughout the globe (Energy Intelligence, 2017). While 177 different crudes are more manageable than the almost infinite variability encountered in the field, it is still quite a few! To provide transparency and facilitate trading for crude oil buyers and sellers, reference points have been set up that are called benchmark crudes. Benchmarks give an idea of what certain types of oil are worth in certain parts of the world and can give an indication of the state of supply and demand of the industry as a whole. WTI, which is one of the main benchmark crudes, is a light, sweet crude with an API gravity around 39.6 and sulphur content of 0.37 wt%. WTI is the price that oil with 0.37 wt% sulphur and an API gravity of 39.6 would fetch if it were sold at the Cushing, Oklahoma delivery point. Other main benchmark crudes include Brent Blend, which is the main benchmark for Europe, and Dubai Crude, which is a main benchmark in the Middle East. Commonly used Canadian benchmarks include Edmonton, Hardisty and Western Canadian Select (WCS). Figure 1 compares the sulphur content and API gravity for several benchmark crudes. WTI Pricing 3

4 2 Western Canada Crude Types British Columbia Peace River Heavy Oil API: 20 S: 5.0% BC API: 40 S: 0.66% Alberta Pembina Sour API: 40 S: 1.1% Saskatchewan Kindersley Medium API: 35 S: 0.17% Manitoba Viewfield API: 43 S: 0.13% Modified from Crude Monitor, 2017 In simple terms, the price of a specific oil is determined by starting with the benchmark price, then adjusting up or down based on quality if the oil is sweeter and has less sulphur than the benchmark, it will generally receive a premium to the benchmark. The price is then adjusted for transportation costs from the wellhead to the sales point. The actual process is much more involved, and of course, the actual price comes down to what a buyer is willing to pay for the product; however, this simple method provides a clearer picture of what different crudes are worth across the main producing areas in western Canada. The remainder of this article will discuss in more detail the factors contributing to crude price differentials between WTI and five Canadian crudes producing from different areas in BC, AB and SK. A Tale of Five Crudes: Quality Adjustments The composition of crude oils is as unique as the rocks that contain them, but crudes can be grouped into streams with similar qualities. The five crude streams examined in this article are shown in figure 2 with API gravity and sulphur content. As the quality of a crude will vary over time depending upon the individual wells and zones being produced figure 2 is intended only to illustrate the effect on oil price due to differing quality and location. A buyer purchasing BC may pay a premium over Pembina Sour due to the lower sulphur content; however, they may pay a lower price compared to Viewfield due to the lower API gravity. Transportation costs also come into the equation and will be discussed in the next section. 4 Discovery Digest Volume 3, 2017

5 The actual discount or premium paid will depend on the contract between the buyer and seller, but general rules do exist to estimate the price differentials due to quality. One estimate is provided by the Canadian Equalization Steering Committee of the Canadian Association of Petroleum Producers (CAPP). This committee has developed a formula to calculate the sulphur and density penalties for Canadian light and medium crude. At a high level, the committee collects a six-month history of the price of various crudes in Canada and the United States, each of a different quality. They then adjust the prices for transportation costs to the Chicago market, which effectively removes this variable from the equation. What is left are several crude oils of differing quality, each with a different monetary value. It is assumed that the cost differential can be attributed to sulphur content, API gravity and a variable that accounts for the difference between Canadian and U.S. crude. This last variable is needed because exchange rates, as well as factors such as pipeline limitations, can influence the price of Canadian crude even if the quality is the same as its U.S. counterpart. WTI is used as the reference price. This leads to a formula that looks something like the following: Price = a(wti) + b(sulphur) + c(density) + d(adjustment) + e (CAPP, 2017). Now it is simply a matter of performing a multivariate linear regression to find the coefficients of the equation. Coefficients b and c are the adjustment factors for sulphur and density, respectively, which can now be used to estimate premiums or discounts due to quality differences. CAPP has a detailed explanation of the procedure and documented the actual model (CAPP, 2017). Using this model and the API gravity and sulphur values for the five different crudes, price adjustments can be calculated (table 1). Note that heavy oil is a different beast and will be discussed later. Viewfield commands a premium due to its high API and low sulphur content. All other crudes are discounted by varying amounts with Pembina Sour having the highest discount of the conventional crudes due to the high sulphur content. Heavy oil has a much higher quality discount due to its extremely low API and high sulphur content as well as some other unique factors that will be discussed in the next section. Heavy Oil When it comes to evaluating the field gate price of heavy oil, a few factors come into play that make the process slightly different from conventional crude evaluation. The first difference is the quality adjustment. The formula presented above was created for conventional light and medium crudes. Information on heavy oil quality adjustment is Table 1. Quality Adjustment Price for Five Canadian Crude Oils BC Peace River Heavy Oil Crude Type Kindersley Medium Viewfield Pembina Sour API Gravity (º API) Sulphur (%) Quality Adjustment ($CAD/bbl) Data from CAPP, 2017 WTI Pricing 5

6 difficult to find, so this example will draw from information in GLJ Petroleum Consultants (GLJPC) Understanding Bitumen Pricing article (GLJPC, 2017) and use a quality adjustment of $4.00/bbl. The second factor that comes into play with heavy oil is blending. When heavy oil is produced, it is far too viscous to flow in a pipeline. Think about trying to get molasses into a drinking straw compared to olive oil. In order to meet the pipeline transportation requirements, heavy crude is blended with a lighter oil to reduce viscosity sufficiently so it can be pumped through a pipeline. The blending oil is commonly referred to as diluent and is usually a condensate. The amount of diluent needed varies depending on the type of heavy crude and is commonly called the blend ratio. According to Baytex Energy, which has operations in the Peace River Heavy Oil area, the blend ratio is 0.23/0.77 (Baytex, 2017). For every barrel of blended bitumen (dilbit), 23% is diluent and 77% is bitumen or heavy crude. The final piece of the puzzle is the actual diluent. Producers of heavy crude oils need to buy and transport the diluent to the field to blend it with their heavy oil or bitumen to meet the pipeline company s viscosity specifications. Options for transporting the diluent to the field include trucking or pipelines. The GLJPC example will again be used, with diluent trucked to the field at a cost of $5.00/bbl. Before the diluent can be transported, it must be purchased. Condensate is generally obtained at a premium to light sweet crude. This example will use the December 2016 Edmonton Benchmark price for light crude provided by the Alberta Department of Energy (Alberta Government, 2016), plus a $0.50 posting premium, for a total of $57.52/bbl. With the transportation cost, the light crude or condensate price becomes $62.52/bbl. Recall that the actual product the operator will be selling is the blended dilbit; therefore, each barrel of dilbit has $14.38 of associated diluent cost. The blending cost is added to the quality adjustment for heavy oil in table 1. It should be obvious at this point that heavy oil has huge associated costs over conventional crude and is one of the reasons why such projects require high oil prices to be profitable. The Pipeline Network Now that crude quality adjustments have been covered, the next step is to examine transportation costs, as this is the second, and currently a more important factor associated with crude oil price differentials. There are several ways of transporting crude oil from the wellhead to the market, including trucks, rail, boats, and of course, pipelines. The mode of transportation depends upon where the crude originates and where it is going. Pipelines will be the focus of this article as they are, by far, the most efficient method for transporting oil. Canadian Crude to Cushing All roads lead to Cushing? In the U.S. world of petroleum gathering systems, yes. Cushing, Oklahoma is the main gathering point for U.S. crude oil. Most of the main U.S. pipelines run to Cushing, where oil is stored and subsequently distributed to many more outbound pipelines. Figure 3 shows the major oil pipelines in North America. The map also shows the two main Canadian Cushing equivalents: Edmonton, AB and Hardisty, AB. Crude oil is transported to and stored at Edmonton and Hardisty before entering the two main pipelines that deliver Canadian crude to the U.S. border and then to Cushing. 6 Discovery Digest Volume 3, 2017

7 3 North American Crude Oil Pipeline Network ENBRIDGE NW British Columbia RAINBOW Alberta Edmonton, AB Saskatchewan HUSKY Hardisty, AB Manitoba NL KEYSTONE SHELL CA EXXONMOBIL CHEVRON PACIFIC OR WA NV AZ ID UT MT WY CO NM WASCANA PONY EXPRESS WHITE CLIFFS Dickinson SD NE ND Cushing, OK OK CENTURION KEYSTONE KS MN KOCH Wood River SPEARHEAD SOUTH IA MO PEGASUS WI IL Flanagan Ontario MI IN KY TN Westover ENBRIDGE LINE 9 KIANT ONE Quebec Newell Philadelphia Montréal NY NJ PA OH MD WV VA DE NC MONTREAL VT NH MA CT RI ME NB Saint John PE NS Artesia Slaughter Big Spring SEAWAY TWIN TRANSCANADA GULF COAST AR SC Crane CACTUS TX CRANE PERMIAN EXPRESS BRIDGETEX Three Rivers Port Arthur/ Nederland/ Beaumont LA EXXONMOBIL HO-HO St. James Lake Charles MS AL GA FL Major Existing Crude Oil Pipelines Carrying Canadian Crude Oil Selected Other Crude Oil Pipelines Modified from CAPP, 2017 TransCanada s Keystone Pipeline, which is one of the major pipelines transporting Canadian crude to the States, runs from Hardisty, AB, into MB, and then crosses the U.S. border into North Dakota. In the U.S., the pipeline branches in Nebraska, where one leg runs into Illinois while the other heads south to Oklahoma before terminating in Texas (figure 4a). Enbridge operates the second major pipeline network transporting Canadian crude to the U.S. The Enbridge Mainline System consists of several lines that carry different crudes from Edmonton and several other terminals in Canada into an extensive network in the U.S. (figure 4b). The Wellhead to Edmonton and Hardisty Secondary gathering systems are used to transport crude from the field to Edmonton and Hardisty, the primary crude oil storage hubs in Canada and the beginning of the major pipelines transporting crudes to the U.S. The specific pipelines transporting WTI Pricing 7

8 4 Major Canadian Pipelines a. TransCanada Pipeline b. Enbridge Pipeline British Columbia Alberta British Columbia Alberta Saskatchewan Saskatchewan Edmonton, AB Hardisty, AB Manitoba Edmonton, AB Hardisty, AB Manitoba WA Ontario WA Ontario OR ID MT ND MN OR ID MT ND MN CA NV UT WY SD NE IA WI IL IN MI CA NV UT WY SD NE IA WI IL IN MI CO KS OH CO KS OH AZ Cushing, OK OK NM MO KY TN AZ Cushing, OK OK NM MO KY TN AR GA AR GA TX LA MS AL TX LA MS AL TransCanada Keystone Pipeline Selected Other Crude Oil Pipelines Major Existing Crude Oil Pipelines Carrying Canadian Crude Oil Enbridge Pipeline Selected Other Crude Oil Pipelines Major Existing Crude Oil Pipelines Carrying Canadian Crude Oil Modified from CAPP, 2017 crude are dependent on the area the crude is coming from. Figure 5 shows the various secondary pipelines connecting the five crudes to the Canadian and U.S. mainlines. BC is unique in that it usually moves to the west coast of BC via the Transmountain Pipeline, and then is loaded onto tankers heading for the Asian market. The other four crudes head to the U.S. through Edmonton, Hardisty or smaller terminals in SK. As this article is comparing the price of the different Canadian crudes with respect to WTI, the transportation costs for BC will be those associated with moving it Cushing. Otherwise, the price received at the West Coast would have to be linked to WTI, which could get complicated. The transportation cost is part of the pipeline toll system that is discussed in the next section. Pipeline Tolls Pipeline tolls are the fees that pipeline operators charge to use their service. While pipelines are a business, and their investors expect a reasonable return, rates are not a free-for-all. Pipelines are considered a natural monopoly. In exchange for being granted approvals to build and operate, the rates of return from the tolls are regulated. Tolls on interjurisdictional pipelines are regulated by the National Energy Board (NEB) in Canada 8 Discovery Digest Volume 3, 2017

9 5 Secondary Pipelines Connecting Five Areas to Mainlines BC to West Coast BC to Cushing British Columbia Alberta Heavy Oil Edmonton, AB Saskatchewan Hardisty, AB Manitoba WA Pembina Sour Kindersley Medium Viewfield Ontario OR ID MT ND MN CA NV UT WY SD NE IA WI IL IN MI CO KS AZ NM Cushing, OK OK MO KY TN Major Existing Crude Oil Pipelines Carrying Canadian Crude Oil AR Selected Other Crude Oil Pipelines Modified from CAPP, 2017 and the Federal Energy Regulatory Commission (FERC) in the U.S. The regulators ensure that the tolls are set so the pipeline companies earn an acceptable return and shippers have reasonable costs. Tariffs are set up that outline the terms and conditions of pipeline services, and include not only the tolls, but the rules and regulations associated with the use of the pipeline. The proceedings to set tariffs are open and are published once they have been set. The tariffs are usually available on a pipeline company s website. The amount a company will charge a shipper to use their pipeline depends upon a number of factors including the volume being transported, the distance to the delivery point, the quality of the product, as well as market factors. Some of the bigger companies, such as TransCanada, have reached agreements whereby it provides a discount for multi-year contracts. Shipping companies can also enter agreements where they commit to ship a certain volume of oil over a certain time frame, and in exchange receive a discounted toll. WTI Pricing 9

10 Table 2. Transportation Costs for Five Crudes on Different Pipelines Delivery Destination Cushing via Enbridge Cushing via TransCanada Canadian/U.S. Leg Units BC Peace River Heavy Oil Crude Type Kindersley Medium Viewfield Pembina Sour Canada $CAD/bbl U.S. $US/bbl Canada $CAD/bbl U.S. $US/bbl Data from TransCanada, 2017 and Enbridge, 2017 Table 2 summarizes the transportation costs for each of the five crudes of interest on the two main pipelines to Cushing (TransCanada and Enbridge). Costs are split according to the Canadian and U.S. portions. As not all fees are easily accessible in the public domain, the costs in the table reflect published tolls according to pipeline company s tariffs. If multi-year contract tolls are available, a 10-year committed volume was used. Where applicable, committed volume tolls are shown over uncommitted. The Loonie: How the Exchange Rate Affects Oil Price The final detail when calculating the difference between WTI and Canadian crudes is the all-important border crossing. As oil is transported from Canada to the United States, there is a point where Canadian dollars must switch to American. The exchange rate has a large impact on the price Canadian producers receive for their product. The exchange rate on March 31, 2017 was 0.75 $US/$CAD and is used to convert the U.S. leg of the transportation fees to Canadian dollars. Not only does the exchange rate affect the transportation costs, it also influences the price a Canadian producer will receive for their production since, in our example, the sale price is in American dollars at Cushing. Figure 6 shows that a weak Canadian dollar is advantageous for Canadian producers. Transportation costs increase and the benchmark value for a barrel of oil decreases as the Canadian dollar strengthens. The Bottom Line: What Is WTI Actually Worth? In order to calculate crude oil price for Canadian producers based on WTI, a barrel of oil will be followed on a journey backward from Cushing, Oklahoma, where all begins on equal ground. After leaving the storage tanks in Oklahoma, the barrel of oil travels through the U.S. pipeline network, crosses the U.S.-Canadian border, and then flows on to the Canadian pipelines. The barrel finally ends at the wellhead where a quality adjustment is applied. Calculating the actual price that different Canadian crudes will receive at the field gate in relation to the posted WTI price comes down to accounting. The results are summarized in table 3 and figure 7. All prices in table 3 are shown in US dollars. The WTI row in the table shows that all crudes start their journey on equal footing. From Cushing, they travel through pipelines to the Canadian border (U.S. Transportation Cost), then on to secondary pipelines that transport each crude to the wellhead (Canadian Transportation Cost). 10 Discovery Digest Volume 3, 2017

11 6 Effect of Exchange Rate on Transportation Costs and WTI Value $70.00 $1.25 $60.00 $50.00 $1.00 Price and Cost ($CAD) $40.00 $30.00 $0.75 $20.00 $10.00 Exchange Rate Transportation Costs $ Exchange Rate ($CAD) 1.25 WTI Data from TransCanada. 2017, Enbridge, 2017, XE, 2017 and Bloomberg, 2017 Finally, at the wellhead, the quality adjustment is made for each crude based on the formula discussed in the Quality Adjustments section. The final field gate price is quoted in US dollars for comparison to WTI. The price differential is shown in the last row of the table 3. As explained at the beginning of this article, the method employed to calculate field gate price is a simplification of the actual process. To get a sense for what producers are actually receiving for their crude, table 4 compares the realized crude price posted by companies with operations primarily in the areas of the five crude types examined in this article. The calculated field gate price is within the ball park of the realized price reported by actual operators. It is important to note that the realized price would be for all crude oil produced by the company, not only the type shown for this article. Also, realized crude prices are quoted when the producer sells the commodity to another party. Some processing of the crude has generally taken place by this point. Processing costs are not incorporated into the calculated gate costs, so may account for some of the discrepancy. WTI Pricing 11

12 7 The Bottom Line WTI U.S. Transportation Canadian Transportation Quality Adjustment Wellhead Value Viewfield Kindersley Medium Pembina Sour BC Price ($US) Peace River Heavy Oil Data from SEDAR Company Reports, 2017 Table 3. Cost Difference Between WTI and the Wellhead for Five Canadian Crude Oils BC Peace River Heavy Oil Crude Type Kindersley Medium Viewfield Pembina Sour WTI $52.00 $52.00 $52.00 $52.00 $52.00 U.S. Transportation Cost ($US/bbl) -$3.38 -$4.39 -$3.38 -$3.38 -$3.38 Canadian Transportation Cost ($US/bbl) -$6.09 -$5.47 -$3.39 -$1.63 -$4.13 Quality Adjustment ($US/bbl) -$0.26 -$ $1.01 $0.61 -$1.08 Field Gate Price ($US/bbl) $42.27 $24.23 $44.23 $47.60 $43.41 Price Differential ($US/bbl) $9.73 $27.77 $7.78 $4.40 $8.59 Data from TransCanada. 2017, Enbridge, 2017, CAPP, 2017 and Bloomberg, Discovery Digest Volume 3, 2017

13 Table 4. Comparison of Calculated Field Gate Price to Operators' Realized Price Crude Type BC Peace River Heavy Oil Crude Type Kindersley Medium Viewfield Pembina Sour Company Kelt Baytex Raging River Spartan InPlay Oil Realized Oil Price ($US/bbl) Calculated Field Gate Price ($US/bbl) Difference ($US/bbl) Data from SEDAR Company Reports, 2017 Conclusions West Texas Intermediate is the benchmark price in North America that is used as the indicator for the health of the petroleum industry. However, the actual price received at the wellhead for a barrel of oil can vary widely depending on a number of factors. At a high level, crude quality and transportation costs can result in discounts in the range of $4.40 to $27.77 to the WTI price. Next time you read a news headline about Plummeting Oil Prices, or hear of people protesting pipeline expansion, remember the actual price Canadian producers are receiving. WTI Pricing 13

14 Selected References Alberta Government Accessed on March 31, Baytex Energy Accessed on March 31, CAPP Accessed March 31, CAPP Accessed March 31, Enbridge Accessed March 31, Energy Intelligence Accessed March 31, Gatlin, C Petroleum Engineering. Prentice Hall, page 2. GLJPC Accessed March 31, Petroleum UK Accessed March 31, TransCanada Accessed March 31, Discovery Digest Volume 3, 2017