Global Investing Hot Spots

Canada pushes Trans Mountain pipeline to sell oil to China far beyond US shores

Key Points
  • The Canadian government has opted to buy a pipeline project that will more than double the oil its energy industry can send to the West Coast — and then on to new markets in Asia.
  • The purchase comes, coincidentally, during the thick of a bitter trade dispute with the U.S., the only customer for its crude oil.
  • By building the Trans Mountain expansion, Canada will be able to sell oil outside North America, bringing in higher prices for its oil.
  • The move should be be good for Canadian producers and the government, which will collect more tax dollars from the crude.
Demonstrators use a mock oil pipeline to block the entrance to the Canadian Embassy in central London on April 18, 2018, as they protest against the Trans Mountain oil pipeline from Alberta's oil sands to the Pacific Ocean.
Tolga Akmen | AFP | Getty Images

As it battles over trade with its big southern neighbor, Canada is looking westward for new markets for its oil.

In the thick of a bitter trade dispute with the United States, the only customer for its crude oil, the Canadian government has opted to buy a pipeline project that will more than double the oil it can send to the West Coast — and then on to new markets in Asia.

While the pipeline project has been moving on its own timeline, the purchase coincidentally comes during one of the thorniest periods in U.S.-Canadian trade relations. Analysts say ironically that should in fact help Canadian Prime Minister Justin Trudeau find some support for the controversial project, which has pit the province of British Columbia against Alberta and has prompted protests across the country.

The construction is slated to begin this summer, but it is opposed by the British Columbia government, local governments, environmental interests and even groups in Washington state. Canada has long sought a pipeline solution, both to the east and west coast, and has so far failed. There is a lot to gain from moving its oil resources outside of North America, including much higher prices and access to the world's fastest growing market.

Trudeau's government late last month announced it would buy Trans Mountain pipeline, its British Columbia terminal and expansion project for about $3.5 billion, after owner Kinder Morgan Canada found the project too risky. Trudeau has said he wants to make sure the pipeline expansion gets built and then sold to a new operator so Canada can send oil on to new customers in Asia.

"We are going to ensure that it gets built so that we can get our resources to new markets," Trudeau told Bloomberg News.

If [the pipeline] doesn't get pushed through, it changes the trajectory of what the Canadian energy industry looks like.
Michael Tran
energy analyst at RBC

The Canadian government has long said it wants a way to expand its export horizons. The current 715-mile pipeline carries oil to markets on the U.S. West Coast, and the expansion along 610 miles would also provide more oil to the United States, in addition to Asian customers, like China. The pipeline runs from Alberta to Burnaby, a port city in Vancouver suburbs.

"Canada is the fifth largest in production and third-largest oil exporter in the world, after Saudi Arabia and Russia," said Jackie Forrest, vice president of energy research at Arc Financial Group. She said Canada produces 4.6 million barrels a day and exports 3.8 million barrels a day to the United States. "When we get to be the third-largest exporter, it makes sense to have more than one customer."

By selling oil into Asia, Canada would immediately benefit from a higher international price and free some of the currently landlocked crude that is also shipped by expensive rail freight to the United States. There have been small intermittent purchases by Asian buyers in the past, but nothing consistent, and the United States is viewed as the current sole customer for Canadian crude.

Forrest said with the government's purchase, odds have increased for the pipeline's construction, which would place a second line parallel to an existing one. The enlarged Trans Mountain would be able to transport 890,000 barrels a day, up from 300,000, at a cost of $7.4 billion.

"I think this greatly increases the chances. It's not for sure, but it's likely the pipeline gets built. Now with the patient capital of the federal government, I do expect that with them making this type of capital investment, it will eventually get constructed," she said. "The plan is, construction will start this summer regardless. It seems the government is willing to take that risk and start that construction without all of these challenges not being resolved. The former owner didn't want to start construction with some of these challenges out there."

Being owned by the Canadian government should also give the pipeline more sway with the courts. "As a crown corporation, it would have a better standing in these challenges," she said.

Canada is producing high levels of heavy tar sands oil, and without easy transport, the oil production has turned out to be a glut of crude that sells for about $15 a barrel less than West Texas Intermediate crude in the United States.

"You could argue the timing was intentional, but this was going on well before Nafta [renegotiations]," said Dana Peterson, U.S. and Canada economist at Citigroup. "The Canadian government needs another venue for evacuating oil, and that's westward. They need another buyer, and that's Asia."

Canada's pipeline expansion

The United States has been sparring with Canada over lumber and dairy products, but the tariff war got a lot bigger when the United States last week slapped tariffs on Canadian and Mexican steel and aluminum. That prompted retaliatory tariffs and has made negotiations toward a revamped North American Free Trade Agreement even trickier.

Oil, and energy in general, has stayed out of the fray between the United States, Canada and Mexico, who are reliant in many ways on each other's output.

The changing role of the U.S. oil industry has provided an even bigger catalyst for Canada to diversify its customer base. The United States produced a record 10.8 million barrels a day last week and exported about 1.7 million barrels.

"This move by the Canadian government to build the pipeline sets up a future U.S.-Canadian rivalry for Asian market share," said John Kilduff, partner with Again Capital. "There's been a lot of pushback on this from a lot of groups. It's smart to merely expand the existing footprint."

The pipeline expansion would change the game for Canada's industry, even though it's not a huge amount of oil.

"This could be as transformative as the Dakota Access Pipeline has been for the U.S.," said Kilduff, noting that the pipeline freed barrels from the landlocked Bakken in North Dakota.

Canada also will be helped by the Keystone pipeline, controversial in the United States but finally expected to be built to take Canadian crude through North Dakota and then south to meet an existing pipeline to the U.S. Gulf Coast.

As U.S. production grows, the need to import oil has shrunk. China has surpassed the United States as the biggest energy importer, at more than 8.4 million barrels a day. U.S. oil imports, in weekly government data from last week, amounted to 8.3 million barrels a day, up from 7.6 million barrels a week earlier, but those figures vary and have been declining.

"If [the pipeline] doesn't get pushed through, it changes the trajectory of what the Canadian energy industry looks like. We talk about how Canada is handicapped by only having one buyer, just sending crude to the U.S. They're affected by differentials that are very wide," said Michael Tran, energy analyst at RBC. He said at the start of this week, the differential between West Canada Select crude resulted in a price about $13 less than WTI.

Sparking an oil boom

The pipeline, which could take a couple of years to complete, should be a boon for Alberta's oil producers. "Today, heavy oil producers are realizing, if you look at the first quarter, they're getting $10 a barrel less than they should. If all that goes to cash flow, it should help the companies and the value of the companies as well," Forrest said. The Canadian government would also receive more royalties and tax revenue.

"In a world without pipelines pointing west and moving Canadian oil to places like Asia, they're held captive to one buyer: the U.S. gulf coast. When you look at where demand growth is coming from, it's all about Asia. It's all about China," said Tran.

"The Canadian energy industry has become a victim of its own success. Canadian production over the past number of years has become extremely prolific. Unfortunately Canada has become hamstrung with a limited amount of takeaway capacity," said Tran.

Trudeau has been criticized by environmentalists who don't believe the government should be in the oil business. "Access to new markets across Asia will make us better able to develop responsibly our resources, better able to invest in the kinds of renewables and protections we need," the prime minister told Bloomberg.

Canada has diverged from the United States in other trade matters, as it remained part of the Trans Pacific Partnership, a pact that includes nations around the Pacific rim, while the United States pulled out.

"I think access to new markets is important to industry and the government. The prices to Asia, minus the transportation costs, means every barrel that goes to Asia would get a higher price than it would in North America. Because of the discount for WTI (West Texas Intermediate), selling it to North America is not nearly as profitable as selling into Asia," Forrest said.

West Texas Intermediate, trading in the futures market Thursday, was at about $65 per barrel, more than $10 less than Brent crude futures, the international benchmark that reflects the price on the world market.

"If the pipeline gets built, Canada is finally getting a seat at the table. People talk about Canada being an energy superpower, but they've never had a seat at the table at what is now the world's fastest-growing demand center," Tran said.

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