Baker & O’Brien, Inc.’s 2023 Q4 PRISM™ update shows that Q4 2023 refining margins receded from the bounce seen in Q3. U.S. refining cash margins for the quarter remained healthy at $12.34/b on average, well above long-term levels but considerably below 2022’s historic peaks.

The Key Refining Margin Metric table below shows that U.S. cash margins declined alongside generally weakening indicators for refinery utilization, demand, crude pricing, product prices, and product cracks.

U.S. refinery utilization fell by 4.6% from Q3 2023. Total U.S. light product demand was down by 0.4% over the quarter, with increased diesel demand overshadowed by reduced jet and gasoline demand.

The year-on-year comparison shows a 2.6% drop in refinery utilization. While diesel demand fell 1.5% from 2022, gasoline demand increased 2.1%, and jet demand increased 4.9%, resulting in a slight 0.1% decrease in overall demand.

Product crack spreads fell sharply in PADD 2 and to a lesser extent in PADDs 1, 3, and 5. PADD 4 crack spreads widened. The light-heavy crude oil (WTI – WCS) price spread increased slightly during Q4 2023, benefiting U.S. Gulf Coast (USGC) coking refiners. However, the spread is considerably lower than in 2022.

Special Topic: How Will the Trans Mountain Expansion Impact Heavy Crude Oil Markets?

The Trans Mountain Expansion (TMX) pipeline project is expected to begin commercial operations in the second quarter of 2024. TMX will substantially increase the pipeline supply of Canadian heavy oil from the Albertan oil fields to the Canadian West Coast, expanding Canadian crude oil supply to North AmericanWest Coast refiners and opening up a new Pacific supply route to Asia. With no major increases in Canadian heavy production anticipated in the short term, TMX will result in Canadian heavy oil barrels being diverted from heavily loaded cross-border pipelines supplying the USGC for refinery processing or re-export loadings. In this special topic, we explore the potential reduction in heavy oil supplies to the USGC, the competitiveness of TMX for exports and the impact on the heavy crude pricing structure.

Currently, the existing Trans Mountain pipeline can deliver up to 300 thousand barrels per day (Mb/d) of heavy crude oil from Edmonton, Alberta, to the Westridge Marine Terminal (WMT) in Burnaby, British Colombia, as shown by the black line in Figure 1 below. Most of this oil reaches refineries in Vancouver and the Pacific Northwest area via pipeline. About 40 Mb/d is loaded at the WMT for waterborne delivery to southern U.S. West Coast (USWC) refiners.

The new 590 Mb/d TMX pipeline (the blue line in Figure 1) almost triples the Trans Mountain pipeline system capacity to 890 Mb/d and includes port upgrades at WMT. Available Canadian Energy Regulatory information indicates that around 450 Mb/d (75%) of the additional TMX capacity is already contracted on a take-or-pay basis. This includes 100 Mb/d of mostly light, sweet crude oil dedicated to terminals serving refineries in Vancouver and the Pacific Northwest. The remainder of the contracted volume is expected to be for heavy crude oil loading and waterborne delivery to southern USWC and Asia refiners following the completion of the WMT port upgrades. Western Canadian heavy crude oil has a poorer quality than the heavy crude oils currently processed by Californian USWC refiners from Central and South America. Our PRISM analysis shows that its poorer quality limits how much waterborne Canadian crude oil can replace heavy crude supplies at these refineries to 200 Mb/d. This leaves 150 Mb/d of committed take-or-pay barrels moving to Asia. In comparison, 215 Mb/d of Canadian heavy crude oil was re-exported from the USGC in 2023, with almost 140 Mb/d of it being delivered to Chinese ports through waterborne trade flows.[1]

Extended delays and substantial cost overruns have undermined TMX’s economics as a competing Western Canada supply route to China. Projected tolls have doubled compared to original estimates. Existing Trans Mountain pipeline tolls from Edmonton to WMT are approximately $3/b. The Canadian Energy Regulatory data indicate that TMX tolls will range from US$7.81/b to US$10.10/b, depending on the level of commitment and volumes. This compares to pipeline tolls of US$10.10/b to US$11.50/b for the USGC delivery via the Enbridge pipeline systems. Thus, TMX’s current toll advantages relative to pipeline delivery to the USGC are US$1.40/b for uncommitted volumes and US$0.80/b–US$2.20/b for committed volumes. However, higher shipping costs offset TMX’s tariff advantages because WMT’s port can only accommodate Aframax tankers, which are less than one-third of the size of Very Large Crude Carriers (VLCCs) required for an economic delivery to Asia. It is envisaged that multiple TMX-loaded Aframax cargos will be combined onto VLCCs using ship-to-ship (STS) transfer operations in offshore Panama for delivery to Asia. Environmental concerns may restrict conducting STS operations in offshore Canadian or U.S. waters. Shipping costs to deliver crude oil to China from WMT via offshore Panama were US$3.50/b higher than direct VLCC shipments from the USGC in 2023.[2]

Figure 2 summarizes the combined pipeline tariffs, as well as the shipping, and loading costs for Canadian heavy oil exports to China from the USGC and Westridge. It shows that overall, the USGC route to China has a $1.25/b to $2.65/b cost advantage versus the TMX 15-year (<75 Mb/d) tariff. This advantage is reduced by $1/b to $1.40/b for TMX-committed shippers with lower incentive tolls.

What does this mean for heavy oil flows and pricing? Once TMX begins operations, around 200 Mb/d of Canadian heavy crude oil will likely be diverted from the USGC to North American West Coast refineries. After supply chains re-balance, a similar volume of Central and South American heavy oil grades will likely flow east to the USGC. The net availability of heavy crude barrels will not change, so USGC heavy crude discounts to West Texas Intermediate (WTI) crude oil should not be impacted.

While TMX will not open a more cost-effective trade route to Asia, we expect it to still spur increased Canadian heavy oil exports. Costly take-or-pay economics will likely drive committed TMX shippers to use the new pipeline for exports. In addition, TMX unloads cross-border pipelines to the USGC, facilitating increased re-exports to global markets.

By alleviating pipelines to the USGC and expanding the global market for western Canadian crude oil, TMX will put upward pressure on its price in Hardisty, Alberta, narrowing the Western Canadian Select (WCS) Hardisty/Houston Differential. However, the associated pricing mechanisms for this are relatively complex. After the TMX start-up, we expect any resulting structural price increase at Hardisty to remain heavily dependent on pipeline tariffs. Competition from Central and South American heavy crude oil in USWC markets will ultimately cap price increases to modest amounts (around $1.5/b).

For further short- and long-term insights and analysis of Canadian crude oil pricing mechanisms resulting from the TMX start-up, look for upcoming articles or contact Ed Scardaville directly.

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[1] Waterborne flow data provided by Kpler.

[2] Shipping Cost assessment provided by Argus