Canada’s oil and gas industry is again facing the possibility of tariffs on its energy exports to the United States.
Canada produces more than five million barrels of oil a day, and exports more than 80 per cent of it to the U.S., so tariffs would have an enormous impact.
The leaders of Canada’s major oil producers and refiners have expressed uncertainty about what is to come.
“I don’t know that anyone on the planet knows exactly what’s going to happen on tariffs,” Suncor CEO Rich Kruger said on a recent earnings call.
But what does seem certain is that tariffs would make Canadian oil more attractive to non-American purchasers by pushing down the price of Canadian oil.
The most interesting alternate purchaser could be eastern Canadian refineries. But the absence of pipeline infrastructure means incremental oil volumes would need to move by rail — a method that is costlier and more dangerous than pipelines.
‘The main driver’
The cost disadvantage of moving oil by rail is clear.
A 2019 analysis by the Canada Energy Regulator found the typical cost of moving a barrel of oil by pipeline is US$5-10. For rail, it is US$15-22.
Rail is therefore used when pipeline capacity is limited, or oil is cheap enough relative to other sources to justify the higher transport cost.
This was the case during much of the last decade. At many points during 2010 to 2019, the Canadian benchmark oil (known as Western Canadian Select) traded far below American benchmark oil (known as West Texas Intermediate).
Mark Sherman, a former COO of New Brunswick-based Irving Oil, pointed to several reasons eastern refiners purchased rail-delivered Canadian oil at the time, including price, logistical capabilities and product specifications.
“Differential [in the WCS and WTI prices] was the main driver on whether it was attractive to move crude that far, given the increased price for rail versus pipelines,” he said.
“[G]iven the additional transportation cost of somewhere between $15-17 or $18 per barrel … rail becomes attractive at a differential of between US$18-22,” said Sherman, who is also a former vice president at Alberta-based oilsands producer Syncrude Canada Ltd.
Jackie Forrest, executive director of ARC Energy Research Institute, has a similar take.
“You really need to have differentials in Western Canada that are in the range of US$20 lower than WTI to start to see a lot of economics for rail,” she said.
Today, the price difference between WCS and WTI is around US$12 a barrel.
“Rail can work,” Forrest said.
“We do have infrastructure … but the issue is it’s expensive. The arbitrage has to be wide enough. If we are talking about 10 per cent tariffs, I don’t think the economics are going to work. If we were talking about 25 per cent tariffs, maybe that would be an option.”
Covering the cost
Sherman identifies refineries in Ontario, Quebec and New Brunswick that have existing rail facilities as logical customers for western oil. These refineries could accept a combined 300,000 barrels a day.
But he is also hesitant to make predictions. “It’s a big unknown,” he said, when asked about the potential impact of U.S. tariffs.
“You can tariff an imported crude to a point where it starts to make sense that you don’t import it anymore,” he said, referring to U.S. purchasers of Canadian oil. “And [the U.S. could] stop exporting some of [its] crudes that attract a WTI price.”
The absence of a domestic Canadian pipeline to the east is another major factor in the equation, Sherman said.
“[T]his is the backdrop that this is all against and the reason crude-by-rail is even partially attractive.”
Pipelines
At present, there is no direct pipeline from western to eastern Canada. West to east pipelines pass through the United States.
In 2017, TransCanada Corporation (now TC Energy Corporation) abandoned plans to build the Energy East pipeline. The pipeline would have carried 1.1 million barrels a day from Alberta to Quebec and New Brunswick refineries, as well as to a marine export terminal on the Bay of Fundy. The company cited regulatory uncertainty, delays and the associated cost increases as prohibitive to proceeding.
Many are now calling for such a pipeline to be reconsidered. But so far, no company has expressed an interest in doing so. Such a pipeline would also take years to construct.
This makes rail the readily available option to respond to changes in market dynamics such as tariffs.
Many Canadian railways run through or near population centres which have become increasingly concerned with potentially hazardous goods passing through their communities.
The 2013 Lac Mégantic disaster — which killed 47 people after 63 cars derailed in the community — highlights these concerns. Since then, regulators have boosted safety standards for cars and rail operations.
But Sherman says safety concerns would still be a possible hurdle to moving oil by rail.
“Before anything gets ramped up, people will intuitively circle back to try to understand what has happened with many of the safety incident recommendations, guideline changes, laws … it all has to be considered.”
Sherman believes oil could be moved safely. “But [there] are legitimate questions that those who might be opposed to crude-by-rail are going to ask and should be answered.”
For now, everything hinges on how matters develop with the United States.
“Without having any clarity on what’s going to happen, there’s no way we can speculate on how we deal with it,” Lane Riggs, CEO of refining giant Valero, said on an investor call.
“We’re just going to have to deal with it when it comes up.”
Asked by investment analysts whether he could recall examples of similar scenarios, Riggs said, “No. And I’ve been around a long time.”
