| | | CG - Energy -- Oil Sands & Heavy Oil
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WE REITERATE OUR VIEW THAT XL DOES NOT MATTER
The U.S. Department of State released around market close on 1/31/14 the Final Supplemental Environmental Impact Statement (FSEIS) for TransCanada’s (TRP : TSX : $48.42 | BUY; covered by Juan Plessis) proposed Keystone XL PipelineProject.
Like the Draft report issued early last year, the FSEIS concludes that the pipeline would not have a significant
environmental impact and that the project would be preferable to the alternatives. Additionally, it notes that neither approval nor denial of the proposed project would likely have a substantial impact on the rate of development in the oil sands, or on the amount of heavy crude oil refined in the Gulf Coast area. This is because according to the report, the oil sands will still be developed and still find its way to markets either by XL or via alternative methods, including rail. This is in line with our thesis laid out in our 9/9/13 report “The Sandbox: Hey Barry, Keystone XL Does Not Matter” (LINK). Therefore, the worst case scenario (i.e. No XL) is neutral to the oil sands/heavy oil space in our view.
Timing of a decision is still questionable: The release of the FSEIS now starts the clock ticking on the 90-day national interest determination period (Figure 1) followed up with a review by the Secretary of State and a determination of whether the project is in the national interest. To that end, a Presidential Permit decision could come as early as the middle of the second quarter of this year; and based on an 18- to 24-month construction period, the pipeline could therefore be operational as early as H1/16. However, there is the potential for the decision-making process to be protracted as discussed later in this note thus further pushing out XL’s operational start-up date.
While approval of XL is still not a slam dunk as it remains very political, we see it as a positive that the Final report reiterated the Draft report’s conclusion and had the same tone. We also find it positive that the Final report sees even greater near-term rail growth than what we forecast. Specifically, the Department expects there to be roughly 900 MBbl/d – 1 MMBbl/d of heavy oil rail capacity by the end of this year vs. our ~850MBbl/d unrisked estimate. Of note, the report does note that rail and other alternatives would yield greater GHG emissions, which makes a case for approving XL.
As a firm, we remain bullish on heavy oil and continue to see it advantaged to light oil: As highlighted in our 1/7/14 North American Energy 2014 Top Picks/Ideas report (LINK): 1) light oil and condensate growth in the U.S. continue to rapidly overtake imports of light oil and refining capacity (although there is still about 1 MMBbl/d of combined imports on the Eastern Coasts of Canada and the U.S. left to be displaced); 2) At the same time, dramatic structural improvements in both demand and transportation capacity for heavy oil are happening today. As shown in our heavy oil supply/demand forecast graph in Figure 2, planned rail plus pipeline expansions EXCLUDING Keystone XL on a risked basis surpass our Best Case supply growth scenario; 3) We believe that any heavy oil barrel that makes its way to the U.S. Gulf Coast (USGC) via the Flanagan South Pipeline (starts up mid-‘14) and rail should see an uptick in value vs. those sold in PADD II given that the ~3.1 MMBbl/d of USGC heavy oil capacity is about 1 MMBbl/d short on heavy oil supply due to the past declines seen in Mexican and Venezuelan production. As such, this demand is being supplemented with medium imports that we expect to be easily displaced. We also believe that Maya crude could start to go to Asia where it has recently traded at an US$8-US$10/Bbl premium to Maya in the USGC. Therefore, we expect the value of WCS in the USGC to be linked to global Maya; 4) The weak C$ provides cash flow torque; and 5) We believe rail regulations can be more punitive to Bakken light than Canadian heavy.
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