Open heart surgery on the aorta artery of Canada’s pipeline system.
Nicholas Lupick, CFA 403-539-8592
On September 27, the Canadian Energy Regulator (CER) announced that the ongoing Enbridge (ENB-T; Not Rated) (the “Operator”) Mainline Open Season would be halted due to the "perception of abuse of Enbridge's market power." Had the process remained on schedule, unconditional binding bids would have been due on October 2, 2019, with the proposed changes to the tolling framework taking effect on July 1, 2021—coinciding with the expiry of the Competitive Tolling System (CTS) presently in place. In the notice, the regulator stated that “Enbridge may not offer firm service to prospective shippers on the Mainline until such firm service, including all associated tolls and terms and conditions of service, has been approved.”
Athough some support the notion of providing predictable egress out of the basin (via firm contracted carriage), the overwhelming majority of Western Canadian Sedimentary Basin (WCSB) producers who submitted letters to the Canadian Energy Regulator oppose the change.
How Do the Logistics Work Today?
The Mainline system currently operates on a spot/non-committed basis (known as common carriage) through a nomination process. Shippers submit their request to utilize the system for the following month with their expected shipping volumes. Due to excess demand on the system, compared to the available capacity, shippers have to compete monthly for as much capacity as they can get through the CTS system. Since the start of 2019, this over-nomination has resulted in shippers being ‘cut-back’ (apportioned) by an average of 40% on their requested shipments.
What is being Proposed?
On August 2, the Operator commenced an Open Season to solicit unconditional binding commitments from shippers to change the Mainline system from a common carriage, monthly spot, nomination framework, to a framework that would see 90% of the capacity locked into long term firm capacity commitments (contract carriage), leaving 10% open for monthly spot (common carriage) nominations.
Why All of the Backlash?
While the prospect of clarity in regards to one’s ability to reliably transport volumes out of the basin (via firm capacity) is enticing, the backlash against the proposal has been prolific—with the primary complaints being 1) an accusation of abuse of power by the Operator and 2) the unintended consequences that would come from its implementation in an operating environment, which is short pipeline capacity. Herein we focus on the latter, leaving the determination of the Operator’s rights to the CER.
The Punch Line
Ultimately, we agree that the unintended consequences on Western Canadian crude markets are underappreciated and could be dire, assuming that current market conditions continue for the foreseeable future. Although the number of physical barrels entering the Mainline system will remain unchanged following the proposed framework, for those producers who do not have firm capacity, a significantly larger proportion of their physical barrels would now need to be sold at distressed prices to shippers who do have space (typically downstream refiners who purchase crude in Edmonton)—leaving these companies in an untenable situation. Additionally, we must also highlight that one of the factors that severely increases the risk of distressed crude markets in Western Canada under the proposed framework is the inherent flaws with the Mainline nomination process. This, combined with our lack of confidence that the nomination process will be corrected, is critical to our claim that the conversion of 90% of the Mainline system to firm contracted capacity has the potential to have a material negative impact on Canadian crude markets so long as the WCSB is short pipeline capacity.
© 2019 AltaCorp Capital Inc. All Rights Reserved. AltaCorp is a member of IIROC and CIPF (Canada) and FINRA and SIPC (USA)