Gartman Is Shocked By What Is Going On With Canadian Oil

Yesterday we remarked that while the pain for US energy traders has been palpable, it is nothing compared to the mass hysteria taking place in Canada, where the price of Western Canada Select oil has collapsed just above $15 as far too much local production remains landlocked, and in desperate search of any buyer.

Today, none other than "world renowned commodity guru" Dennis Gartman - who correctly picked the exact moment to advise his clients to "short this rally" and is still short even as Marko Kolanovic has been repeatedly urging JPM clients to triple down on the S&P where he saw nothing but smooth sailing  - picks up on this theme, and in his latest letter to clients expresses his shock at the collapse observed in local prices.

We excerpt from his latest letter below.

IF YOU THINK THAT WTI AND/OR BRENT CRUDES ARE CHEAP... then consider for a moment what is happening in Canada these days where Western Canada Select crude (WSC as it is always referred to) trades below $16/barrel or a stunning $43/barrel  “discount” to WTI! WCS is a “heavy” crude type with an API of about 20 while WTI is a “light” crude with an API “gravity” rating  near 40 and so by definition given the greater difficulty in refining WCS compared to WTI it has always sold at a discount to WTI. It had to; there had been little choice.

Historically... and in this instance we mean the past ten years... WCS has tended to trade on the order of $17- $22/barrel discount to WTI although it fell to nearly a $40/barrel discount back in ‘13 when a massive short covering rally in the crude futures sent prices of WTI and Brent futures soaring. Further, in ‘15 and on into the autumn of last year the discount narrowed toward $15/barrel and remains relatively steady there until early this year.

That narrower discount should have held, for the US refineries were refitting themselves to take on “heavier” crude types coming down from Canada and from the Bakken. Instead, they discount has grown steadily as Canadian bitumen production has increased in anticipation of pipelines being constructed to take that increased production south to the US and/or west to the Vancouver area for export. However, the First Nations groups in western Canada, aligned with the environmentalist groups that protest any and all use of fossil fuels, were able to suspend the pipelines heading west to Vancouver, while environmentalists, farmers and First Nations groups in Canada and the US were able to delay... now seemingly indefinitely... the construction of the Keystone XL pipeline. WCS crude is literally trapped at its production sites, with railroad tankers over-the-road trucks being used to carry WCS southward to the US. Oh, and the environmentalists/farmers/First Nations are opposed to the use of railroads and trucks too for safety and environmental reasons also.

The single judge’s decision last week to delay any further work on the Keystone XL pipeline... construction that had been approved by the Trump Administration... has only served to send WCS to a further, deeper and perhaps semi-permanent, historic discount to WTI. Trucks capable of carrying crude oil are in uncommonly and increasingly short supply thus widening WCS’ discount to WTI, and so too are tanker rail cars. Truck drivers too are in short supply while trains are now being used to take grains from the grain production areas that so dominate the middle of the North American continent to the export facilities on the West Coast, the Gulf of Mexico and even from some of the export facilities here on the East Coast, thus making rail movement of crude more and more expensive and sending WCS’ discount to these historic lows.

WCS is not alone in suffering. Crude produced in the fecund Permian Basin now sells at a wide and widening discount to WTI crude futures for it too suffers from a shortage of pipelines, rail and truck facilities. Last year and earlier this, crude coming out of the Permian Basin tended to sell at $7-$10/barrel discount to nearby WTI futures; that has widened to $20/barrel presently, reflecting higher transmission and/or transportation costs of getting that crude out of the Basin and moving it on the Houston/Galveston/Port Arthur where it can be loaded aboard ships and moved into export trade. Indeed, bids for crude oil at the Houston/Galveston/Port Arthur export facilities are now at large... and growing... premiums to WTI! Crude is needed there and so “Houston” crude is backwardated to WTI futures and those who have fortunately been “Long of Houston/short of Midland” crude in the spot market has made enormous profits; those who’ve been on the other side of trade have lost billions.

This then brings us to the harsh financial realities of Canada and its oil industry for as the spread between WCS crude and WTI futures widens to these historically wide... and we hope eventually remediable... discounts, Canada is losing perhaps $100 million dollars/day in revenues! This has to stop of course, but the decision by lone U.S. district court Judge Brian Morris ... an Obama appointment of course... to deny any further construction on the Keystone XL pipeline has served to suspend further building until at least mid-year next year and thus extended completion of the pipeline until mid-‘20 at the earliest [Ed. Note: Judge Morris might have been appointed by President Obama but from what we have read he is hardly a left-of-center ideologue for he was a celebrated football player for Stanford where he graduated from and then went to law school. He clerked for US Supreme Court Justice Rehnquist, who was hardly a leftist and served for years on the Montana Supreme Court before being raised to the Federal district court there in Montana, writing some of the courts more conservative decisions.].

Who are the winners here... indeed if there are any winners? Perhaps it is Kinder Morgan and TransCanada who both had thrown in the proverbial towels last year on their projects in question that would have carried crude out of Alberta with the former’s to have carried WCS westward to the export facilities in and around Vancouver and with the latter having canceled its proposed pipelines eastward out of Alberta [Ed. Note: In the case of the former Kinder Morgan facility, it was rather famously bought by the Trudeau government forC$4.5 billion, putting that government in opposition to itself! We are left to wonder when Ottawa will actually be forced into selling its participation back to Kinder Morgan... or to some other oil industry company... for half or less than what it paid initially?]. Kinder Morgan and TransCanada... the latter for whom we’ve had the distinct honor and privilege of speaking for several times in the past decade!... knew, apparently, that as in any bad trade the first loss is the cheapest.

In the long run, we have to believe that wiser, better, cooler minds will prevail; that Judge Morris’ decision on the Keystone XL pipeline will be overturned by a higher court; that the eco-radical/First Nation alliances will prove ill-advised and that the pipelines in question will be built and that WCS will return to a far more normal $17-$12/barrel discount to WTI. Indeed, at some point in the long distant future WCS may actually trade to a premium to WTI. But certainly for the next few months and perhaps for the next few years the discount is likely to remain at $25/barrel or more discount. Once again, the facts are the facts.