Dentons Canada LLP Crude by Rail: Current Considerations Cameron Hughes Presentation to the IECA June 11, 2013 Banff, Alberta
Outline Why has rail become so important to Canadian oil? Recent changes in the business of transporting crude by rail. How does the law impact the risk assessment of transporting crude by rail? Recent legislative change Rail transport contractual arrangements Current Government direction Environmental / Liability 2
Oil Prices and Price Disparity 3
Crude Supply Canada cranks up oil output, Calgary Herald, March 14, 2013 Canadian oil production has increased rapidly over the last several months, reaching an all-time high of 4.1 mbpd in December. Alberta light and medium output also rose to 440,000 bpd, its highest level in a decade, on the back on new light tight oil developments in Cardium and Viking in Alberta, along with other plays in Saskatchewan and Manitoba. America Strikes Oil, National Geographic Magazine, March 2013 Since early 2006, production from what's known as the Bakken formation has increased nearly 150-fold, to more than 660,000 barrels a day, moving North Dakota into second place among domestic suppliers, behind Texas and Alaska.
Crude Transportation Costs From Hardisty Terminal - To West Coast: $3 per barrel to move oil by pipeline $8 to $14 per barrel by rail service $5 to $11 difference To Gulf Coast: $7 to $11 per barrel by pipeline $14 to $21 per barrel by rail $3 to $14 difference Price differential exceeds difference in transportation costs; viable long term option Source: Gibson Energy Inc., Crude by Rail Forum, Toronto, Oct. 2012
Pipelines Northern Gateway Enbridge twin pipeline from Bruderheim, AB to Kitimat, BC approx. 1200 km long proposed in mid 2000 s ongoing public and government review process; Joint Review Panel led by the NEB and the Canadian Environmental Assessment Agency decision by end 2013; construction mid 2014; commissioning mid 2017 Source: Canadian Press 6
Pipelines Keystone XL TransCanada Corporation proposed Keystone XL in 2008 Proposed Phase III and IV will consist of 1,661 miles Capacity to deliver 590,000 bpd of Canadian crude into mid-west refining market Source: Wikipedia
Solution Transport Crude by Rail 8
Growth in Crude by Rail Shipments North America wide, BNSF Railway, CP, CN, CSX Corp. and Union Pacific have been shipping over 400,000 barrels per day This is over 4% of North American production, and growing at a rapid rate Saskatchewan shipped 12% of its production by rail CN expects its shipments to reach 110,000 barrels per day this year, and believes crude will reach 7 to 8 per cent of total corporate revenues in the next few years Nathan Vanderklippe and Guy Dixon, As pipelines struggle, producers move oil by rail, The Globe and Mail, May 23, 2013. Canadian Pacific shipped 53,000 carloads in 2012 and expects to triple that volume in the long term. Yadullah Hussain, Crude-via-rail: Not a fleeting business, Financial Post, February 28, 2013 9
Oil Exports by Transportation System Thousands of Cubic Metres (10³m³) 140,000 120,000 100,000 80,000 60,000 40,000 20,000 0 Canadian Crude Oil Exports By Export Transportation System Summary 5 year trend Pipe Marine Rail Truck Export Transportation System 2008 2009 2010 2011 2012 0.480529249 Highlight on Canadian Crude Oil Exports by Rail 2012 0.064021867 0.02559196 PADD I PADD 2 0.425183531 PADD 3 PADD 4 PADD 5 2012 Canadian Crude Oil Exports by Rail 2,654,711 m³ PADD 1 Petroleum Administration for Defense District (U.S.A.) PADD 2 East Coast PADD 3 Midwest PADD 4 Rocky Mountain PADD 5 West Coast Source: National Energy Board
Rail Line Networks Source for both images: Financial Post 11
Rail Line Networks Source: Dr. Jean-Paul Rodrigue, Dept. of Global Studies and Geography, Hofstra University, New York, USA
Current Trends in Transporting Crude by Rail It [rail transport] gives us increased flexibility and opens up a lot of options about where to send oil when there are regional pricing and supply differences. We can ship to both the west and east coast of Canada and U.S. locations as far as the Gulf Coast Ken Hall, V.P. Investor Relations and Communication, Gibson Energy Inc. Crude by rail is operational and growing. The delays in pipelines and the huge price gaps between oil inland and coastal prices is creating significant demand. Rail shipments will increase by about 600,000 barrels a day over the next four years even if all planned pipeline projects proceed. ITG Group, electronic trading brokerage based in New York 13
Current Trends in Transporting Crude by Rail Recent Stock prices of Canadian Pacific and Canadian National Railway Company and Net Earnings of BNSF Railway 2012 - $3,372 2011 - $2,972 2010 - $2,459 - Warren Buffet, 2011 and 2012 Letter to Shareholders, (in millions) The burgeoning crude business was one of the key drivers behind the company s ability to deliver CP s best first-quarter results in its 132-year history Times Colonist 14
Crude by Rail: Short and Long Term Although the rail financial arbitrage will likely dissipate, we believe there is a permanent role for rail in the North American transportation mix. The advantage that many producers have observed is having more flexibility to reach different markets and that is a key offering for rail versus pipelines. - Andrew Potter, Managing Director, Institutional Equity Research, CIBC World Markets Inc., quoted in the Financial Post, March 25, 2013
Legal Considerations 16
Legal Considerations: Transportation Contracts contracts directly with railway / carrier contracts with company that has procured rail capacity contracts governed by and subject to Canada Transportation Act, S.C. 1996, c. 10 and (for U.S.), 49 U.S.C. 10709: (a) One or more rail carriers providing transportation subject to the jurisdiction of the [Surface Transportation] Board under this part may enter into a contract with one or more purchasers of rail services to provide specified services under specified rates and conditions. (b) A party to a contract entered into under this section shall have no duty in connection with services provided under such contract other than those duties specified by the terms of the contract. Canada Transportation Act prescribes levels of service which must be provided, including adequate accommodation for receiving, loading, carriage, unloading and delivery. Railway and shipper may by means of confidential agreement agree on and vary manner in which such obligations are fulfilled U.S. Interstate Commerce Act governs railway operations and tariffs
Contracting: Transportation Contracts - Railway - contracts subject to carrier s tariffs, rules and regulations, e.g.: CN Tariff 6800 Rules and Regulations for Rates and Acceptance of Intermodal Traffic CN Tariff 7403 Fuel Surcharge Tariff CN Tariff 9000 Optional Services Carload - Shippers are generally contract takers; railway side in fantastic bargaining position - Price increases; movement to take-or-pay style arrangements, should be avoidable - Plant Rationalization provisions waiver of default
Contracting: Transportation Contracts - Agents Altex Energy Ltd. and Global Partners LP Front-running companies that anticipated pipeline regulatory delays: Altex Energy created in 2005 and envisaged the PipelineOnRail TM system. Altex signed transportation contracts capturing long term rail rates with CN in 2008. Altex website: To understand the credit issue, a company that subscribes to a long-term commitment like pipeline capacity normally would have to include a note on their balance sheet to the effect that a take-or-pay commitment had been made to a pipeline for a certain volume, for a certain term, at a certain fixed cost. For example, a 15 year commitment of 50,000 BPD at a toll of $5/Bbl would involve a $1.37 Billion footnote on the balance sheet. This contractual commitment effectively prevents the company from using some of its credit for other purposes. A typical capital cost for developing a Steam Assisted Gravity Drainage ( SAGD ) project is in the range of $30,000 per BPD, implying that a 50,000 BPD facility would have a $1.5 B cost. The pipeline commitment could effectively double the company s credit requirement of developing SAGD production.
Contracting: Crude Purchase & Sale Arrangements No North American standard, especially for crude shipments by rail BP, Statoil General Terms and Conditions Enter LEAP: Leadership for Automated Processing Mission Statement: The mission of LEAP is to promote efficient and reliable transaction processing within the trading of crude oil and refined petroleum products by means of automation and standardization. LEAP has developed non-proprietary published terms and conditions for trading and delivering crude oil by tank railcar: LEAP Tank Truck and Tank Railcar Annex (April 2013): extends the scope of the LEAP Master Agreement to include purchases and sales by tank truck and tank railcars in North America Attaches to the LEAP Master Agreement for Purchasing and Selling Refined Petroleum Products and Crude Oil Version 2.1, which is also a free download from the website if you register LEAP has also developed a Canadian Addendum to the Master Agreement Thank-you to Karen Mikkelborg of Nexen Marketing
Contracting: Other Contractual Arrangements CP is not putting up much in the way of capital for this. They re not building loading terminals. They re not leasing railcars. That s up to Global Partners. Steven Paget, analyst at FirstEnergy Capital Corp., quoted in the National Post, March 25, 2013 - Rail Car Lease Agreements - Back Haul Arrangements - Land lease or acquisition - Terminalling Services - Transloading Services - Tank Storage - Terminal Construction Agreement - Crude Purchase & Sale - Regulatory requirements (customs, export permits); BUT, shipping crude by rail in itself needs no regulatory approval only terminals and tankers
Legal Considerations in Transporting Crude by Rail Recent Legislative Change Safer Railways Act largely came into force on May 1, 2013. This Act substantially amended the Railway Safety Act which governs Canadian rail operations safety response to a number of high-profile train derailments in 2005 and 2006, in AB, BC and Quebec Minister of Transport conducted a full review of the Railway Safety Act in 2007 in 2009, Government of Canada committed $72 million over 5 years to a safe, reliable transportation system 22
Legal Considerations in Transporting Crude by Rail Recent Legislative Change New S. 17.1(1) of the Railway Safety Act requires companies to obtain a railway operating certificate in order to do anything operational on rail lines within federal jurisdiction (which most if not all transporting crude would be) Railway operating certificates are approved by the Minister and may contain any terms and conditions that the Minister considers appropriate Key Provisions Safer Railways Act: 1. Require railways to obtain operating certificate 2. Strengthen Transport Canada s enforcement capacity 3. Increased focus on safety management systems 4. Trumping provision Act prevails; railways cannot contract out of these statutory requirements 23
Legal Considerations in Transporting Crude by Rail Senate Committee Standing Senate Committee on Energy, the Environment and Natural Resources is studying the state of the safety elements of bulk transport of hydrocarbon products in Canada. Trying to determine the relative safety of transport by pipeline and by rail and have been told by witnesses two things, either: We cannot determine the relative safety because there are too many factors; or Rail transport is safe, but less safe than pipelines Final report due June 30, 2013 24
Legal Considerations in Transporting Crude by Rail Dangerous Goods The Transportation of Dangerous Goods Act works under the polluter pays principle Emergency Response Assistance Plans are required by dangerous goods regulations that necessitate special expertise and response equipment For oil, an Emergency Response Assistance Plan is required only if the transport is done by a unit train of 17 or more inter-connected rail tanks cars filled to at least 70% capacity, carrying oil under certain UN classifications Proceedings of the Senate Standing Committee, Issue 40, Evidence, March 2013
Shipping Crude by Rail Environmental Spills more frequent with rail, but volumes spilled with pipelines are typically much greater Recent incidents: 5 cars in a CP Rail train left the tracks in Saskatchewan and spilled about 575 barrels of crude In April, a train derailed in Northern Ontario and spilled about 400 barrels of crude In March a CP derailment in Minnesota spilled more than 350 barrels Greenpeace has recently highlighted concerns by Canadian and U.S. regulators over the safety records of the tank cars primarily used to ship oil by rail. Calgary Herald, May 2013 Sixteen environmental groups signed a letter sent to CN CEO Claude Mongeau this week to express opposition to any plans to ship product from the Alberta oil sands west by rail. Canadian Press, January 31, 2013
Summary Production increases and pipeline capacity restrictions have helped to create a large price gap between North American inland crude and coastal prices Rail, even at a higher transport cost, has added value considering the large price gap The legal risk factors exist for rail; nothing prohibitive 27