The Trans Mountain (TMX) Pipeline Project is nearing the final stages of construction, with commercial service expected May 1, 2024. S&P Global Ratings expects Western Canadian Select crude oil volumes transported to the West Coast of Canada will increase, mostly bound for Asian markets, resulting in a decline in volumes to the U.S. Gulf Coast. In this Credit FAQ, we consider how changing crude oil flows will affect price differentials and refining margins for the U.S. refining sector. While we forecast a narrowing WTI-WCS discount will be a headwind for certain refiners, we expect refining margins will continue supporting credit quality.
Frequently Asked Questions
What is the TMX pipeline expansion project?
Trans Mountain Corp. operates Canada's only crude oil pipeline system transporting crude to the West Coast. With approximately 300,000 barrels of existing throughput capacity, the expansion project will almost double existing throughput, increasing nominal capacity by approximately 590,000 barrels per day (bbls/d) to a total of 890,000 bbls/d. The approximate C$34 billion expansion project has been plagued by years of delays and cost overruns.
The majority of crude oil produced in Western Canada goes through one market, the U.S. The Midwest is the initial market, which then diverts oil to other regions, including the U.S. Gulf Coast where the majority of the nation's complex heavy crude refineries are located.
What will happen to the WTI-WCS discount?
Western Canadian Select (WCS) is a heavy sour crude. For much of the last decade, Canadian crude has been selling into the U.S. at a discount to WTI (chart 1). Increasing heavy oil production from the Western Canadian Sedimentary basin along with insufficient pipeline takeaway capacity resulted in the discount averaging approximately $18/bbl and reached a maximum of over $28/bbl in 2023. This discount has been wider than other heavy crudes such as Maya (a heavy sour crude oil produced in Mexico), which reached a maximum discount of approximately $15/bbl but averaged approximately $9/bbl over the same time period.
Chart 1
Most of the new capacity coming online via TMX will be allocated for heavy crude, giving Western Canadian producers optionality in sending barrels to the U.S. West Coast and Asia, or to the U.S. Midwest and Gulf Coast. As a result, producers will send their barrels of crude to the markets commanding the highest price. We believe this increased optionality will improve demand for WCS and narrow the WTI-WCS discount. That said, if crude oil production in Western Canada continues to rise such that Canada exhausts the incremental pipeline capacity and infrastructure bottlenecks arise, the discount could widen again.
The government of Alberta forecasts its production to increase from approximately 3.4 million bbls/d to over 3.5 million bbls/d in 2025. We believe this could narrow the WCS-WTI differential to the $12-$15 range, similar to the existing tariff to get WCS to the Gulf Coast and similar to the proposed tariff for the TMX expansion.
Chart 2
What will happen to refining margins?
We expect 2024 refining margins will remain above mid-cycle levels but slightly below 2023 levels. Refining margins in 2023 were below 2022 record levels and the approximate $18/bbl discount for WCS helped certain refiners maintain strong margins in 2023. Only certain refineries are configured to process heavy oil because it requires additional, more expensive processing to produce high-value products. Complex refiners are able to process heavy crudes as their feedstock. Having access to lower-cost crude at a meaningful discount often results in stronger realized margins.
We believe a narrowing of the WCS discount relative to WTI could be a headwind and reduce margins for complex refiners in 2024. However, WCS is typically priced by the export market in the U.S. Gulf Coast, which could benefit refineries in the region by maintaining a WCS discount relative to other grades of crude. That said, even if WCS becomes more expensive, TMX crude shipments to the U.S. West Coast will likely displace other crudes from Latin America, which will then compete on price with other imported crudes in the Gulf Coast. This will not only provide optionality to refineries in the region but also potential attractive discounts.
With 80% of new capacity committed, TMX could run at less than full capacity if pricing on the Gulf Coast is higher, given the numerous heavy crude refineries located there. That said, we believe the added capacity on TMX will incentivize upstream producers in the basin to increase production and take advantage of the additional egress.
Certain companies have made significant 15- and 20-year commitments that add up to roughly 80% of capacity. A subsidiary of Marathon Petroleum Corp. (MPC) is the only U.S.-based merchant refiner with a commitment to be an off taker on TMX (table 1). Its 2023 year-end audit disclosed that it sourced over 20% of its crude oil supply from Canada, and we expect approximately 50% of their 2024 processed crude will be sour.
PBF Energy Inc. ran approximately 27% heavy crudes in 2023, Valero Energy Corp. approximately 15% of heavy sour crude in 2023, and HF Sinclair Corp. approximately 13%. A material tightening of the WTI-WCS discount could meaningfully impact refining margins (table 2). That said, refineries in PADD 5 (West Coast) are likely to benefit from the increased supply of WCS, which we anticipate will displace more costly grades from Latin America and the Middle East (chart 3).
Table 1
| Committed shippers | ||
|---|---|---|
| BP Canada Energy Trading Company | ||
| Canadian Natural Resources Limited | ||
| Cenovus Energy Inc. | ||
| Imperial Oil Limited | ||
| MEG Energy Corp. | ||
| Parkland Corporation | ||
| PetroChina Canada Limited | ||
| Suncor Energy Marketing Inc. | ||
| Marathon Petroleum Canada Trading & Supply ULC | ||
| Source: Trans Mountain Website. | ||
Table 2
| Refining and Marketing segment Annual EBITDA | ||||||
|---|---|---|---|---|---|---|
| S&P Global Ratings-adjusted, 2024 | ||||||
| Company | Sensitivity | Mil. $ | ||||
| Marathon Petroleum Corp | Sour differential sensitivity (per $1.00/barrel change) | 500 | ||||
| Phillips 66 | WTI/WCS Differential (per $1.00/barrel change) | 100 | ||||
| Source: Company filings. | ||||||
Chart 3
What will be the impact to credit quality?
We expect North American independent refining creditworthiness to remain resilient despite the possible decline in refining margins. We forecast that the narrowing of the WTI-WCS discount will be a headwind for the financial measures of certain refiners with the ability to process heavy crude, but we expect refining margins will remain supportive of credit quality.
Refiners are flush with cash; their S&P Global Ratings-adjusted debt to EBITDA remain at low levels, and in some cases have resulted in S&P Global Ratings-adjusted leverage of 1x or lower. As refiners use excess cash to repurchase outstanding stock, we would expect their cash position to decline, leading to a normalization of financial measures as the margin environment returns to mid-cycle levels in the next 24 months.
This report does not constitute a rating action.
| Primary Credit Analysts: | Mike Llanos, New York + 1 (212) 438 4849; mike.llanos@spglobal.com |
| Michael V Grande, New York + 1 (212) 438 2242; michael.grande@spglobal.com | |
| Research Assistant: | Jada S Berthoumieux, New York |
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