Oil terminal proposal a matter of timing

Stripped bare, the effort to build the nation’s largest rail-to-marine oil terminal at the Port of Vancouver is about money. Tesoro Corp. and Savage Cos. intend to make plenty of it, and they promise the community will get plenty too.

Surely the companies calculated when they launched this process in 2013 that Vancouver is their best bet for maximizing profits. But global oil markets had a different plan. High supplies, low prices and a decline in North Dakota’s oil production raise questions about whether the massive terminal planned here looks like a Fort Knox of liquid gold anymore.

Industry analysts are quick to point out the oil market’s extreme volatility in recent years has changed financial expectations of projects like the Vancouver oil terminal.

“(Crude-by-rail) economics between North Dakota and Washington state have turned upside down in the past year,” wrote Sandy Fielden, an analyst with Houston-based advisers RBN Energy, in a March report.

Of course, the project’s backers wouldn’t spend the time and money slogging through years of regulatory and political challenges if they didn’t still expect a healthy long-term financial return. The Tesoro-Savage joint venture known as Vancouver Energy shows no signs of backing away from the project, which won’t be operational until 2018 at the absolute earliest.

“The key things with these investments is you have to consider long-term horizons,” analyst Afolabi Ogunnaike of international energy consultancy Wood Mackenzie told The Columbian.

The proposed Vancouver terminal, he said, has attracted a lot of industry attention as a potential game-changer in the U.S. oil market.

“It’s a big, big project,” said Ogunnaike, who is based in Houston. “If it had been built a few years ago it would certainly have changed the flow of crude oil across North America.”

That could still happen if the terminal wins approval from state officials and the governor without conditions that would make developers walk away from the project.

Those who study oil’s bottom line, and are far from the bitter local controversy over the Vancouver terminal, see financial sense for industry giant Tesoro in staying the course. But Ogunnaike acknowledges that the economic case for the terminal may not be as strong now as it was three years ago.

“Perhaps they only build the first phase and see what the economics are like,” he said. “A lot of things have changed since this project was proposed.”

A change in fortunes

Rewind for a moment to 2013, the year the Port of Vancouver approved a lease for the oil terminal. The price of crude was hovering around $100 a barrel. California refineries were short 330,000 barrels per day. An ever-growing smorgasbord of light crude was coming out of the center of the continent. Oil trains carried 25 million barrels of oil per month in the U.S., a five-fold increase in just two years.

Sure, an oil-by-rail terminal that brings North Dakota oil to California sounded like a highly profitable investment, if U.S. Energy Information Administration data was any guide. With an eager port in Vancouver and presumably easier regulations to overcome in Washington, the light bulb went off for Tesoro and Savage.

But time has not been kind to the proposal for the nation’s largest such terminal.

Today, despite last month’s jump in prices, oil has trouble staying above $40 per barrel. Oil production in North Dakota’s Bakken formation has fallen, but international supply is abundant: California refineries now have only 84,000 barrels of unused capacity. After reaching a peak in 2014, oil train traffic fell to 18 million barrels per month in December. In just one year, oil shipments had been cut in half, according to the Energy Information Administration.

If that doesn’t sound great, the Tesoro-Savage joint venture that’s looking to cash in on that oil at the Port of Vancouver isn’t sweating.

“Vancouver Energy is designed to be the most cost-effective facility of its type on the West Coast and will be well-positioned to provide a cost-competitive route for midcontinent crude to West Coast refineries in a variety of crude price environments, including the current one,” Vancouver Energy spokesman Jeff Hymas said in a statement.

Three things dim that optimism, however.

First, not many wells in the vast Bakken field are sustainable at or below $40 per barrel, and some only break even above $60, according to a report by Bloomberg Intelligence, the research arm of the vast market information and media firm. The price of oil hasn’t been above $60 since a brief window last summer.

Second, a 450,000-barrel-per-day pipeline from North Dakota to Illinois is set to come online soon — and pipelines are a much cheaper way to transport oil. Because of that, “We expect crude-by-rail out of the Bakken will decline significantly,” Ogunnaike said.

Already, he said, rail shipments of crude are straining profitability.

“The economics to move crude by rail are weaker now,” said Ogunnaike, a senior analyst. “One would argue it’s sub-economic to move crude by rail to the East Coast, however it’s still continuing.”

Finally, prices of Alaskan and international crude are currently lower than Bakken crude shipped by rail, according to RBN Energy, the Houston energy analysis firm. Though shipping North Dakota oil by rail is getting prohibitively expensive at today’s low prices, some shipments continue due to long-term contractual commitments at terminals on the East Coast and in Washington state, RBN Energy’s Fielden wrote in a sweeping review of the state of oil-by-rail in America.

‘Cost has to make sense’

Vancouver Energy wants to handle 360,000 barrels of oil per day at the Port of Vancouver, receiving it by an average of four 120-car unit trains per day and shipping it to West Coast refineries. California is the most likely final destination, but there doesn’t appear to be enough demand at the Golden State’s 18 refineries.

Oregon has no refineries, and Alaska and Hawaii have no spare capacity. Oil already comes by rail to Washington’s five refineries to the tune of 175,000 barrels per day — likely due to long-term shipping commitments signed when prices were high, says RBN Energy.

And if Vancouver Energy were to further replace foreign oil at any of those West Coast refineries — the oft-repeated “energy independence” argument — it’s going to need oil that can compete.

Current market conditions don’t speak to a strong demand for the vast quantities of oil that would flow in and out of a Vancouver terminal, said Clark Williams-Derry of the Seattle-based Sightline Institute, an environmental organization that opposes the terminal.

“In order for it to make sense to get Bakken oil to the coast, the cost has to make sense,” he said.

The transport of oil by rail to California never gained much traction, despite that state’s vast population and oil consumption. Far more oil comes by train to Washington every day than rolls into California in a month, according to RBN Energy. If Tesoro and Savage wanted to send Bakken oil directly to California, a state known for its strong environmental protections, they likely found the political and regulatory climate less than inviting.

“(Crude-by-rail) terminals are not welcome in California, and getting a permit is akin to finding a needle in a haystack,” Fielden of RBN Energy wrote.

That has largely been Vancouver Energy’s experience with Washington’s Energy Facility Site Evaluation Council, which is expected to give a recommendation on the project’s fate to the governor late this year or early in 2017. A conditional approval is a common outcome for the evaluation council process, and it’s possible that stringent conditions could cripple the project.

Even with full approval, Williams-Derry said while some see long-term growth in the oil market, he sees a more permanent shift that may never boost Vancouver Energy’s bottom line.

“I’m prepared to be wrong about this, but when you see shifts like this not due to political forces and not due to temporary supply and demand mismatches, instead you see a fundamental and irreversible technology shift,” he said. “Anybody betting on the wrong side of that is putting money at risk.”

Williams-Derry said other countries can turn to fracking, reducing demand for America’s unexpectedly bountiful oil. That would keep supply high, prices low and demand further weakened by clean-energy alternatives and energy efficiencies.

Also complicating long-term calculations is America’s return as a crude oil exporter, since Congress lifted the ban on foreign exports last winter. Though Tesoro Vice President Keith Casey recently told Port of Vancouver commissioners it would not be economically feasible to export from Vancouver — and the port has banned foreign export from the terminal — other terminals doing so can have a big effect.

For example, there is much oil-by-rail infrastructure built out on the East and Gulf coasts, and plenty of capacity sits unused while prices are low. Exports could breathe new life into those terminals, said RBN Energy, diverting Bakken oil away from the West Coast.

Williams-Derry said that international and domestic markets have “converged,” giving domestic oil — and a Vancouver terminal — less of an edge in the long run.

“Only the best projects survive,” Williams-Derry said. “Some that made sense when prices were high may no longer make much sense.”

Staying optimistic

Yet the project isn’t getting built tomorrow. Port of Vancouver Commissioner Brian Wolfe said recently that 2020 is a “conservative estimate” of when the terminal could come online. Oh, the places the market could go in the next four years and beyond.

Such a delay doesn’t give Vancouver Energy pause, at least not publicly.

“Commodity markets are always changing, but logistics assets like Vancouver Energy take a long time to design, permit and construct, and the terminal itself will be in use for many years,” company spokesman Hymas told The Columbian by email. “Therefore, when evaluating economic viability of logistics assets, we have to do so with a long-term perspective.”

Even while Mackenzie Wood’s senior analyst Ogunnaike sees Vancouver Energy in a tough position today, he thinks the future might be much kinder to the terminal’s backers.

“We are forecasting oil prices will rise significantly. And as they rise, oil production will rise substantially — and that growth continues through the 2020s,” Ogunnaike said. “We could see a point where we have more oil than pipeline capacity and crude-by-rail becomes necessary again.”

A recent Bloomberg Intelligence report said demand for U.S. oil could pick up as early as mid-2017 as today’s stockpiles start to dwindle and prices rise.

Other variables work in the terminal’s favor even if foreign oil continues to flood the market, or Bakken just gets too expensive to ship by rail. The volume of oil coming from fields in Alaska and California is declining, and volatile international politics can work in favor of domestic oil production. Sensing that, Vancouver Energy remains ready to give refiners another choice with its Vancouver terminal, something Ogunnaike said the market wants.

“I think refiners want to have the optionality,” he said. “They want to access crude oil that makes sense to them given the market conditions.”

And without much ability to build a pipeline to the “oil island” of California, Ogunnaike said, the Vancouver Energy terminal provides the best access available.

RBN Energy said oil-by-rail could rise again if there is more oil than pipelines, echoing other analysts.

“It seems unlikely that these projects will provide good returns once (long-term) commitments expire,” Fielden wrote, referring to terminal contracts for oil-by-rail shipments. “Unless, that is, crude oil prices take off again and U.S. production grows to a point where pipeline capacity is inadequate and rail is needed to take up the slack as it did in 2012.”

Fielden concluded that at least in the near term, that is unlikely.

Vancouver Energy has always had its sights set on the long run, where there’s an assumption that oil prices will go higher. But how far prices will climb, and whether they’ll remain high, is anybody’s guess.

“Anyone who thinks prices will be staying high indefinitely is going to get hurt,” Williams-Derry said.