Canada Aims to Sell Its Oil Beyond US

Last fall, Canadian oil producer Husky Energy Inc. sent a batch of crude on a journey to India. It was just a drop in a sea of global oil transactions, but a step toward reshaping North American energy trading.

The million-barrel shipment to Indian Oil Corp. 530965.BY +1.54% , described by Husky as a test sale, foreshadowed what Canadian producers hope will become many new overseas markets for their oil.

“We are doing it opportunistically to have the wheels greased” for more exports far afield if they become feasible, said Asim Ghosh, Husky’s chief executive. Recently, Husky also shipped a batch of oil to Italy’s Eni ENI.MI +0.58% SpA.

While the U.S. debates whether to loosen a decades-old prohibition on shipping its oil overseas, Canada is quietly positioning itself to become a significant exporter of North American oil beyond the continent.

Canada’s producers long ago came to rely on the U.S. to buy almost all of their exports, in an era when the American appetite for imported oil seemed sure to continue growing steadily. But that appetite is easing, thanks to the U.S. oil-shale boom, even as Canada’s rich oil sands keep producing ever more oil. That leaves Canada a country with too much oil and not enough buyers.

Overseas markets could solve this problem, and probably bring higher prices to boot. But there is one major obstacle. Canada’s long reliance on the U.S. market has left it with few ways to get its oil to ocean ports.

A half-dozen new or expanded pipelines are planned, but are years from being built. These include the proposed Keystone XL tying Alberta’s oil sands to the Gulf of Mexico, a project that remains uncertain amid environmental and political opposition.

Some Canadian producers are so intent on finding new markets they are looking to a loophole in the U.S. rules against oil exports. The rules apply only to U.S.-produced oil, so Canadian producers can apply for licenses to ship oil to the U.S. Gulf Coast and then re-export it to distant lands from there.

“This could be the next big game changer for the North American crude-oil markets,” said Martin King, vice president of institutional research at FirstEnergy Corp. FE +0.43% , an investment bank in Calgary, Alberta. “Re-exports of Canadian crude, mostly out of the Gulf Coast, are going to change the industry,” he said.

To make that happen, producers have to jump through some hoops, including segregating batches of overseas-bound Canadian crude from U.S.-produced crude. Canadian Natural Resources Ltd. CNQ.T +1.12% has suggested color coding. “As long as you color it properly and segregate it, you can re-export it out of the U.S., including U.S. Gulf Coast,” said Réal Cusson, an executive of the oil-sands producer, at an investor conference last year.

The company said it had no specific plans to re-export crude, but some evidently do. The U.S. Department of Commerce granted more than 50 permits to export crude oil in the six months through March, targeting destinations such as Japan, South Korea and Spain. One permit went to a U.S. subsidiary of Canadian pipeline operator Enbridge Inc. ENB.T -0.77%

The trade publication Platts has reported a plan by Madrid-based Repsol SA REP.MC -3.97% to import around 550,000 barrels of Canadian oil via the Gulf of Mexico. The exporter’s identity isn’t clear. Repsol declined to comment.

Reaching for customers beyond North America could allow oil-sands producers to get higher prices than in the U.S., where their output—so heavy it has the consistency of peanut butter—sells at a discount. Called Western Canadian Select, it fetches less than West Texas Intermediate because of transportation costs, lower quality and limited access to U.S. refineries that can process it, although the gap has narrowed lately.

The Canadian Chamber of Commerce has said oil-sands producers could get $50 million a day more for their output if it were sold outside the continent, citing a 2012 CIBC World Markets report.

A Canadian shift toward non-U.S. buyers could have consequences for bilateral trade, energy policy and even political ties between Ottawa and Washington. Despite its shale boom, the U.S. still relies on Canada for a third of America’s nearly eight million barrels a day in net oil imports and will continue to need Canadian oil.

The U.S. Energy Information Administration projects that domestic American oil production—estimated at 8.4 million barrels a day this year—will climb to 9.6 million barrels a day by 2019, and will stay at or above 7.5 million barrels daily through 2040.

Meanwhile, U.S. imports have fallen each year for nearly a decade. In 2005, the U.S. imported 60% of the oil and oil products it used. That was down to 40% in 2012 and is projected to bottom at 23% later this decade.

The U.S. will remain a net importer of crude oil for decades, and Canada its leading supplier, say industry officials on both sides of the border. But for Canada, demand from the U.S. won’t be enough to soak up all of the output from the vast oil-sands deposits under Alberta’s boreal forests as projects keep coming on stream and increasing output.

Companies active in the oil sands are investing about $30 billion a year to expand production, according to Peters & Co., a Calgary-based investment bank. Oil-sands production is up 71% since 2007 and is forecast by research firm IHS Inc. IHS +0.70% to double to 3.8 million barrels daily by 2025.

Producers have been caught off guard in betting on a single big customer to the south. If they fail to find new buyers, the oil sands, which rank among the world’s largest industrialization projects, could also turn into one of its biggest white elephants.

“For an industry of the size and strategic importance of the oil sands, it makes absolute sense that we have more than one customer,” said Steve Williams, the CEO of Suncor Energy Inc., SU.T +1.01% one of the main oil-sands producers. “It’s crazy for [production] numbers of national importance and for Canada’s future to be dependent on one customer.”

So far, exports to destinations other than the U.S. remain a fraction of production. Although such shipments more than doubled last year, they averaged a mere 82,955 barrels a day, according to Canada’s National Energy Board, while Canada’s total oil exports were closer to 2.5 million barrels daily.

Much of the oil going to non-U.S. buyers came from offshore wells in eastern Canada, including the oil sent to India and Italy by Husky Energy, HSE.T +0.06% which is Calgary-based but majority-owned by entities controlled by Hong Kong billionaire Li Ka-shing; 99.3% of exports from western Canada’s landlocked oil sands went to the U.S.

Canadian producers are racing to secure capacity on railroads and pipelines, including proposed ones. Worries about market access forged an informal consensus in the past year between the industry and provincial governments to fast-track a 2,858-mile pipeline from Alberta and Saskatchewan to Canada’s East Coast.

The TransCanada Corp. TRP.T +0.89% project, known as Energy East, would carry 1.1 million barrels of oil a day to refineries in Quebec and coastal New Brunswick. While still needing a federal signoff, the project looks increasingly likely to be built—but not until 2018.

“The Energy East pipeline will connect western Canada to global markets. Once you’re in the water, you can get oil around the world at a very, very low price,” said Husky’s Mr. Ghosh. He said the pipeline would make it as cheap to ship oil-sands crude to markets such as India from the Atlantic coast as from Canada’s Pacific coast.

Five years ago, when TransCanada proposed extending its existing Keystone system with a direct Alberta-to-the Gulf route called Keystone XL, few in the oil sector or in Ottawa foresaw how much it would get caught up in U.S. politics and environmental debate.

Oil-sands producers also didn’t anticipate the degree of competition for pipeline space they would face from light crude from shale in U.S. states such as North Dakota.

An early wake-up call came in the fall of 2010. Enbridge temporarily closed a pipeline connecting western Canada to Chicago-area refineries after a spill near Romeoville, Ill., which followed a larger spill in Kalamazoo, Mich. The bottleneck spurred a rush by Canadian producers to secure railroad tank cars and to push for construction of new pipelines.

Both efforts have since accelerated. In 2012, Canada exported an average of 46,000 barrels of oil a day to the U.S. by rail. In this year’s first quarter, it was more than 160,000 barrels daily.

While a spate of fiery derailments has shown the risk in shipping oil by rail, producers of the oil sands’ heavy crude say it is far less volatile than the lighter shale-oil crude. Peters & Co. projects that as new rail loading terminals are built, western Canada’s crude-by-rail capacity may reach 1.1 million barrels daily by the end of next year.

That would exceed the proposed Keystone XL’s 830,000 barrels daily capacity, and would help soak up the oil sands’ output.

Even so, two million more barrels a day of pipeline capacity will be needed to meet crude-oil growth forecasts through 2025, the Canadian Association of Petroleum Producers estimates.

Half a dozen projects are proposed to meet that demand. They face strong opposition both from environmentalists and from the aboriginal people who control much of the land through which pipelines, especially to the Pacific, would have to pass.

Some Canadian oil producers are pulling back on expansion projects amid the uncertainty. Barclays BARC.LN +1.02% PLC estimates that concern about distribution bottlenecks has deferred projects totaling 500,000 daily barrels through 2016. Last week, Total SA FP.FR +0.97% ‘s Canadian unit suspended an oil-sands project in the works for nearly a decade, citing rising costs and concern about its ability to generate profits.

Other producers are hedging their pipeline bets. “We have participated in multiple new pipeline offerings,” said Rich Kruger, chief executive of Exxon Mobil Corp.’s XOM +1.04% Calgary-based Imperial Oil Ltd. IMO.T +0.43% unit. He described rail as “an insurance policy if pipelines ultimately don’t come about in the time that we would need them.” Husky, Suncor and Canadian Natural Resources also have committed to using proposed pipelines.

At present, Canada’s Pacific coast is served by only one, 60-year-old oil pipeline, called the Trans Mountain. Its operator, a Canadian unit of Kinder Morgan Energy Partners KMP +0.67% LP, routinely receives bids to move three times as much oil as the pipeline can carry. Most oil traveling on it goes to refiners in Vancouver and Washington state.

A trickle has made it to China. In 2012, oil-sands producer Cenovus Energy Inc. CVE.T +0.06% used the pipeline to ship about 250,000 barrels to the coast and then on to a Chinese buyer. Cenovus says it wants to send more but faces shipping-capacity limits.

Among the projects proposed is a tripling of the Trans Mountain’s capacity. Another is a pipeline from the oil sands to British Columbia’s north coast. Cenovus has earmarked shipments on both, in hopes of selling to Asian customers.

Some smaller Canadian shale-oil producers, including Crescent Point Energy Corp. CPG.T +0.43% , plan to start exports to China later this year by using rail access to the Gulf of Mexico and Pacific coasts. Abroad, the company could get $5 to $10 a barrel above what U.S. buyers pay for light and medium Canadian crude from shale deposits, Crescent Point CEO Scott Saxberg figures.

Freed from their role as captive sellers, Canada’s producers might find the U.S. market less beguiling, and Americans might no longer be able to count on as much relatively cheap Canadian oil.

Said Rick George, a former Suncor CEO who is now a partner at Calgary-based Novo Investment Group: “If you produce a commodity, you never want to be in a position where your customer has more bargaining strength than you do.”

WSJ