Analysis: Harper's bet may pay off; China open to Canadian oil

China is set to embrace Canada's offer of more crude, heating up competition with the United States as the world's top two oil consumers jostle to secure supplies and meet ravenous demand.

Shipments from a politically stable country such as Canada will be a welcome diversification of supply sources as top consumers make plans to deal with a supply shock if tensions in the Middle East escalate and choke off Iranian exports, barely a year after markets coped with a disruption from Libya.

Canada's plan to ship crude to Asia got a boost after Prime Minister Stephen Harper said his nation would step up efforts to supply the region after the United States delayed a decision on a pipeline supply link.

A Canadian source could offer a diversity of supply attractive particularly to North Asia, said John Vautrain, director at consultancy Purvin & Gertz. Canada is a stable country, not subjected to geopolitics, and the crude would be valued in the market to make it competitive.

Canada's oil sands output is expected to double by the end of this decade from 1.5 million barrels per day (bpd) now, according to IHS Cera, close to Libya's exports before a civil war disrupted output this year.

China is an ideal client for Canada in Asia as it has the ability to process a wide range of crude and its appetite continues to grow. The Canadian heavy sour grade, which will be shipped to Asia, has API gravity of 19-22 degrees and contains around 3 percent sulphur. Most Asian refineries process crude of 30 degrees API.

There is no oil that we can't process, an official at Sinopec, Asia's largest refiner, said, declining to be identified as he is not authorized to talk to the media. With 30 refineries, there will be some that can use Canadian crude.

China, eager to secure extra energy supplies to power its rapidly growing economy, is already buying more Canadian crude.

Canadian crude exports to the Asian nation rose more than 60 percent this year after the arbitrage window opened on low freight rates and deep spot discounts and a depressed West Texas Intermediate marker. But that still makes up less than 0.3 percent of its total purchases.

The top three Chinese oil companies PetroChina, Sinopec and China National Offshore Oil Corp (CNOOC) own equity stakes in oil sands fields, while Sinopec is one of the backers of the Northern Gateway project that would carry Canadian crude to the west coast for loading on tankers.

OTHERS WARY

Regardless of how much crude Canada has to sell, other Asian buyers in the Pacific -- South Korea and Japan -- may not be so keen to take more because the crude has API gravity below 20, which makes it one of the heaviest, or of lowest quality.

The refining capacity is being expanded and with more supply issues, they can take the crude if it is at their doorstep, said Kang Wu, senior advisor at FACTS Global Energy. But that's a big if.

The low quality means other Asian buyers will have to blend with better crudes and reduce the sulphur content before processing, cutting into profits from processing each barrel. Or refiners have to build so-called secondary units that are capable of producing cleaner-burning fuels from low quality oil.

Upgrading means you have to add a new unit and you have to retire some other units. That's a tough choice that involves millions and billions of dollars of investment, Wu said.

Asia is building refineries, so they need more crude. But unfortunately everybody is doing the same thing, designing their refineries based on light-medium crude or even heavy, although not as heavy as Canadian, Wu said.

A South Korean refiner said he hadn't looked at the economics of processing Canadian crude while another said logistics and operations were major hurdles.

It's not going to be a good replacement, compared with the Middle East, because of operational issues, the official said.

It would also be difficult for Asian refiners to plan ahead as they buy most of their crude two months forward while Canadian grades are sold just one month before, he said.

If trading houses bring it out to Asia, then we can start talking, he said.

Even though Japan's JX Holdings holds a small stake in Syncrude Canada, it generally doesn't make economic sense for the company to bring the crude back to process, a company spokesman said.

Apart from China, India is the only country that could feasibly take large Canadian volumes as it has refineries designed to process such crudes. But Asia's third-largest oil consumer is an unlikely buyer because it has the vast Middle Eastern oilfields just 7-11 days away by tanker, analysts said.

OPERATIONAL HURDLES

Even if Prime Minister Harper wants to increase sales to Asia, supplies will be limited by infrastructure hurdles.

As the fastest-growing non-OPEC producer, Canada urgently needs more pipeline and rail capacity, to expand a terminal at Vancouver and add storage tanks to move more of the landlocked oil to the west.

The existing Trans-Mountain pipeline linking Alberta to the Pacific Coast for exports to Asia only has the capacity to transport 300,000 bpd.

The pipeline's operator, Kinder Morgan Energy Partners LP, may expand its capacity by a few hundred thousand barrels a day by 2015, while Enbridge Inc plans to build a new multi-billion dollar Northern Gateway pipeline.

Canada will get the pipelines and ports in place, much as Russia did by diverting Siberian crude to Asia, but it may take at least 10 years before the facilities are fully up and running, analysts said.

Having a single export option leaves Canada in a weaker commercial position than if it has a two-way flow of oil to both the Atlantic Basin and Asia, said Lawrence Eagles, global head of oil research at J.P. Morgan.

There is clear federal support to provide broader market access.

Until port facilities and rail networks are upgraded, sales to China and other Asian nations may only remain a pipe dream.

As an end user, I don't mind if more crude enters my market, but logistics is a big issue, said the official at Sinopec.