So today is the day to talk about why Enbridge is extracting rent from Canadian producers and taxpayers. Read this thread. Then come back.

("Extracting rent" is a fighting word to an economist). /1 https://twitter.com/GK_Fellows/status/1346887296281309184

Seriously, read that for the background on how the Mainline common carrier regulatory environment works. Then come back here, and I will explain how this is very, very bad for Canadian producers, taxpayers, and good for refiners and Enbridge. /2

The thing to know about the Enbridge Mainline is that producers don't generally move oil. They sell the oil at the pipeline head (Edmonton or Hardisty) and shippers move that oil to where it gets consumed at a refinery. "Shippers" are generally refiners. /3

It's partly evolved this way because oil producers don't want to think about commodity logistics, but also because building out an end-to-end supply chain is hard and expensive. Refiners are naturally short crude (they consume it) and really smart on logistics. /4

That all works great when there's a small excess in pipeline capacity. Basically, the refiner pays the toll for the pipeline, and on balance, the market price of crude at the pipeline head (Edmonton or Hardisty) reflects the toll over time. /5

A "common carrier" means that Enbridge has to offer non-discriminatory access to anyone who wants to ship, but in practice it means you need to be either a large, sophisticated producer (CNQ), a sophisticated physical trader (BP), refiner (BP, PSX) to ship. /6

Now, here's Enbridge's problem: One new pipeline is going to be built. Transmountain. And it's under FIRM CONTRACT. Not common carrier. To build the pipe, shippers, primarily producers, guarantee a toll for a period of time. And in Canada, that's like C$7+/bbl and 20y. A lot!! /7

Keeping it simple: "common carrier" is a restaurant reservation. Guarantees your spot, you don't pay until you show up and eat. You pay for what you use.

"Firm" is a wedding. You guarantee a guest count, date, food, wine, everything up front. /8

Enbridge has some firm shipments too, for a few producer-sponsored projects such as Flanagan South. But, in the main, the Mainline is common carrier. Must take all comers. And has few committed shippers. /9

That's bad for Enbridge, because if there is too much pipeline capacity compared to production, then Mainline volumes will fall first, because most of the other meaningful shipping options are contracted. Like TMX. If you have a contract on TMX, you're using it. /10

So Enbridge finds itself with the marginal shipping option in a marginal basin. Western Canada is an uneconomic oil basin and growth is gone. These new pipes, even without KXL, will take forever to fill up. We seriously might not be using oil by then. /11

So what to do? The last five years of constrained egress pipeline (too much production) offered an opportunity. Plus there were a lot of hassles with common carrier nomination procedures... shippers would over-commit volumes because they would get cut back... /12

... like making two restaurant reservations for New Years Eve. This isn't Enbridge's fault, but the "nom gaming" reduced pipeline capacity availability in a tight market because when a shipper doesn't show up, ENB has to scramble to fill that capacity or it goes wasted. /13

So in light of all these issues, Enbridge proposed the ballsiest maneuver I could contemplate: convert the Mainline to Firm Transport! This is a huge risk transfer away from Enbridge, because the shippers would now take on the volume risk. /14

It's one thing to demand firm contracts because, otherwise, the pipeline won't get built. It's entirely another to propose firm contracts because you feel like it's strictly in your best interest.

So far, this is just business. /15

But one nuance makes this an extraordinarily unpatriotic action. Remember that most Mainline shippers are refiners? And there's a small number of them? That's called a monopsony. A small number of buyers. Like a monopoly, but on the other side. /16

Suppose one refiner signs up for the entire capacity of the Mainline. 3 MMbbl/d (round numbers). Now, I'm paying for all of it. But I don't have to use it all! Suppose that the oil available for my pipeline is 2.8 MMbbl/d. So I can ship 2.8 across my 3.0 capacity, no problem. /17

(Note: you can't sign up for the entire Mainline. It would cost too much, and my reading of the docs says it wouldn't be allowed. But the intuition holds for any small number of shippers. One shipper is an example only.) /18

Now, what if I say, "I'm only going to ship 2.7 MMbbl/d." Why would I do that? Because it would collapse prices at the head of the pipeline, at Edmonton or Hardisty. Differentials could spike $10, $20, $50!!!. We have seen such numbers. /19

A shipper who throttled capacity would lose a few $ on the unused capacity, but gain so, so much more on lower acquisition cost of crude.

"Oh, but Samir, this is criminal market power manipulation."

Okay, so go down for maintenance. Pump is down at the tank farm... /20

The temptation to throttle the pipeline and mint it would be absolutely overwhelming to someone whose multimillion $$ bonus depends on it. Good luck trying to solve that with regulation. /21

And royalties are set on the basis of oil prices at the pipeline head, not on prices at the refiner, which are non-transparent. /22

No surprise, producers hate this proposal. Refiners love it. That's why Enbridge says 80% of shippers support the deal, or whatever the volumes are. They will get to hammer producers and taxpayers and get a license to print money at our expense. /23

It's as if we are gift wrapping our oil sands and giving them away for free to US refiners, keeping only the risk and environmental liabilities and bad carbon ESG reputation. /end