The Fuse

Canada Faces Oil Shut Ins As Prices Drop Below $5

by Nick Cunningham | April 01, 2020

Oil prices have dropped to their lowest level in almost 20 years, and some analysts believe that WTI and Brent may fall into the teens for a period of time as global storage begins to fill up.

If anyone is bearing the brunt of the oil market downturn, it is the oil producers in Canada. Western Canada Select (WCS), a price that tracks heavy oil in Alberta, recently plunged below $5 per barrel. The price is so low that some producers have begun to shut in production.

It now costs more to ship the oil than the value of the oil itself.

Cheaper than beer
WCS prices traded at around $4 per barrel as of March 30. CNBC noted that a barrel of oil – which contains 42 gallons of crude – cost less than a pint of good beer in Canada. Put another way, it now costs more to ship the oil than the value of the oil itself. Meanwhile, the tar-like bitumen that is blended with light condensate was trading under $1.50 per barrel last week, according to Bloomberg. As recently as late February, WCS traded in the upper-$30s per barrel.

WCS typically trades at a discount relative to WTI, due to differences in quality and the long distance it needs to travel to reach global markets. That discount has gyrated in recent years from just a few dollars to more than $40 per barrel when production growth in Alberta ran up against a ceiling of pipeline capacity bottlenecks 18 months ago.

The latest price collapse is obviously the result of cratering demand amid the global coronavirus pandemic, combined with the Saudi-Russian price war. But while the pain is felt across the globe, oil-producing regions that are in more remote locations – far from a refinery, export terminal or a pipeline – are seeing a total meltdown in prices.

Wyoming Asphalt Sour has traded at negative prices.

For instance, while WTI traded at just over $20 per barrel in late March, Bloomberg reported that Wyoming Asphalt Sour, a type of oil used for asphalt and is produced very far from a large market, has traded at negative prices, meaning that a producer actually pays for someone to take the oil.

Canadian oil is not quite as desperate, but nonetheless faces a severe crisis. At less than $5 per barrel, production may start to go offline. Roughly 125,000 barrels per day (b/d) has already shut in, but the decline of WCS to such low depths “will likely trigger additional production shut-ins,” TD Securities said in a note.

“Canada’s oilsands are at the upper end of the (cost) curve, even in a benign price environment,” Wood Mackenzie said in a report on March 27.

More than a few oil companies in Alberta announced spending cuts. Husky Energy cut 2020 spending by $1 billion. Suncor Energy cut spending by $1.5 billion, or 26 percent.

Cenovus Energy cut capex by 32 percent. Both Suncor and Cenovus said shipping crude-by-rail no longer made economic sense. “Global upstream production will need to be reduced or remain in storage unsold,” Suncor admitted in a statement.

The government of Alberta released a budget in February, noting that for every $1 decline in the price of oil, the province loses C$355 million in revenue, which “gives a sense of how serious the fiscal hit could be,” Scotiabank said.

The potential for Saudi-Russian talks, U.S.-Russian talks, or some other combination, are a sideshow at this point.

More room to fall
Global demand is getting crushed by the proliferation of global lockdown measures, and demand forecasts grow more negative by the day. The drop in global demand could be as large as 30 million barrels per day (Mbd) in April, according to Trafigura, a sum that would more than an order of magnitude larger than what OPEC+ was holding off the market. The potential for Saudi-Russian talks, U.S.-Russian talks, or some other combination, are a sideshow at this point. There is nothing global producers can do in the face of 20-30 percent decline in demand.

The collapse of oil prices over the past few weeks has immediately led to an increase of floating storage. “This will soon be followed by inventory builds across onshore tanks in the U.S., with refinery margins collapsing and refinery runs soon to follow,” Roger Diwan, vice president of financial services at IHS Markit, said in a March 25 report. The number of refineries curtailing or shutting down production is growing by the day.

“So far, the supply chain is absorbing the weakness, but soon the pain will have to back into the wellhead, and as it does, prices will have to follow lower,” Diwan of IHS Markit said.

A separate report from IHS Markit predicts that 10 Mbd of global supply will be shut in between April and June. U.S. shale is widely expected to decline and near-term shut ins appear likely. But rock bottom prices in Canada suggest that bottlenecked heavy oil in Alberta will come under particularly acute pressure.

Rystad Energy estimates that Canadian oil production could fall by 440,000 b/d in the coming weeks as storage maxes out. “Western Canada’s storage infrastructure has a generally accepted maximum storage capacity of approximately 40 million barrels,” Rystad said in a March 23 report. “Based on our calculations, more than 30 million barrels of crude oil and diluted bitumen is already held in storage, and the volume is likely to edge towards the high end of capacity by the end of March under current production assumptions.”

The pressure will likely continue as long as the pandemic rages across the world. “Inventories are already elevated in the Western Canadian oil patch; that may bring more downward pressure on WCS in the coming months,” Scotiabank said in a note on March 31.

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