The Fuse

Canada’s Oil Sector Squeezed Out By Infrastructure Woes

by Alex Adams | @alexjhadams | January 25, 2019

As major oil producers worldwide enjoyed the higher prices of 2018, Canada looked on in envy. As the world’s fourth-largest oil producer, it pumped oil at record levels last year, missing out on the price recovery that characterized much of 2018 due to pipeline constraints. Canada’s oil was left with nowhere to go.

Three key projects are designed to alleviate this pressure. A federal judge in the United States blocked the Trump administration’s approval of the Keystone XL pipeline, stating it could not progress without a supplemental environmental review. Similarly, the Trans Mountain Pipeline, which would link Alberta’s oil fields to British Columbia’s Pacific coastline, is also mired in legal issues. The Energy East pipeline, which would offer an Atlantic outlet for Alberta’s oil in New Brunswick, has become a political hot potato. Energy East is planned to pass through Quebec—a province that Prime Minister Justin Trudeau views as important to his reelection, but strongly opposes the pipeline.

The lack of options to get crude to market has hampered the industry, leaving millions of dollars in revenue on the table as U.S. oil prices climbed to $76 per barrel and Brent reached $86.

The lack of options to get crude to market has hampered the industry, leaving millions of dollars in revenue on the table as U.S. oil prices climbed to $76 per barrel and Brent reached $86. This pain was keenly felt in the oil-rich province of Alberta, where “at $85 Brent, it certainly didn’t feel like a bull market in Calgary,” a Canadian oil trader told the Wall Street Journal.

The problem has taken on greater urgency as Canada produces more oil than ever before. Output reached a record high of 5.8 million barrels per day (Mbd) in August 2018 –. In December, Alberta was producing 190,000 crude oil and bitumen barrels per day more than could be shipped by pipeline, rail or other means, with storage facilities nearing full capacity. In November 2018, Western Canadian Select (WCS) averaged just $11.03 per barrel, with a “historically high oil price differential that is costing the national economy more than $80 million per day,” according to the Alberta government. Their figures show the price differential for WCS versus WTI had been varying from $30 per barrel to $50 in 2018, reaching a peak of $52 per barrel in October.

Energy accounts for 11 percent of the country’s nominal GDP, but Canada’s lack of infrastructure is beginning to constrain economic development, alarming the nation. A survey by the Angus Reed Institute found that 58 percent of Canadians thought the lack of new oil pipeline capacity was a crisis. Sixty-nine percent of the country believes that Canada will face considerable economic impacts if no new pipeline capacity is built. Consequently, 53 percent of Canadians support both the Energy East and Trans Mountain projects, with 19 percent opposing both pipelines.

Sixty-nine percent of the country believes that Canada will face considerable economic impacts if no new pipeline capacity is built.

The situation has reached a point where the Alberta government has been forced to make a temporary OPEC-style intervention into the province’s oil production, mandating a short-term cut of 325,000 barrels per day, representing an 8.7 percent reduction, which is to stay in place until December 21, 2019. The restriction on production has proved divisive among Canada’s oil industry. Advocating for the cut, Cenovus Energy called the decision “difficult but necessary,” because of the “extraordinary situation Alberta finds itself in.” Others, such as Suncor, Imperial Oil and Husky Energy have opposed the cut, with Suncor stating that “the market is the most effective means to balance supply and demand and normalize differentials.”

Announcing the cuts, Alberta Premier Rachel Notley said, “Every Albertan owns the energy resources in the ground, and we have a duty to defend those resources. But right now, they’re being sold for pennies on the dollar.”

The move has positively impacted prices for Canadian producers. WCS jumped from $13.46 per barrel in November 15, 2018 to $43.37 per barrel on January 23, slashing the WTI price differential to just $9.25. On January 11, the WTI-WCS differential was just $6.95. This, however, has brought with it another set of issues. The smaller discount has made it harder for producers to export their oil by rail, which is estimated to cost between $15 and $20 per barrel and is well above the current price differential. Alberta’s decision has forced some companies to revise their 2019 spending plans. Devon Energy was planning to ship 20 percent of its crude by rail this year, but the narrow differentials have made that “more difficult now,” according to Rob Dutton, the company’s senior VP of Canadian operations.

The restrictions on Albertan crude has resulted in some companies spending their money elsewhere.

Additionally, the restrictions on Albertan crude has resulted in some companies spending their money elsewhere. Whitecap Resources is now intending to spend 80 percent of its $340 million capex in Saskatchewan, up from the 60 percent it had originally planned on spending. “As soon as we heard this curtailment was taking place, we shifted our capital to Saskatchewan from Alberta,” Whitecap CEO Grant Fagerheim told Reuters.

Although the cuts are likely to provide some short-term relief, the long-term issues surrounding Canada’s global competitiveness remain intractable. Until Canada’s infrastructure problems are solved, the woes plaguing the world’s fourth-largest oil producer are set to stay.

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