The Fuse

Elections Likely to Worsen Calculus for Canada’s Beleaguered Oil Industry

by Nick Cunningham | October 15, 2015

Even with current increases in production,  the long-term outlook in Canada is grim as low prices have undermined investment

Despite growing misfortunes for Canada’s oil industry, the country’s output has remained steady during the ongoing slump in oil prices, and should continue to rise. Even with current increases in production, however, the long-term outlook is grim as low prices have undermined investment, which is critical for the industry’s long-term health. The election of a new government next week is not likely to help matters, given that the industry-friendly Conservative party is expected to be ousted from power.

Crude output still on the rise

Canada’s output largely comes from oil sands, which is different from shale production in the U.S., where the weaker oil market is curbing output. Oil from shale consists of relatively short ramp-up times at comparatively lower up-front costs, while oil sands require years of development for a much higher sum. Crucially, however, oil sands can produce for decades, whereas oil flows from shale fields drop almost immediately after coming online.

This difference is key, and it explains why Canada has been able to increase production over the past year, even as oil prices plunged. Oil production in the U.S. is already declining, but in Canada oil output could continue to rise as a number of backlogged projects, planned years ago, reach their completion.

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Canadian companies face setbacks, long-term outlook in jeopardy

Even as companies proceed on construction that is already underway, low oil prices have killed off the appetite for new projects. Cenovus Energy, Canadian Natural Resources, Royal Dutch Shell, Statoil, and Suncor Energy, among others, have delayed major investments in new oil sands production because the projects aren’t economical at current price levels. Canadian producers are particularly price sensitive because Canada’s heavy crude streams fetch a significantly lower price than the international benchmarks. Western Canada Select generally trades at a $15-$20 discount to West Texas Intermediate, and finding buyers can be a challenge in a glutted oil market.

Against this backdrop, after the construction queue is cleared, the project pipeline will dry up. The Canadian Association of Petroleum Producers (CAPP) was forced to downgrade its long-term assessment for Canada’s oil production earlier this year. CAPP now projects that Canada’s output will grow from 3.7 million barrels per day (mbd) in 2014 to 5.3 mbd in 2030, down from a June 2014 projection of 6.4 mbd by 2030.

The oil and gas industry is the largest capital investor in Canada, and as a result, the resource-based economy is suffering as oil companies cut back. The International Monetary Fund (IMF) slashed its economic outlook for Canada, expecting GDP to expand at just 1 percent in 2015, down from a 1.5 percent expansion the Fund forecasted in July.

Despite the grimmer outlook, the overall state of the economy has slightly improved from this past summer, after Canada briefly went into recession. The fall in the Canadian dollar—down 10 percent relative to the U.S. dollar since the start of the year—has allowed exports to tick up a bit. Nonetheless, the Bank of Canada said in its latest quarterly survey that “Business sentiment remains tepid over all.”

No outlet for Canadian oil

Low oil prices are compounding problems for Canada’s oil sector, which is already suffering from one major competitive disadvantage—inadequate pipeline infrastructure. Alberta, where most of the country’s oil is produced, is landlocked and needs long-distance pipelines to export its oil.

Low oil prices are compounding problems for Canada’s oil sector, which is already suffering from one major competitive disadvantage—inadequate pipeline infrastructure.

Environmentalists have targeted the Keystone XL pipeline, believing that keeping the oil sands disconnected from international markets will prevent their expansion. Canada’s oil industry agrees. Tim McMillan, President of CAPP, told Reuters in September that the lack of pipelines is even more painful now that oil prices are low. “At $100 a barrel, it was a big concern. At $45 a barrel, that is a far larger percentage (of revenue) and is likely the difference between profitable and unprofitable on many of the assets,” he said.

But there aren’t any near-term solutions to alleviate this problem. Keystone XL, after years of legal limbo, could soon be killed off. TransCanada is now seeking to delay the review process in hopes that the next U.S. president, who will take office in January 2017, will approve the controversial project.

While the U.S. is stonewalling TransCanada, the company has proposed the Energy East Pipeline, which would carry 1.1 mbd of Alberta crude to Canada’s Atlantic Coast. However, the $12 billion 4,600-kilometer pipeline has also faced environmental blowback.

The outlook for a western route is just as dim. Enbridge’s proposed Northern Gateway Pipeline would carry oil from Alberta to the Pacific Coast where it could be then shipped to Asia, but it has faced fierce opposition from First Nations groups. The federal government approved the project in 2014, subject to more than 200 specific conditions, which include Enbridge bringing onboard First Nations, but tribal groups are now litigating the pipeline.

Kinder Morgan is also proposing a Pacific route—an expansion of a pipeline that runs from Edmonton to Vancouver. The company wants to more than triple its capacity from 0.3 mbd to 0.89 mbd. This project faces fewer hurdles since it would merely consist of expanding an existing piece of infrastructure, but the project still faces regulatory delays. Kinder Morgan hopes to complete the expansion by the end of 2018.

New government expected

Canada is set to elect a new government on October 19, with potentially wide-ranging implications for the energy industry.

A provincial election earlier this year in the oil and gas dependent province of Alberta could be a harbinger of what to expect from a new prime minister. The conservative ruling party was forced out of power in May 2015 after 44 years in control. The incoming NDP Premier, Rachel Notley, is much less friendly to the industry, although she is not outright hostile to oil and gas production given that Alberta depends directly on energy royalties to fund 30 percent of its budget.

Canada is set to elect a new government on October 19, with potentially wide-ranging implications for the energy industry.

In a province that is often compared to Texas because of its conservative, free-market, oil-friendly electorate, the new NDP government’s lukewarm embrace of the industry is quite a departure from the past. Alberta’s revenues could fall by more two-thirds this year, from CAD$9 billion down to CAD$3 billion. Around four-fifths of wells in the province are paying no royalties at all because oil prices are too low.

This situation has prompted Alberta’s NDP to raise the corporate tax rate from 10 to 12 percent in order to boost revenues. The government is also considering an increase in energy royalties, but the depressed oil patch is in such bad shape that the Notley government has promised to hold off until 2017.

Notley’s support for action on climate change is also a stark difference from Conservative rule, and a threat to the oil industry. “Canadians are of one mind on this issue. They expect their governments, all of their governments, to act decisively and responsibly on climate change. And so we are listening carefully to Albertans about this issue,” Notley said in a speech on October 2.

Notley said that she would support a federal cap-and-trade plan put forward by her party’s candidate for Prime Minister, Thomas Mulcair, as long as the revenues generated from the program stay within Alberta. Moreover, she argues that pipelines from Alberta will only gain acceptance from neighboring provinces as well as the U.S. if Alberta can demonstrate meaningful action on climate change.

“If we don’t get it right on this issue, the solution is going to be imposed upon us,” Notley said. “We know that—sooner or later by others, by the federal government, by the markets, who will increasingly insist that energy products are mined and processed responsibly.”

Headwinds coming for Canadian producers

The industry-friendly business climate in Canada is about to change after 10 years of Conservative rule.

Nationally, the NPD is slipping in the polls in what had been a close three-way race for prime minister, but the Liberal Party, led by Justin Trudeau, is leading just days before the October 19 vote. A minority Liberal government would have to form a coalition, and it is more likely that the Liberals would work with the NDP rather than Conservatives. Trudeau has come out against the Northern Gateway Pipeline for environmental reasons, but has not taken a position on the other three major pipeline projects. He also favors a price on carbon.

Under these circumstances, the industry-friendly business climate in Canada is about to change after 10 years of Conservative rule.