Alberta Intervenes in Canada’s Crude Conundrum
December 4, 2018
- On December 2, the government of Alberta announced a short-term oil production curtailment in response to historically high oil price differentials, which it estimates is costing the Canadian economy more than C$80 million per day.
- A curtailment of 325 thousand barrels per day (b/d) of crude or bitumen will take effect on January 1, 2019, and remain in place until excess oil inventories are drawn down. Thereafter, the reduction will drop to an average of 95 thousand b/d until the end of 2019.
- Alberta’s current output of 3.67 million b/d, exceeds takeaway capacity by 190 thousand b/d, which has resulted in a doubling of storage beyond “normal levels.” The cuts are expected to reduce the backlog of oil in storage and help rebalance production levels to transport capacity.
- Relative to inaction the government of Alberta expects that this curtailment will increase the price that producers in the province receive by an average of $4 and add an estimated $1.1 billion of government revenue in 2019-20.
- The announced cuts follow another recent decision by the province to support its embattled oil industry by investing in rail capacity capable of moving 120 thousand b/d starting in late 2019.
- The Albertan government has, however, continued to highlight that the crux of the matter is a lack of available pipeline capacity. It hopes that these temporary measures will act as relief before pipeline capacity is added by Line 3 towards the end of 2019 and eventually by way of the Trans Mountain Expansion Project and/or Keystone XL.
Alberta’s oil sector is in crisis. The province has been facing major takeaway capacity constraints for more than a year, which has seen its crude trade at record discounts to that of global benchmarks. These differentials have cost Albertan producers and both the provincial and federal governments billions of dollars in foregone revenues and royalties. The move to curtail production is not entirely unprecedented with the province last implementing production restrictions in 1981. However, the cuts in the 1980s were politically motivated and came in response to the implementation of the National Energy Plan. While this latest move is not entirely free of any political messaging on behalf of the Albertan government, the nature of the planned 2019 curtailment and the market conditions that have instigated the cuts are pretty unique. The government of Alberta was left with very few options to provide relief for its industry and economy while the seemingly never-ending pipeline wait proceeds.
Canada’s benchmark crude stream Western Canada Select (WCS) in 2018 has traded at a record discount of 39 percent to that of its U.S. counterpart West Texas Intermediate (WTI). This is nearly double the 23 percent average experienced in 2017, with the discount averaging $46 in October alone. The problems created by capacity constraints came to a climax in late September through early November, as rapidly rising levels of output beginning in August and continuing through November, ran up against slow additions to takeaway capacity and rising storage levels that were reaching capacity, at a time of high refinery maintenance in the United States. The differentials have since narrowed as refinery throughput in the United States recovers from turnaround season and as Albertan production levels have begun to ease off. The two major announcements have also provided some direly needed price support. While the worst of the breakout in differentials for Canadian crude in the short term is now likely behind us, the WTI-WCS price spread still stands at over $20 per barrel.
Barring any major disruptions, the curtailments starting in the new year and rail capacity additions starting in late 2019 will help accelerate a rebalancing that has already been underway. They will also provide insurance in the short-medium term that the extreme discounting over the past few months will not be experienced again until additional pipeline capacity can be brought online. While the impending curtailments will help restore some semblance of normality to the differentials, the root of the problem—which is a lack of available pipeline capacity—will not be resolved by these actions. The lack of adequate pipeline capacity for the province is not an issue confined to 2018 alone; it has beleaguered the province for more than a decade. Assuming an inherent $10 average discount for Albertan crude exports to that of WTI, the differentials so far in 2018 have resulted in at least $15 billion of forgone revenues for the Albertan upstream industry and at least a billion dollars for the provincial government in royalty revenues, and additional losses for both the federal and provincial governments in tax receipts.
In addition to the economic benefits that the cuts and rail capacity additions will provide, the move by Premier Rachel Notley also carries some political connotations. The steps taken to cut production has received widespread support in Alberta, with the majority of investors and companies favoring government intervention, apart from three integrated producers whose refinery businesses have benefitted from low crude prices. The government has structured the cuts in such a manner so as to not unduly stress smaller producers or those that have already moved to reduce their output voluntarily. In addition to the widespread backing that market intervention has received in the province, Alberta’s government has stated that it is doing everything it can to support its industry and has highlighted that the only lasting solution to the problem is if the federal government can get the Trans Mountain Expansion Project completed.