Alberta Premier Rachel Notley’s plan to cut through an unrelenting glut of heavy crude has perked up Canadian oil prices and energy shares. But analysts warn the government’s hand on the output tap can only do so much to stabilize a dysfunctional market desperate for new pipelines.
The main grade of heavy crude from Alberta recently plunged to a near-record low of US$10 per barrel, thanks to a one-two punch of robust production and jam-packed pipelines. Fear of damage to Canada’s economy, including the risk of losing energy sector jobs, has risen instep with Alberta’s oversupplied oil market.
The discount on Western Canadian Select (WCS) oil versus the U.S. standard West Texas Intermediate narrowed to under $20 a barrel a day after Notley announced production will be curtailed by 325,000 barrels per day beginning in January 2019. The discount has recently swelled into the mid-$40s range.
The province said the plan will clear the glut of excess oil and improve prices within three months.
“It’s a big deal,” Michael Dunn, an analyst at GMP FirstEnergy in Calgary, told Yahoo Finance Canada. “We certainly think the measures they announced will fairly quickly and a significantly correct the oversupply situation we have.”
The cut will work in tandem with a plan for the province to buy thousands of new rail cars to move shut in oil to market.
Alberta is currently producing 190,000 barrels of raw crude and bitumen per day over what can be shipped by pipeline or rail, according to the province. About 35 million barrels of processed oil is currently in storage, the government said. That’s 16 million too many, by its own estimate.
Scotiabank commodity economist Rory Johnston said many of the oilsands projects pumping extra barrels into the market are from “half a decade ago, back when we had four or five major pipelines, forgive the pun, coming down the pipeline.”
“It was reasonable to assume that at least one of them would have gotten built,” he told Yahoo Finance Canada. “This is an abnormal situation. The government has taken extraordinary steps to alleviate the value destruction in an extraordinary discount situation.”
He notes the glut could be even larger than the Alberta government is acknowledging, pointing to data from the Alberta Energy Regulator indicating the province’s total inventory is closer to 75 million barrels. The province said its reduction efforts will be “adjusted as needed” until its authority expires on Dec. 31, 2019.
Reaction to the planned cuts from major oil executives has been mixed. Cenovus Energy Inc. (CVE.TO) has been a major proponent. While critics, including Imperial Oil (IMO.TO) CEO Rich Kruger, have suggested such intervention carres trade risk, and will scare investors away from Alberta’s energy sector.
Bob Fitzmartyn of GMP FirstEnergy in Calgary acknowledges Notley’s move to bolster oil prices could credibly be viewed as anti-free trade by the United States, the chief buyer of Alberta crude. The risk of inflaming Canada-U.S. trade tensions is remote, but possible he said, given President Donald Trump’s propensity to escalate seemingly minor irritants.
“I’m not adept at keeping up with the tweets,” he told Yahoo Finance Canada, referencing Trump’s active social media habit. “Moves like this aren’t exactly indicative of free trade.”
Fitzmartyn called Notley’s two-pronged response plan, the production cut and additional rail car capacity, “appropriate” given the circumstances. But he is concerned that the advent of a state-managed oil sector in fiercely free-market Alberta, if only for a year, could jolt investors.
“You are signalling to the market that the government needs to actively manage things. I’m not sure that is the correct message,” he said.
At the beginning of its mandate, Notley’s NDP government riled energy executives with a hard cap on greenhouse gas emissions from the oil sands and a carbon tax — environmental measures perhaps intended to make pipelines that have yet to materialize easier for some to swallow.
“You torched the house, and now you’re coming with your buddies to bring a pail of water,” Fitzmartyn said. “I’m not sure overall, holistically, the entire policy initiatives by the NDP since they got in have been credible.”
Johnston is less critical.
“There has been a rise in an opposition to pipelines that began back in the mid-2010 to 2013 period. In many ways, it really started with the opposition to Keystone XL,” he said. “It’s not something that’s directly in the Alberta government’s control.”
Federal Natural Resources Minister Amarjeet Sohi has said Ottawa is working on short and long-term solutions to Alberta’s oil crisis. He ordered to the National Energy Board (NEB) to examine options to optimize pipeline capacity out of the region.
However, Sohi noted in a letter to NEB chief executive officer Peter Watson that “in light of the Line 3 Replacement and Keystone XL pipelines approved by the Government of Canada, current transportation challenges are unlikely to be long-term in nature.”
Notley has repeatedly called on the federal government to take action, including sharing the cost of purchasing additional rail cars.
Ian Lee, an associate professor at Carleton University’s Sprott School of Business, said the Alberta government’s response to low oil prices is a “suboptimal” response in lieu of pipelines, but an understandable one.
“It’s real purpose it to ratchet up the pressure on the Government of Canada. Premier Notley understands that ultimately it is going to require the federal government to intervene,” he told Yahoo Finance Canada. “They claim they are doing everything possible, which is not accurate.”
Lee said the federal government could even go as far as invoking the controversial notwithstanding clause to overturn the court ruling halting construction on the Trans Mountain Pipeline expansion. Although, he admits such a move would be unlikely.
‘Safe-ish’ for now
Johnston said the Alberta government’s production cut at the wellhead is the only meaningful course of action near-term, given the six to 12 months required to get new rail cars online, and the persistent regulatory delays and construction lags associated with new pipeline capacity.
He predicted Canadian crude was on the cusp of rebalancing prior to Notley’s interventions, as the heavy discount wipes out high-cost production, and the industry invests in more rail cars to haul away the glut. Thanks to the government imposed stop-gaps, he’s calling for WCS to remain in the low $20 range into 2020.
“After we get Line 3, and we have those rail cars on, we’re probably ‘safe-ish’ for another one to two years. After that, we are still going to need one of the other two major pipelines,” he said. “Up until the court of appeal overturning of the Trans Mountain approval, that pipeline was viewed to be the most likely candidate. After that, Keystone XL jumped in front. I think that one is the more likely candidate at this stage. We probably put it at about 60 to 70 per cent that we get one of those pipelines within 2021 at this stage.”