For the first time in three years, Canada is close to getting world price for its valuable oil. Trends and indicators suggest that sending out 3.3 million barrels of oil every day at bargain-basement discounts, sometimes as steep as 40 per cent, may now be behind us. So, instead of peddling our barrels to U.S. refineries at $80 or less, we’re now back above the century line, getting almost $110 for our best light crude. That’s good news.
But now I’m getting nostalgic. The fiscally nagging price differential, or the “Diff” as it’s known in some circles, did have some benefits that hopefully won’t be lost. Budgetary pain and thin corporate margins provoked important conversations in this country. Forward thinking is at risk of being marginalized with a reversion to status quo. Think of it this way: The death of the Diff resurrects fiscal benefit, but takes Canadians back to a strategic deficit.
First a look back; oil produced in Canada and the U.S. has a long history of trading within a few dollars of global prices, even through the Financial Crisis. The Diff started appearing in August of 2010. Figure 1 shows the price gap between Canada’s best light oil grade, Edmonton Light, and the global benchmark produced out of the North Sea. Painful discounts were felt on most grades of Canadian oil between May, 2011, and June, 2013, with annual revenue forfeiture in the billions.
Two well known factors contributed to the discount: a 10-per-cent reduction in the consumption of oil in the U.S. market, combined with a rapid rise in production from new North American light, tight oil (LTO) plays, in addition to ever increasing output from the Canadian oil sands.
Lower demand, combined with greater supply, means lower price – that’s Economics 101. But the antagonistic issue was matching the new supply to the shifting demand. Aging pipelines, some built many decades ago, couldn’t keep up with the new volumes. Inventories of oil coming from new geographies swelled up in the middle of the continent, mostly in big storage hubs like Cushing, Okla. Like high blood pressure in sclerotic veins, the oil glut backed up all the way to Canadian suppliers. The inland congestion meant that new oil volumes, especially from western Canada, couldn’t get to the big refineries on North America’s coasts where the highest global prices were being paid.
The free market has a remarkable way of sorting out multibillion-dollar mismatches in price. A surge of oil found its way into rail cars and rejigged, expanded pipeline networks, especially in the U.S. Getting the flood of new oil to the right markets did much to unclog the congestion and eliminate discounts to global prices on both sides of the border.
But that’s enough about price. Oscar Wilde said it best when he suggested that only a fool knows the price of everything and the value of nothing. The real value of losing out on billions of dollars in government revenue and corporate profitability was that it forced some long overdue strategic conversations within Canada.
Top of the discussion agenda was how to get our oil to sovereign coastlines, to touch high-value global markets without going through U.S. geography, politics and pipeline congestion. The Diff revived 60-year-old thinking about the country’s east-west energy security: Why should a major oil exporting country like Canada still be heavily reliant on importing barrels from the Middle East and Africa? Why doesn’t Alberta serve oil to Ontario, Quebec and the Maritimes through a west-to-east pipeline?
Other topics have cascaded on to the long, single-spaced list of concerns related to energy resource development, including the many complex facets of social licence like environment, safety, First Nations and prosperity. The dialogue even brought to the surface an awareness of the large contribution made by the oil and gas industry to Canada’s economy. Even if contentious subjects vexed certain constituencies, at least we could say there were dialogues, debates and daily newspaper headlines bringing issues out from under the carpet. That was the multibillion-dollar legacy of the Diff.
The oil and gas industry rallied too – there is nothing like a good margin squeeze to sharpen the innovative mind. Living with the prospect that the Diff could last for years, instilled a new, lean-and-mean mindset of cost discipline and process efficiency. Progressive companies that were hitherto victims of complacency began adopting new technologies, streamlining logistics and improving their process efficiencies. Two years of low prices did have its benefits.
The Diff is gone. But for how long is debatable. Myopic questions such as “Do these big pipeline projects like Keystone XL and Gateway matter any more?” are starting to pop up. Of course they do. Let’s not fool ourselves into thinking that near-term issues of price are more valuable than long-term strategic thinking.