By slashing oil production to prop up prices, Alberta Premier Rachel Notley joins an age-old industry tradition that always generates unintended consequences.
The first, it appears, is a breakdown in cohesion among the producers that are party to the curbs. It’s all very OPEC.
This part is already happening. Some Alberta oil sands producers, such as Cenovus Energy Inc. and MEG Energy Corp., are supportive of output being squelched, saying the crisis demands what is almost a nuclear option in an industry dominated by free-marketeers. Imperial Oil Ltd., Suncor Energy Inc. and Husky Energy Inc., wanted no tinkering. This will make for tense meetings of the Canadian Association of Petroleum Producers.
Recall that the Organization of the Petroleum Exporting Countries is often pressed to tinker with output levels when global oil prices are deemed to be too high, as in 2008, or too low, as in the past few years.
In a dance led by Saudi Arabia, members of the cartel are either onside with plans or opposed, depending largely on the state of their own economies. It gets heated. Some cheat. Rifts form. Witness Qatar’s bombshell announcement on Monday that it is leaving OPEC.
Of course, Alberta is no cartel. Its problem is that it’s hostage to a market, not in control of one. A major increase in province-wide bitumen and heavy-oil production, in concert with insufficient pipeline capacity and reliance on one major export customer, the United States, has led to brimming storage tanks and a collapse in prices. There’s no shortage of blame being shifted on how this has come to pass. In Calgary, the federal Liberals are a frequent target.
It’s clear the Premier did not go into production quotas lightly and, by all accounts, her consultations with senior finance and industry professionals in the lead-up showed her solid grasp of the gravity of the situation. It follows her plans to buy thousands of rail cars as a stopgap measure with pipeline approvals stuck in the mire.
Any disagreement in the producer ranks has to be treated as a necessary evil.
Heavy oil has been selling for, basically, peanuts. Last month, Western Canadian Select heavy crude blend (WCS) fetched less than US$15 a barrel, nearly US$36 less than benchmark U.S. light oil West Texas Intermediate (WTI). No producer makes money at that price.
On Sunday evening, Ms. Notley announced that her government was tightening the taps to the tune of 325,000 barrels a day, or 8.7 per cent. That’s a lot, and it will be fascinating to see how her government deals with the side effects. Oil sands producers in the past have warned that shutting down steam-driven production from some facilities could mean long-term damage to reservoirs. There will also be an effect on the pricing for that condensate that is blended with bitumen so it can flow in pipelines, given the drop in demand. Natural gas demand will also fall.
But the oil market responded immediately. The discount on WCS compared with WTI narrowed by US$8 to US$20.50 a barrel, putting the price of a barrel of WCS at US$32.22, according to Net Energy Exchange.
This shows one reason why large, integrated companies were less than enamored with Ms. Notley’s intervention in the market. Free-market philosophy aside, the paltry cost of crude in recent months had made the business of making gasoline and other fuels incredibly profitable. But given the larger consequences, it couldn’t last.
It is a factor that did not go unnoticed on Monday. When many Canadian energy stocks exploded out of the gate in reaction to Ms. Notley’s announcement, shares of the integrated producers weakened during the day.
Suncor said it is assessing the effect of the cuts on its financial and operating targets for 2019. "Suncor believes the market is the most effective means to balance supply and demand and normalize differentials. Less economic production was being curtailed and differentials were narrowing as a result of market forces,” the company said in a statement.
Clearly, for Ms. Notley and the bulk of the industry, however, that wasn’t happening fast enough to avert the industrial and economic crisis that was unfolding.