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The bright side of Canada's weak oil prices

It could be said that Canada's oil industry is facing a crude reality these days.

Stymied by insufficient pipeline capacity, Alberta's oil patch is facing problems in getting its product to market. The resulting glut has driven the price for Western Canadian Select oil more than $30 (U.S.) a barrel below that for West Texas Intermediate crude.

The steep discount hurts the profitability of the Canadian industry and could put a damper on investment in some of Alberta's biggest energy projects. That has raised fears of a broader slowdown since the oil and gas industry accounted for 15 per cent of Canada's capital investment as recently as 2011.

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However, a new report from RBC Economics says that oil patch investment will continue to provide a bright spot for the Canadian economy. It also argues that there is good reason to think that the spread between Western Canadian oil and West Texas crude will narrow in the years ahead.

The report notes that swelling production from the oil patch has outpaced pipeline expansion, creating a bottleneck that will be tough to unplug without a direct southbound corridor (think Keystone XL) and an east-west pipeline (Saint John's enormous oil refinery says hello).

The good news is that the current $30-plus discount on every barrel of Canadian oil provides powerful motivation to build the needed pipelines.

The larger the price difference grows between Alberta and U.S. oil, "the more incentive there is to add infrastructure to get product into regions that earn a higher return," write RBC economists Nathan Janzen and Josh Nye.

The two cite estimates that about 1.4 million barrels a day of pipeline capacity will be added from Cushing, Okla., to the Gulf Coast over the next two years. They expect the new capacity to help narrow the price differential between Alberta and Texas oil. If the Keystone XL pipeline is completed, as expected, by early 2015, it will squeeze the pricing gap even tighter.

Meanwhile, oil companies have good reason to continue investing in production since extraction projects aren't as expensive as they used to be. Steam-assisted gravity drainage (SAGD) methods are cheaper than surface mining and should prevent the current low prices for Canadian crude from deterring many projects, the authors write. According to RBC, the break-even price for SAGD projects is about $52 a barrel, well below the current price of about $65, so they remain worthwhile ventures.

The proof of that can be seen in corporate budgets. Canadian Natural Resources Ltd. is raising its capital expenditures budget by nearly 8 per cent this year over last; Suncor Energy Inc., about 10 per cent; and Canadian Oil Sands Ltd., more than 18 per cent.

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So, yes, the price spread is hurting – but RBC makes a case that its impact, at least on business investment, is relatively limited. It expects investment to grow at a 5 to 7 per cent pace over the next two years.

Considering that spending in the oil and gas industry made up more than 3 per cent of GDP in 2011, this is good news, not just for Alberta, but for Canada.

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About the Author

Josh O’Kane is a reporter with The Globe and Mail's Report on Business. Since joining the paper in 2011, he has told stories from New Brunswick to Nairobi. More


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