The Government of Alberta’s move ordering oil producers in the province to temporarily cut output by 8.7 per cent reminds us of what Winston Churchill once said about democracy: It’s the worst possible idea – except for all the others.
In a properly functioning market, Alberta’s plan to turn back the taps would be costly, counterproductive and irrational. In normal times, no sane government would even consider it. The thesaurus would strain to contain all the words necessary to condemn it.
But just at this moment, the Alberta oil market is not a normal market. It’s completely out of whack, thanks to a combination of bad luck and a decade’s worth of failed federal policy. The market is so messed up that less oil output stands a very good chance of leading to more oil royalties for the people of Alberta.
The provincial government says that if oil prices rise as much as it hoped, it will spell an additional $1.1-billion in royalties next year. According to economists at BMO Capital Markets, every $1 narrowing of the price differential between Western Canada Select and the West Texas Intermediate benchmark puts an extra $210-million in the Alberta treasury.
Right now, Alberta oil is stuck. The cause is an acute shortage of shipping capacity, notably pipelines. That has oil producers competing with one another for space in the pipe or on rail cars. The result is a deeply depressed Alberta oil price.
In the long run, everyone knows what the solution is: build at least one major new pipeline, and expand a few existing ones.
That’s why Enbridge is pursuing the Line 3 Replacement program, from Alberta to Wisconsin. It’s why TransCanada has spent years trying to finish the Keystone XL project, in the face of political and regulatory obstacles in the United States. It’s why the Trudeau government bought the critical Trans Mountain pipeline from Kinder Morgan, to give its expansion the best chance of completion.
In the long run, more pipe is the solution. In the long run, there’s reason to believe more pipe will be built. But as the economist John Maynard Keynes said, in the long run, we’re all dead. What about the short run? What about the next year or three? Should Alberta simply hunker down and accept losses?
No, it should not. Under the extremely unusual circumstances of a broken market, the Notley government’s decision to order a temporary production cut makes sense. The best analysis suggests that, if less oil is produced in the coming months, prices will rise, the gap between Alberta and global prices will narrow, and the Alberta government will end up with higher oil royalties.
The plan is to cut Alberta crude oil and bitumen production by 325,000 barrels a day, beginning in January. The expectation is that the cut will get smaller each month, and could end after a year.
By that time, Line 3 is expected to be up and running. The thousands of rail cars that Alberta is leasing will also begin to come on line. The former is a permanent solution. The latter are temporary measures.
And it’s a sign of confidence in the future – the long-term future – that the market itself isn’t willing to invest in enough rail cars to clear the backlog of oil. Rail is generally more expensive than pipe, and investors are betting that more pipe will get built. Eventually.
That’s why, in the long run, the gap between Alberta and world prices is likely to narrow. Keystone XL keeps meeting American regulatory surprises, but there’s reason to believe it will ultimately go through.
Barring further delays in the United States, Line 3 will come on-stream in a year. And the courts have laid out a road map for environmental review and Indigenous consultation on Trans Mountain. If Ottawa puts its all behind it, eventual completion is likely.
But in the short term – in the here and now – Alberta had to step in. It couldn’t just dream about tomorrow. It had to increase the value of the province’s natural resources, today. Pumping less oil will have costs, temporarily lowering Alberta’s gross domestic product and possibly lowering federal tax revenues by as much as $2-billion, according to BMO. Nevertheless, faced with no good alternatives, the Notley government made the least bad choice.