It's costing the energy patch $50-million for every day that Canadian oil sells on the cheap.
That's an $18-billion annual hit to companies, and it could endure into 2013 or longer, according to a new analysis of the damage wreaked by an ongoing supply glut.
"If you don't think this is a big issue, think again," said CIBC World Markets Inc. analyst Andrew Potter, who calculated the dollar impact of the current lower value of Canadian oil.
Mr. Potter based his analysis on what he called, in a recent report, the "double discount" facing the Canadian oil patch. The industry spent 2011 watching the value of North American crude tumble relative to the international price of oil because of pipeline backups in Cushing, Okla., the key U.S. trading centre. Now, additional backups face Canadian oil moving into its key export market, the U.S. Midwest, and prices have fallen further.
With the benchmark West Texas Intermediate price at more $105 (U.S.) a barrel, Canadian light oil this month has barely broken $90, while Canadian heavy has sold in the mid-$70s.
Canadian heavy oil has been trading below U.S. prices by more than $30 (U.S.), while light oil has gone for a discount of greater than $10 – in February, it briefly sold for $25 below, until several crude refining outages in Alberta resulted in higher prices.
The implications are far-reaching. In Alberta, roughly 10.5 per cent of oil and gas revenue flows to the government in royalties, according to the University of Calgary School of Public Policy. That means provincial revenues are being diminished by some $5-million a day, or $1.9-billion a year.
"That hurts," said Jack Mintz, the school's executive director, and "doesn't include corporate taxes, which will get affected, too."
Opinions vary widely on how long the current discounts will last. Mr. Potter has suggested they could be sustained past 2013; whereas some companies, including Canadian Natural Resources Ltd., expect more normal pricing by June, after a raft of refinery repairs in April and May.
Regardless of how long the discounts last, there is little doubt they are having an impact. In a conference call to discuss his report Monday morning, Mr. Potter warned that CNRL cash flow, which touched a record $2.16-billion (Canadian) in the fourth quarter of 2011, could fall by 20 per cent in the first quarter of 2012.
A drop like that could alert markets to the severity of the issue and "there could be another wave of selling," he warned. Mr. Potter noted, however, that while the oil discounts are "important in terms of near-term cash flow," they should not cause major pain to the long-term value of Canadian energy producers.
Still, crude is selling so cheaply that it's prompting questions about future spending, especially by oil sands producers who are laying out billions of dollars on the belief that prices will remain strong.
And it means that although oil sands critics are concerned rapid expansion will cause irreparable environmental harm, "the potential worry is the reverse, that we actually have a contraction because there's just too much of the stuff," said Peter Tertzakian, the chief energy economist with ARC Financial Corp.
That possibility, he added, is "extreme, I'm not suggesting that at all." But, he said, for Canada, "the challenge here is not necessarily one of managing the growth. The challenge is optimizing the value of what we already produce."
The difficulty for Canada has been compounded by strong growth in North Dakota's Bakken play, which is pouring an extra 15,000 to 20,000 barrels a day every month onto the market. A good portion of that travels on pipelines built to handle Canadian crude, into Midwestern refinery markets that Canadian producers depend upon. That has exacerbated a situation that is unlikely to ease as both Bakken and oil sands output continues to surge.
For now, the prevailing oil patch view is that "these discounts are temporary," said Scott Bolton, who leads PricewaterhouseCoopers' energy practice. But he cautioned that Canada crude could continue to sell on the cheap long enough to reduce capital spending, especially given the obstacles that have confronted new pipeline projects such as Keystone XL and Northern Gateway.
"We could be looking at another couple of years before the situation starts to rectify itself," he said.