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Shale oil boom drives down prices versus rest of world

The wellhead at a hydraulic fracturing operation near Bowden, Alta. North American oil production is booming, but the resulting supply glut, weak demand, and refining and pipeline shortfalls are keeping the price of oil well below the international benchmark.

Jeff McIntosh for The Globe and Mail/jeff mcintosh The Globe and Mail

North America's crude market is increasingly diverging from the international scene, as rising U.S. production and weak demand pose long-term challenges for Canadian-based oil companies.

The U.S. is forecast to lead the non-OPEC world in crude production this year, with Canada not far behind. But that surge in supply is splashing against constraints in pipeline and refining capacity, and against a "peak demand" scenario in which U.S. consumption is not expected to return to the 1985 high water mark any time soon.

That stands in sharp contrast to the international crude market. Globally, high-growth emerging markets like China are driving demand higher, while new production capacity is increasingly concentrated in the hands of a few Persian Gulf states. Geopolitical risks – like the standoff over Iran's nuclear ambitions – add strain to a fundamentally tight market.

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The result is a sharp disconnect between international oil prices and what U.S. and Canadian producers can get for their crude, a divergence that will widen if refiners and pipeline companies fail to keep up with rising production.

Some analysts believe the growth in production in North America will continue to exceed market expectations and will swamp the mid-continental region with oil, driving down the benchmark U.S. crude, West Texas intermediate, and forcing Canadian producers to accept steep discounts on WTI prices .

Though buoyed recently by signs of U.S. economic growth, WTI prices remain $17 (U.S.) a barrel below North Sea Brent. Canadian price discounts against WTI are well above average, though they narrowed somewhat after Canadian Natural Resources Ltd. said last week its unplanned shutdown at the 100,000-barrel-per-day Horizon oil sands project would last until the end of March.

The threat of long-term price discounts poses a risk not only to the Canadian companies – whose oil sands projects have some of the highest costs per barrel in the world – but also to provinces such as Alberta and Saskatchewan which depend heavily on price-based royalties for their budgetary revenues.

North American oil production is witnessing a resurgence that many have compared to the shale gas boom that fundamentally changed the continental energy picture. Indeed, the explosion of "tight, light oil" production – such as North Dakota's Bakken play – relies on the same high-tech drilling and hydraulic fracturing techniques that unlocked shale gas.

Combined with lower demand and increased biofuel production, growth in oil output has resulted in a reduction of U.S. imports to 8 million barrels per day at the end of 2011, from 13 million barrels per day in mid-2007. Imports as a percentage of U.S. demand dropped to 45 per cent last year, from 60 per cent in 2005.

In recent report, Citigroup analysts forecast that additional tight oil production could add as much as 3 million barrels per day to U.S. supply by 2020, with the Gulf of Mexico output climbing by another 2 million barrels per day.

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In addition to North Dakota's booming Bakken, more production is expected in Texas's Eagle Ford and Permian Basin, Colorado's Niobara, Louisiana's Mississippi Lime, Ohio's Utica and the Monterey basin in California, a state that the U.S. Energy Information Administration estimates could hold 15 billion barrels of recoverable reserves, several times greater than the Bakken.

"The shale oil revolution is in full swing in North America," the Citigroup analysts wrote.

"For now, the immediate, tangible market impact will first be to drive down oil prices in the U.S. versus the rest of the world," they said, adding the discounts will not disappear "until mid-decade at the earliest and perhaps not until much later."

Landlocked producers, such as those in mid-continental U.S. and in Canada, face several years of pipeline bottlenecks, even as companies push ahead with plans like TransCanada Corp.'s Keystone XL and Enbridge Inc.'s Northern Gateway, which are designed to deliver Alberta oil sands bitumen to the U.S. Gulf Coast and Pacific Rim market, respectively.

Both Ottawa and the Alberta government have focused on the value-destroying pipeline logjam when they promote both the Keystone XL project and efforts to export to Asia.

Still, North America is not immune to international oil market trends. Crude oil and refined petroleum products like gasoline and diesel are globally-traded commodities that – despite price differentials – generally reflect the worldwide supply-demand balance.

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Booming production in the U.S. and Canada is welcome news in a world where global producers are struggling to keep pace with demand, and geopolitical tensions threaten supply disruptions that will send prices even higher.

Iran said on Sunday it was ending oil sales to Britain and France in retaliation for a European Union decision to end purchases of Iranian oil by July 1. Neither of those countries were major customers for Tehran. But markets will be roiled as Greece, Spain and Italy – which are significant users of Iranian crude – look to comply with the boycott. Iran has also threatened to block the Strait of Hormuz outlet from the Persian Gulf.

While U.S. oil imports will drop by 4 million barrels per day by 2020, Chinese imports will grow by 7 million barrels per day, the Paris-based International Energy Agency forecasts.

In a video appearance before a Senate committee in Ottawa last week, the IEA's chief economist said Canada's growing oil sands production – and energy supply, generally – represent critical elements in the world's effort to meet rising demand.

"Canada is one of the cornerstones of the global energy system and will stay so for several years to come," Fatih Birol told the senators.

The IEA economist said tensions over Iran are only exacerbating fundamental concerns about tight supply and the concentration of capacity in four countries of the Persian Gulf: Saudi Arabia, Iraq, Iran and the United Arab Emirates.

"I believe the main issue are fundamentals," Mr. Birol said in an interview from Paris. He noted that North Sea Brent – the main international benchmark – was trading above $100 per barrel before the Iranian tensions arose.

"As I have said before, the era of cheap oil is over."

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About the Author
Global Energy Reporter

Shawn McCarthy is an Ottawa-based, national business correspondent for The Globe and Mail, covering a global energy beat. He writes on various aspects of the international energy industry, from oil and gas production and refining, to the development of new technologies, to the business implications of climate-change regulations. More

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