Production curtailmEnt backfiring on albErta
Movement by rail has become uneconomical, Martin King says.
Alberta’s crude oil production curtailment has been working so well of late in terms of generating stronger prices and lowering crude oil inventories, that Premier Rachel Notley recently announced an easing of the curtailment mandate.
As is often the case when the government tries to level the playing field, things often tilt in the other direction when least expected. The most recent data seem to be telling a different story as the province’s crude oil inventories are now rising at the same time that rail shipments have been falling. So how well is the curtailment really working?
Although crude oil inventories have declined from critically high (and price-depressing) levels, the higher prices for Alberta crude have also squeezed the economics of moving crude by rail, at the same time that pipelines remain completely full.
The end result is that slowing rail shipments may now be contributing to the unwanted outcome of rising inventories, the very opposite of what the province intended. The production curtailment — and the narrowing price gap it artificially created between Western Canadian Select and West Texas Intermediate crudes — does not allow for economical crudeby-rail shipments, and the data appear to be proving this out.
Rail shipment of crude oil, and the pricing economics to support it, remains one of the main ways by which producers must
ship crude out of Alberta due to limited pipeline capacity. Which is why Alberta is in the process of trying to procure more rail cars for the province, though at a cost of at least $1 billion and a timeline of being in use by late 2019, they won’t do much good.
When the price of Alberta crude was at its lowest in November and December, and the price difference between WCS and WTI at its highest, crude-by-rail shipments peaked. Rail shipping threw a valuable lifeline to producers who needed to reduce excess supply, one of the key goals of curtailment.
When curtailment manipulated the price of WCS crude, it quickly undercut the economics of this vital transportation method. Now, U.S. Gulf Coast refiners may not be able to afford to receive Alberta crude by rail, and at a time when Alberta’s heavy oil supplies are acutely desired thanks to embargoes by the United States on Venezuela.
It’s simple rail economics. When WCS is 15 to 20 dollars cheaper than WTI, producers and refiners can afford to ship by rail. Once the price difference between the two crudes sharply narrowed, rail is too expensive.
Imperial Oil was the first to ring the alarm that the price difference induced by curtailment didn’t justify shipping by rail. This company, which accounted for almost half of rail shipments in December, has decided to drop
its rail shipments to “effectively zero” in February.
And it unfortunately wouldn’t matter if curtailment ended tomorrow; it could take months for Imperial to start shipping by rail again once the decision is reversed and only if the price difference justifies the railing cost.
A few days later Suncor made a similar statement.
And that is the quandary that curtailment has created: When the price difference was so high, the government’s impulse to do something, anything, to fix the problem created a new one; it’s now too expensive to ship by rail and crude inventories are starting to rebuild.
Alberta producers have been very good at increasing crude oil supplies so rapidly, against a backdrop of limited export pipeline capacity, that it created an unexpected low pricing and bloated inventory outcome of its own making.
However, market forces prior to the government’s intervention, were starting to fix that unexpected outcome with low prices forcing voluntary (not mandated) production curtailments by some oil producers and incentivizing record rail shipments.
By the Alberta government trying to fix the problem more quickly, it has unwittingly undermined one budding transportation alternative, crude by rail, as well as creating a host of other issues affecting jobs and future investment in the province.
We need a process to exit this period of market intervention and get Alberta’s oil moving again to market as efficiently and as cost-effectively as possible.
It unfortunately wouldn’t matter if curtailment ended tomorrow.