Canada’s great big oil bind
Western Canada’s hydrocarbon sector is constrained in virtually every sense of the word.
It’s physically constrained. It has been well known for some time that the growing supply of Western Canadian oil and gas was on course to overtake the pipeline capacity capable of carrying it out of province. However, it became increasingly clear this year that crude-by-rail capacity has also lagged demand, stranding oil in Western Canada. The result: the value of Western Canadian crude oil has diminished, and with it the economic potential of Canada.
The price is constrained. In recent weeks, the price difference between Western Canadian heavy crude oil and the North American benchmark West Texas Intermediate (WTI) grew to around a whopping $50 per barrel lower than WTI. It has since subsided but remains well above $40/bbl. At this point, the difference in price, or discount, is greater than the value of crude oil at the wellhead. To add some context, in 2017, the price difference between these two crudes was just over $11/bbl. (All prices are in U.S. dollars.)
The price of light oil has also broken from historical norms in recent weeks, trading down well over $30/bbl beneath WTI, well in excess of historical norms.
Expanding price discounts have pushed the absolute price of heavy oil in Western Canada into the $20s and light oil into the $40s while global prices have reached levels not seen since 2014.
In fact, it is no longer the case that global oil prices are holding back Western Canada. IHS Markit estimates the lowest-cost oilsands project has fallen from requiring a WTI price of $60 to $70/bbl in 2014 to $45 to $55/bbl, well below the current WTI average around $70/bbl. And the average emissions intensity of oilsands extraction has continued to fall through this period, declining 11 per cent from 2014 to 2018.
Yet the potential for vast new development in Western Canada is also constrained. Producers have just begun to understand the potential of emerging unconventional and new technology plays in Western Canada. This includes the Montney formation (spreading from just west of Edmonton and across the B.C. border), which is physically twice the area of the Permian Basin and 30-per-cent thicker at its maximum.
There are also the new technology plays of the Viking formation (spread between central Alberta and west-central Saskatchewan) and the Cardium formation (western Alberta). The Cardium is one of the largest oil and gas deposits in the world. The application of new technologies developed over the past few years are allowing producers to target liquidrich regions with much greater precision.
The results are remarkable, including break-evens ranging between around $20 to $35/bbl. This could be the start of an entirely new engine of Western Canadian crude-oil-production growth.
There are still negative stereotypes about the inefficiencies of Western Canadian production, well earned over years of cost escalation resulting from the rapid expansion of the oilsands in the years preceding the price collapse. However, much has changed since then and the potential of the Western Canadian energy sector is just as huge as its resources.
But it’s constrained. Current differentials are taking the wind out of the sails of producers, their revenues, and their capital plans. Numerous estimates of the economic losses have been presented, however the impact is broader than just the reduction in revenues from artificially low oil prices. The current situation is reducing cash flows, depressing share prices, impairing drilling activity, delaying project approvals, reducing employment opportunities and affecting access to capital.
Western Canada is not known for having “easy” oil and the growing difficulty in getting it to market only underscores this point. But global demand for oil continues to grow, topping 100 million barrels a day this year. Meanwhile Western Canadian producers have managed to drive down both their costs and their emissions intensity and new innovations look poised to unlock even greater potential from the region. Unfortunately, as long as Western Canada is constrained, that potential will be delayed and the benefits of so much oil and gas to the entire Canadian economy will be far less than they could be.