Oil curtailment should cease as soon as possible

Policy counterproductive, Robert McNally writes.

The year-long delay of the Enbridge pipeline reconstruction will understandably cause frustration for Alberta, a province that was already in need of more pipeline capacity. But the provincial government should avoid the temptation to build on its curtailment policy and introduce more stringent production quotas.

Quotas are ill-suited to managing this challenge or the broader issue of transportation bottlenecks.

Alberta’s problems began long ago: because its crude is landlocked, much of it must travel south to U.S. refiners. Pipelines are the cheapest way to transport crude on land, but new pipelines like Enbridge’s have been tied up in federal and political battles. This meant that when world crude prices fell sharply across the board last November, Alberta’s transportation congestion caused Western Canadian Select (WCS) to fall even further than other global crude prices, including the global benchmark West Texas Intermediate (WTI). WCS normally trades $10-$15 below WTI. But late last year the spread exploded to over $45 per barrel.

Throughout history, oil price busts have impelled normally competitive, free-market oil companies and officials to co-ordinate supply cuts. The Texas Railroad Commission’s quotas anchored a global oil supply management system, including other U.S. oil states and major international oil companies that successfully stabilized oil prices from 1932 to 1972. No wonder OPEC’s founders patterned themselves after Texas.

Alberta followed a similar playbook, mandating curtailed oil production beginning in January. While Alberta’s leadership did not take the decision lightly, slapping quotas on producers created two unintended new problems that threaten near-term recovery and the province’s long-term investment outlook.

Peculiarities of both Alberta crude and quota design initially resulted in a production cut significantly higher than what was intended. The price difference between WCS and WTI collapsed, but this collapse in the differential created another, much bigger problem: It vaporized incentives for industry to transport crude south to U.S. refineries by the only incremental means available — railcars.

The delay of Enbridge will only exacerbate this issue for Alberta producers this year because they have cancelled long-term contracts to move their oil by rail that could take months to reestablish. As production recovers, inventories will just fill up again because the rail cars are not there to move the crude.

Generally speaking, Alberta’s action has brought about renewed interest in the outsized impact volatile oil prices have on governments and the public. Alberta certainly isn’t the first to try to control a dynamic and mercurial market like crude oil.

Crude oil prices have been on a wild ride in recent years, swinging between $143 and $26 per barrel — a price volatility the world hasn’t seen in over 80 years. The reason extreme oil-price volatility has returned for the first time in four generations is that OPEC is unable to play the role of an effective swing producer, while supply and demand are imbalanced due to soaring Asian demand and U.S. shale production.

The return of extreme oil price volatility is deeply unsettling not just to oil producers, but consumers and governments as well. Today and for the foreseeable future, oil’s domination of transportation makes it the lifeblood of modern civilization. We’re all on the oil-price roller-coaster now.

So, while oil’s history and intrinsic wild price volatility merits some sympathy for provincial, state and national governments who have imposed quotas after price collapses, Alberta’s current curtailment policy makes little sense and is counterproductive.

For the sake of investment in Alberta and hemispheric energy security, Alberta’s quotas should be phased out as soon as possible. Market forces should be allowed to move crude south while Canada and the United States work to speed up permitting and building of pipelines.

We’re all on the oil-price roller-coaster now.