The Sole Silver Bullet For Western Canada’s Crude Crisis

The politicians are pondering how to quickly counter catastrophic prices for Western Canadian crude oil.

 “The complexities and the layers involved require us to really listen to the experts, and that’s where sitting down with industry leaders this afternoon will hopefully give us an approach that will make sense,” Prime Minister Justin Trudeau said in Calgary on Thursday.

On Monday, Premier Rachel Notley sent out a posse of three, with a two-to-four week timeline to find a silver bullet.

Folks, this ain’t no rocket science. All the options are already in clear sight on the table. The most effective of them, albeit not necessarily a fair one, only requires political will on the part of the Notley government to pull the trigger.

The best option to get regional crude differentials back to more reasonable levels, significant additional pipeline and rail capacity to move our crude to market, will take time, and with the exception of Enbridge’s Line 3 Replacement project the amount of time for additional oil pipeline capacity is highly uncertain.

The Alberta government has touted, and thrown money at other options, partial-upgrading to decrease the amount of diluent needed to ship bitumen — and hence, indirectly increase the amount of pipeline and rail capacity available for paying crude —  and value-add oil refining and petrochemical projects to increase domestic consumption of our crude, but these projects will take years and years to bear fruit, and likely would no more than put a dent in current crude differentials.

Squeezing air barrels off of the Enbridge system has been identified by the Alberta government and executives from some oil companies as another option to counter our crude price crisis, but this is likely no more than a red herring. The nomination system certainly has its warts, with some companies overbooking on the system, but according to Enbridge its pipelines are running at virtually full capacity with real barrels, suggesting fixing it means no more than chump change.

This leaves us with two relatively timely options to restore Western Canadian crude prices to reasonable levels, the ones presented to Premier Notley at a closed-door meeting with high-level executives from many of our most important oil companies in Calgary on October 22, and the two sides have been fighting about ever since —  voluntary versus mandatory production cuts to relieve the regional supply glut.

Executives from Canadian Natural Resources Limited and Nexen Energy argued in favour of temporary, mandatory production cuts at the Calgary meeting — Cenovus Energy and a number of smaller producers have since publicly supported this position.

These companies encouraged the Alberta government to immediately curtail provincial crude production, invoking powers last used by Premier Peter Lougheed back in the 1980s. Some companies were said to have called for a 10 per cent across-the-board cut, or about 380,000 bbls/d, for as long as it takes to revive regional crude prices.

However, Suncor Energy, Imperial Oil, and Husky Energy, the three most integrated of the Canadian oil companies, who tend to make on the refining side what they lose on the production side —  if not more —  in this low price environment strenuously argued that the free market should be allowed to work out the oversupply issue instead, through voluntary cuts by companies that cannot afford to produce at these prices.

These integrated companies are correct to suggest the market is working, at least to a degree. A number of large and small companies have announced voluntary heavy oil output cuts, including industry heavyweights CNRL and Cenovus. The Daily Oil Bulletin estimated these to total around 122,000 bbls/d for November and December on November 9, and 140,000 bbls/d has since being bandied about in the media.

At the meeting in Calgary, during their third quarter earnings calls and in the media since, opponents to temporary, mandatory production cuts by the Alberta government have provided a number of reasons they are a bad idea, some better than others.

For example, during his company’s earnings call on November 2, Imperial Oil CEO Rich Kruger was correct to suggest that mandatory production quotas simply aren’t fair. “In market conditions like this, anything on the high cost or marginal end would be at risk,” Kruger said. “Our view is those situations are the result of choices and strategies and investments that individual companies have made over time … Our view is you live with the consequences of your decisions in your investments.”

In a subsequent interview Kruger went on to say: “Short-term market manipulation will not resolve the underlying structural issues. To me, it’s kind of like treating a patient with a major head injury with Aspirin, and hoping it solves the problem. It won’t.” No one is suggesting temporary, mandatory cuts are a permanent cure for Western Canada’s crude crisis. They are simply being recommended as a stop gap until new pipeline and rail capacity can be brought on line.

In the same interview Kruger also said: “Government intervention with the objective to manipulate market prices would send a very negative signal to investors about doing business in Alberta and in Canada.” Mark Scholz, president of the Canadian Association of Oilwell Drilling Contractors, has also warned of its negative impact on capital investment, but with a shorter term focus. “We unequivocally do not support that direction,” Scholz said. “If we shut down the winter drilling season, there will be collateral damage in the service industry, no question.”

A temporary, mandatory production cut may have a negative impact on capital investment in the short and longer term, whereas sub-US$20/bbl Western Canadian Select (WCS), which may or may not cover the cost of diluent, let alone operating and capital costs, definitely will.

At the same time, massive crude differentials are making many of our oil companies takeover targets, hostile and otherwise, especially by foreign oil companies currently receiving much higher world prices for their oil and gas production. And the longer these differentials last, the larger the bullseye on the Western Canadian oil industry. Fewer oil company headquarters mean less high-quality jobs and even more vacant office space in downtown Calgary.

There is no doubt a Lougheed-like mandatory allotment system for Alberta’s oil producers would provide a more timely solution to the crude crisis than voluntary cuts, and hence provide greater protection to Western Canada’s oil industry as we know it, and potentially provide a more rapid rebound in capital spending as well.

In addition, every day difference between these two options to be effective will cost the Canadian economy $84 million —  via lost revenue to the oil industry —  and the Alberta government $18 million, based on the province’s own estimate. There is only one silver bullet, mandated production cuts, and unfortunately, it’s a rather tarnished one.