Civil War In The Oilpatch And A Lougheed Solution

There would be no civil war in Western Canada’s oilpatch now, if the Alberta government and the province’s oil industry had followed the advice of former Premier Peter Lougheed last decade.

Lougheed counseled a go-slow approach to oilsands development, whereas Premier Ralph Klein and his successors chose a laissez-faire approach instead. This led to runaway growth, massive cost-overruns, less royalty revenue for the province per barrel produced, and a huge bull’s-eye for the global environmental movement to target.

As a result, it is ironic that one of the two sides in the oilpatch’s civil war is evoking Lougheed’s name to defend the adoption of mandatory curbs on Alberta’s oil production — which the Lougheed government did to protect against cash grabs by the Feds — to quickly counter massive discounts for western Canadian crude given a lack of pipeline and rail capacity to get it to market.

“This is not a new situation. If you look back in history, Peter Lougheed actually did this in the ’70s and ’80s, curtailed volumes out of Alberta to manage the pipeline space and ensure Albertans got a fair price for the oil,” said Steve Laut, executive vice-chairman of Canadian Natural Resources Limited (CNRL), in a recent interview with The Calgary Herald. “The legislation is already there. Lougheed has already developed a playbook and it’s there for them to look at and do.”

The management of CNRL has implicitly suggested oil companies opposed to the Alberta government again adopting an allotment system for producers are putting their interests ahead of the oil industry’s as a whole and the people of Alberta. “To be honest with you, the resources are owned by Albertans,” Laut said. “They are Alberta’s resources, so they should decide at what price they want to sell them at.”

However, other major western Canadian producers such as Suncor Energy Inc., Husky Energy Inc. and Imperial Oil Limited have balked at voluntary cuts to their heavy crude production — let alone accept mandatory ones — since they have more integrated business models, with lower crude prices simply meaning greater profits from their refinery units.

Suncor CEO Steve Williams hammered home this point during his company’s earning call on Nov. 1. “I have a great deal of sympathy for where the market is, and I understand the pressure that others are under.… If we were to get in that circumstance, we wouldn’t hesitate to pull throughput back, but our marginal barrel is making a profit, making cash,” Williams said.

Anyways, the excess oil production problem will take care of itself, according to Williams. “What’s happening is the market is working,” he said. “The higher-cost producers are having to pull back because they’re not making any margin on their last barrel. We are not in that circumstance.”

Williams is correct to suggest the market is working, at least to a degree. CNRL, Cenovus Energy Inc. and MEG Energy Corp. all announced voluntary heavy oil output cuts during their recent earnings calls. Tim McKay, president of CNRL, said that his company shut-in 10,000 bbls/d to 15,000 bbls/d in October, and is planning to defer 45,000 bbls/d to 55,000 bbls/d of production in November and December. MEG is moving forward a maintenance shutdown originally scheduled for next year to the fourth quarter, reducing output for this quarter by 4,000 bbls/d to 6,000 bbls/d.

Cenovus did not specifically indicate the quantity of crude currently being withheld from the market and for how long, but executive vice-president Drew Zieglgansberger said the program would likely be at lower volumes and a longer duration than in the first quarter, when the company reduced production by between 40,000 bbls/d to 50,000 bbls/d for six to seven weeks.

But the voluntary oil production cuts to date are likely a mere fraction of what’s required to rebalance the western Canadian market, suggesting it will take substantially more time and financial pain to bring regional crude differentials back to more normal levels, especially since Cenovus CEO Alex Pourbaix has warned that other producers have to help bear the burden. 

“We’re going to do our part, but we’re not going to carry the industry on our back.… We’re doing it because it is the right thing for our company and hopefully other industry players would have a similar view,” Pourbaix said during his company’s earnings call.

The amount of excess western Canadian crude weighing on regional crude prices is currently a hot topic of debate, with Hal Kvisle, former CEO of both TransCanada Corporation and Talisman Energy and another advocate of mandatory output cuts, suggesting a seven to eight per cent reduction — translating to roughly 260,000 bbls/d to 300,000 bbls/d — in Alberta oil production is required to do away with unusually large differentials.

Statistics Canada data appears to support Kvisle’s estimate, with almost 230,000 bbls/d of crude exported to the U.S. by truck — an extremely high-cost option — in August. But, of course, this is assuming above normal regional crude differentials are acceptable to Kvisle and others, given almost 230,000 bbls/d of crude was also exported by relatively high-cost rail in August, according to the National Energy Board.

The decision whether or not to adopt a mandatory allotment system appears a no-brainer, but the Alberta government has chosen to go another route.

On Oct. 22, after what she described as extensive discussions with oil industry leaders, Premier Rachel Notley said her government had identified increased crude-by-rail capacity as the best and quickest way to relieve massive discounts for western Canadian oil. Notley said the province would be presenting a business plan to the federal government in the near future outlining several strategies to do so, including getting the Feds to invest in locomotives and tanker cars. But wasn’t the failure of the two major railways — CN and CP — to serve as a stopgap for a lack of pipeline capacity the reason for these massive crude discounts in the first place?

In regards to the quick and effective option of mandatory oil production cuts, the Notley government simply punted. “The bare-bones legal authority for an allocation system does exist,” Mike McKinnon, a spokesman for Energy Minister Marg McCuaig-Boyd, said in a statement. “However, modern-day realities such as free trade agreements and integrated oilsands operations would make it far more complicated to simply institute a quota system.”

It is true the Notley government would make some enemies by adopting a Lougheed-like allotment system for oil producers, in particular, the most integrated oil companies, but Notley is supposed to serve the interests of Albertans first and foremost. At the same time, to the best of my knowledge, her government has no friends in the Alberta oilpatch. So what does Premier Notley have to lose on that front?

In terms of free trade agreements, the proportionality clause will be dropped once the United States Mexico Canada Agreement (USMCA) — the new NAFTA — is passed into law by the three countries, according to the law firm Blake, Cassels & Graydon LLP, conveniently allowing Alberta to export oil and to cut production as it sees fit.

Massive crude differentials are putting the western Canadian oil industry at risk, not just in terms of lower levels of capital spending — with Encana Corporation’s US$5.5 billion acquisition of U.S.-shale producer Newfield Exploration an extreme example — but by making many of our companies takeover targets, hostile and otherwise, especially by foreign oil companies currently receiving much higher world prices for their oil and gas production. Fewer oil company headquarters mean fewer high-quality jobs and even more vacant office space in downtown Calgary.

Premier Notley, the province of Alberta and our oil industry as a whole have taken enough of a beating. The time to channel Peter Lougheed and adopt a mandatory allotment system for the province’s oil producers is now. If you do so, the great man, if he was still alive, would be proud of you.