Oil Price War 4.0 Series Part 4 – Canada As Collateral Damage

In the first two articles of this series I put forth the thesis that the current oil price war was instigated by Russian President Vladimir Putin with the goal of causing substantial permanent damage to the U.S. shale industry, and the third article discussed three possible wildcards related to my thesis.

Despite the target of Putin’s price war being the U.S. shale industry, the Canadian oil industry is collateral damage, and is in fact getting hit harder than America’s. The price of heavy benchmark Western Canadian Select (WCS) closed at US$5.06/bbl on March 27, due both to the price war and massive demand destruction caused by the global coronavirus pandemic, compared to a still pathetic US$21.51 for North American benchmark West Texas Intermediate (WTI).

In this article, the fourth and final one of the series, I discuss the pros and cons of some potential government actions to protect the Canadian oil industry from annihilation, including a joint Canada-U.S. strategy proposed by Alberta Premier Jason Kenney on Friday.

But before doing so, I have two matters I wish to discuss related to the central thesis and one of the three wildcards, based on comments by some friends and colleagues over the past few days. On March 27, the title of a Reuters article read, “Russia Calls For New Enlarged OPEC Deal To Tackle Oil Demand Collapse,” in which Kirill Dmitriev, the head of Russia's sovereign wealth fund, said a new OPEC+ deal could potentially balance oil markets if additional countries agreed to make production cuts.

A headline and article such as this makes me nervous that my Putin price war thesis may be wrong —and at the same time hopeful for the Canadian oil industry — and to re-question all of my core assumptions. It’s easy to be wrong. But I continue to feel quite confident about my thesis, as Putin was a trained KGB officer, and “redirection” is a classic KGB technique.

A comment by a relatively minor Russian official such as Dmitriev may simply be a redirection, similar to Putin tricking MBS into “starting” the price war to quickly drive prices into the Russian president’s preferred price war range — the meeting was held before the high degree of demand destruction being caused by the pandemic had become apparent. Since the failed OPEC+ meeting on March 6, Kremlin officials have also tended to say, “What price war?”

Secondly, the new NAFTA would not stop President Donald Trump from adopting an oil quasi-cartel to protect solely the U.S. oil industry. His administration has ripped up, or simply ignored, numerous international treaties in the name of national interest during its three plus years in power.

Fortress CanAm strategy

On that note, I was pondering a joint Canada-U.S. strategy to counter Putin’s oil price war when I wrote the third article in this series, and suggested a U.S. oil quasi-cartel as one of the wildcards, and what policy options to discuss in this article to protect the Canadian oil industry.

At first blush, Kenney’s proposal for a Fortress CanAm, by using tariffs to protect Canadian and U.S. oil producers from “predatory dumping” of Saudi and Russian crude, and following up with a co-ordinated approach to curtail production once our two countries emerge from the COVID-19 pandemic, appears almost naïve.

In December, prior to the current market mayhem, the International Energy Agency (IEA) said the U.S. was on track to become a net oil — crude oil and petroleum products — exporter on a sustained basis in late 2020 or early 2021, after accomplishing this feat for the first time since 1947 in September 2019.

In that case, why would the U.S. agree to continue to import roughly 3.8 million bbls/d of Canadian crude oil under Kenney’s proposed joint strategy, apparently backing out a similar amount of American oil production? Because the U.S. is actually crude oil short, in particular heavy oil, Canada’s specialty, for its relatively complex refineries. In 2019, the U.S. imported 3.8 million bbls/d more crude oil than it exported, importing 6.8 million bbls/d of primarily heavier grades and exporting three million bbls/d of light shale oil.

The major downside of Kenney’s Fortress CanAm strategy is Canadian crude oil exports would be constrained by America’s need for imports under bi-national crude curtailment, which may not bounce back fully after the pandemic and would likely decline over time as the U.S. adopts measures to combat climate change — Trump isn’t going to be president forever. As mentioned in the third article in regards to an U.S. oil quasi cartel, Fortress CanAm would provide Putin with a partial victory.

Although there is logic to Kenney’s joint strategy proposal, I will continue to explore other ones as this alone won’t be enough to save the Canadian oil industry in the short term, while his proposal is no slam dunk. Kenney said himself that the timing of his proposal was an attempt to keep the Canadian oil industry from being sideswiped by potential unilateral actions by the U.S. to defend its own oil industry. And Kenney putting forth his proposal during a telephone call to a mere assistant of state, Francis Fannon, doesn’t exactly instill confidence, as does Prime Minister Justin Trudeau dodging a question about the proposal on March 28.

Stop-gap measures

A number of stop-gap measures have been suggested to support the Canadian oil industry, and while these are needed to save the industry in the short term, it will simply be a case of throwing good money after bad if they are not followed up by a more radical solution — such as Kenney’s Fortress CanAm. Demand destruction by the coronavirus pandemic may only last months, but Putin’s oil price war could last years.

The most widely anticipated stop-gap measure is a funding facility similar to the Troubled Asset Relief Program (TARP) that bailed out U.S. banks and automobile companies during the 2007-09 global financial crisis. A TARP-like measure by our federal government would provide capital to financially distressed oil and gas companies in exchange for equity stakes, just as the U.S. — and Canada — did for automobile companies in 2008.

On numerous occasions in recent weeks Kenney said the Alberta government would deepen crude oil production cuts under its ongoing curtailment program to protect the domestic industry. But with “catastrophically low” oil prices occurring so quickly, the province’s premier has now dismissed the idea, saying there is no point in doing it as leading companies such as Suncor Energy Inc. and Husky Energy Inc. are already shutting in output on a voluntary basis. At this point in time, Kenney must feel like the little Dutch boy with his thumb in the dike.

Anti-National Energy Program

If Kenney is unable to sell the Canadian and U.S. governments on Fortress CanAm, the next best radical strategy for protecting our oil industry from Putin’s price war may be a so-called anti-National Energy Program (NEP). Instead of paying the country’s oil producers below world prices for production sold domestically, as was the case under former prime minister Pierre Trudeau’s NEP, which ran from 1980-85, his son’s anti-NEP would pay them above world prices instead.

An anti-NEP would not provide the Canadian oil industry with the same level of support as Kenney’s Fortress CanAm for a given price of oil, as only 45 per cent of the country’s 5.6 million bbls/d of oil production was consumed domestically in 2019, but at least it would provide a subsidy for the industry as a whole. This would increase the possibility of exporting at least some crude oil to foreign markets at low international prices.

The adoption of an anti-NEP by the federal government would have the added benefit of giving back to the oil producing provinces — after taking for so long — nipping Western separatist sentiment in Alberta and Saskatchewan in the bud.