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Canada’s Oil Crisis Is Far From Over

Nick Cunningham

Alberta decided to extend its mandatory production cuts through the end of 2020 because of a lack of pipeline capacity.

The former New Democratic Premier Rachel Notley imposed the curtailments, but the current United Conservative Premier Jason Kenney is extending them. “We’re doing this because we have to. In the short term, we don’t have the capacity to move the production,” Alberta Energy Minister Sonya Savage told reporters in Calgary.

The cuts were controversial, but succeeded in trimming the supply glut and sharply pushing up prices for Western Canada Select (WCS), which had plunged to less than $15 per barrel prior to the announcement.

Alberta has been steadily and gradually unwinding the mandatory limits this year, and by October, the limits will drop to roughly 100,000 bpd, down from 325,000 bpd initially.

But chronic pipeline delays prevent a full lifting of the cuts. The delay of the Line 3 replacement in particular has surprised provincial authorities. The replacement is slated to double the existing line’s throughput, and was supposed to come online at the end of 2019, but it has been pushed off until late 2020 at the earliest. Indigenous and environmental groups continue to oppose the project, so more delays are possible.

The decision to extend the mandatory cuts presents “upside risk” to WCS price forecasts, according to a report from Goldman Sachs. There will also be a “ceiling” on the WCS discount relative to WTI, “as free markets will be less able to function and drive differentials toward the marginal cost of crude-by-rail transportation,” Goldman analysts wrote.

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Goldman had originally forecasted a WCS price discount of $17.50-per-barrel relative to WTI in the third quarter, $20 in the fourth quarter, and $21 in 2020. It has not yet updated its forecast to incorporate the extension of the mandatory curbs by Alberta, but noted that the discounts will be narrower than originally anticipated. Shipping oil by rail implies a discount of around $15-$17 per barrel, Goldman said.

Forthcoming regulations on sulfur content in marine fuels by the International Maritime Organization (IMO) are also negative for Canada’s heavy oil. Beginning in 2020, the market for high-sulfur fuels is set to shrink, and that could show up with a greater discount for WCS.

Production curbs from Alberta is a “net positive” to cash flow though, with higher WCS prices offsetting the pain of lower output, the investment bank said. Suncor is Goldman’s “top pick” in terms of Canadian oil stocks. At the same time, the cuts are negative for refiners, who have less oil to work with and higher prices.

While Alberta has stabilized the market, the lack of pipelines continues to be a drag on Canada’s oil industry. “Longer-term, we think this results in a deferral of growth capex in the industry, most notably Imperial’s Aspen project, Canadian Natural’s Horizon expansion and debottlenecking projects, and Suncor’s in-situ replication projects and Fort Hills debottlenecking,” Goldman Sachs said. “Given this, we expect 2020 capex budgets to fall relative to initial expectations, and increased deleveraging and capital returns to materialize.”

“We expect limited project sanctions to take place until production curtailments are lifted and greater clarity is achieved around export pipelines,” Goldman said.

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In fact, since the 2014 oil market meltdown, Alberta has seen an exodus of investment and capital. Major international oil companies have mostly exited Alberta’s oil industry altogether. The latest example is Kinder Morgan’s decision to sell off its remaining holdings in Canada to Pembina Pipeline Co. for about $3.3 billion. Bloomberg estimates that Canada has seen roughly $30 billion in divestitures in the past three years. Total capital expenditures have declined for five straight years.

The negatives for Canadian oil are multiple: Pipeline bottlenecks, heavier and lower quality oil, mandatory production cuts, high sulfur content, and high-cost and carbon-intensive oil that is increasingly a target in the global efforts to address climate change.

Trans Mountain Corp. has restarted construction on the Trans Mountain Expansion, more than a year after it ran into a brick wall of delays. The federal government essentially nationalized the project in 2018 after Kinder Morgan wanted to exit, and court orders suspended construction. The project still has permits outstanding, but the government-owned corporation hopes to obtain those in the coming months. If all goes according to plan, the pipeline could be operational by mid-2022.

“If they thought things were getting better in Canada, they might hold on, but they don’t see things getting better,” Laura Lau, of Brompton Corp. in Toronto, told Bloomberg in an interview. “The pipeline situation is getting worse; everything is getting worse.”

By Nick Cunningham of Oilprice.com

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