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Is This The Next Disaster For Canadian Drillers?

Irina Slav

The government of Alberta this week took an unprecedented decision to enforce a crude oil production cut so excess inventories could be shrunk and the price of western Canadian grades could improve, but the industry’s problems are far from over. They will be among the hardest hit by the International Maritime Organization’s new emission rules, to enter into effect in two years, which will require a reduction of the sulfur content of bunkering fuel to 0.5 percent from 3.5 percent.

“We’ve got challenges with respect to pipelines, we’ve got challenges with respect to rail and now we’ve got challenges with respect to our demand market,” Bloomberg quoted the chief executive officer of the Canadian Energy Research Institute as saying at a presentation this week. The emission rules will start affecting the price of Canadian crude next year, Allan Fogwill, along with other analysts, believes.

Canadian crude is heavy and sour, that is, high in sulfur content, which is the obvious reason why the IMO changes would affect prices, adding to already substantial pressure from pipeline bottlenecks and the rising amount of crude that is being transported by costlier rail.

According to IHS Markit analyst Kurt Barrow, the emission rules will make Canadian crude another $7-8 cheaper than West Texas Intermediate in 2019. Even the completion of the Line 3 replacement project won’t offset these losses, although it will add 375,000 bpd to daily pipeline capacity.

Another analyst, Wood Mackenzie research director Mark Oberstoetter, told Bloomberg Western Canadian Select will likely be US$20 cheaper than WTI for most of 2019, which is the cost of railway transportation for Albertan heavy crude. All in all, things are looking pretty bad. But how bad is bad?

Related: OPEC Oil Exports Jump Ahead Of Meeting

For one thing, Canadian heavy is the main heavy crude feedstock for U.S. refineries. Canada is in fact the biggest exporter of crude to the United States, at a rate of over 4 million bpd as of September, according to data from the Energy Information Administration, which compares with around 3 million bpd from OPEC. There aren’t a whole lot of alternative sources of heavy crude, what with Venezuela spiraling down into a deeper crisis and production falling along with exports.

For another, the new emission rules will not eliminate demand for fuel oil, it will only reduce it. Reuters recently polled 33 refiners on their IMO 2020 plans and found that although as much as 40 percent planned to stop producing high-sulfur fuel oil, the rest had no plans to suspend production despite the expected drop in demand. Instead, they were upgrading their refineries to further process the residual petroleum product into more gasoline and diesel, and also banking on stable demand from the power generation sector: when fuel oil becomes cheap enough, it serves as an alternative to coal.

The new emission rules will definitely present a new challenge to Albertan producers on top of what they already have to deal with. However, the importance of their crude for U.S. refineries and the low prices that have opened up the Chinese refining market for more Canadian oil exports should serve as a cushion against major price and production shocks.

By Irina Slav for Oilprice.com

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