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Is Production Cut in Alberta Too Good for its Own Good?

Production cut from the Premier of Alberta reduces differentials between Western Canadian Select and WTI.

Alberta, one of the highest oil producing provinces of Canada, decided at the beginning of the month to curb output from the start of 2019. Premier of Alberta, Rachel Notley’s decision of reducing production of heavy crude by 8.7% has worked miraculously for oil prices in the country. Western Canadian Select (WCS), which has been witnessing a big discount against the U.S. benchmarks, due to the takeaway capacity constraints, is now too expensive to ship to refiners in the U.S. Gulf Coast. Most of the oil produced in the Alberta region is usually headed for refineries in the United States.

Differential Narrows

In October, the differential between WCS and WTI amounted up to $50 per barrel. Crude prices in Canada fell to $14 per barrel in November, which led the government to take a step to remove 325,000 barrels of oil production per day from the market from 2019-begining. Presently, heavy crude from Alberta is priced around $41 per barrel, leaving about $9 for midstream companies to support their cost of shipping, as the U.S. benchmark WTI is presently hovering just above $50 per barrel.

Producers’ Gain is Shippers’ Loss

Producers in the province are happy as they have witnessed a relatively higher price after a long time. Cenovus Energy Inc. CVE welcomed the government’s move. Since the announcement, the stock has gained nearly 7%. However, large companies like Suncor Energy Inc. SU and Imperial Oil Limited IMO, owning refineries as well as upstream assets, believe that the market is the most efficient tool that balances demand and supply, which determine differentials. Intervention from the government can affect the efficiency of market mechanism. Both these companies have a Zacks Rank #3 (Hold). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Moreover, the decision has made shipping heavy crude to Houston through TransCanada Corporation’s TRP Keystone pipeline pretty expensive. Enbridge Inc.’s ENB pipeline in the province is also facing the same problem. Notably, for companies without predetermined commitments, shipping crude down the Keystone pipeline will cost more than $15.50 per barrel while that through Enbridge’s mainline will cost $9.40 per barrel, per Bloomberg. Moreover, moving oil through rail to the Gulf costs around $18-$22 per barrel. With the differential failing to meet transport costs, shippers are likely to incur losses.

Where is Alberta Headed?

The North West Sturgeon Refinery near Edmonton is scheduled to commence commercial operations next year.  It has an estimated capacity of 80,000 barrels a day. Producers in Alberta are expected to benefit from the project. However, it is not sufficient to offset the impact of the price crisis.

Notley, looking for solutions to solve the ongoing price crisis in the region, recently announced her intention of building a new refinery in Alberta. Given the present situation in Alberta, she thinks a refinery will do wonders for the local economy and producers operating in the region. However, finding a solid refining project and investments associated with it will likely take time and there’s no relief in sight for the industry in the near term.

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Suncor Energy Inc. (SU) : Free Stock Analysis Report
 
Cenovus Energy Inc (CVE) : Free Stock Analysis Report
 
Imperial Oil Limited (IMO) : Free Stock Analysis Report
 
Enbridge Inc (ENB) : Free Stock Analysis Report
 
TransCanada Corporation (TRP) : Free Stock Analysis Report
 
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