Canada鈥檚 oil producers have been grappling with a lack of transportation, access to markets, and limited storage capacity, which the Alberta government managed through a production curtailment order for 2019 that remains in effect. Yet in recent weeks, global oil market turmoil has had relatively less impact on the Canadian oil patch because of its isolation. The paradox is that the short-term benefit of insulation from global market price volatility underscores the long-term problems for Canadian oil that today is sold at a discount in the United States.
With the rapid spread of COVID-19 decreasing oil demand around the world and a coinciding market share war, oil prices descended to last month and have yet to stabilize.[1] Canada鈥檚 benchmark Western Canadian Select (WCS) started March at and proceeded to plummet.[2] As of April 28, WCS has not experienced the volatile crash into negative prices seen south of the border on April 20, but it has languished in single digit prices, below other world oil prices, with its discount. In the last month, WCS rose above twice.[3]
Oil prices are not like other commodity prices around the world because they do not hover around daily production costs. Oil prices vary slightly by type of oil and transportation costs, but they are predominantly based off demand and supply cues from global markets. With low and uncertain demand, oil sellers have become oil stockpilers. Moreover, in an U.S oil storage shortage, the negative prices of Western Texas Intermediate (WTI), North America鈥檚 oil benchmark, on April 20 reflected a first panic as U.S. oil sellers and traders competed for buyers by paying them to avoid paying for indefinite storage.
In Canada, the oil sector鈥檚 environmental, social, and economic impact have pervaded conversations across the country over the past year, and the October 2019 federal election gave Prime Minister Justin Trudeau a minority government, with which he pledged to address climate change aggressively.
Limited pipeline and problematic rail capacity as well as a lack of oil storage led the Alberta government to impose a production curtailment in 2019, which continues today with production capped at .[4] Meanwhile disagreements over the progress of transportation construction has thrown Canada into social conflict, from nationwide railroad blockades to calls in Alberta and Saskatchewan for the provinces to leave Canada鈥檚 federation.
This year, the oil industry has also faced another deep shock: low demand as COVID-19 shuts down oil intensive activities, such as driving and flying. On February 10, Finance Minister Bill Morneau warned the sector that the dip in Canada鈥檚 oil prices since the outbreak was a small foreshock of future demand.[5] COVID-19 had its devastating start in China. Although the United States is the world鈥檚 top oil consumer, China is notably the world鈥檚 top oil importer. In 2019, the world consumed and China consumed , importing .[6] Canada does not supply oil to China, but as world oil prices move up and down together, Canada鈥檚 oil price has trended downward alongside international oil prices.
OPEC and OPEC+鈥檚 Oil Curtailment
As of March 6, Canada鈥檚 oil producers are now experiencing the additional shocks of the oil war, and its aftermath, between Russia and OPEC鈥檚 unofficial leader Saudi Arabia over the breakdown of an OPEC production curtailment. OPEC鈥檚 14 member countries control of the world鈥檚 oil production and of global oil exports.[7] They have been curtailing their oil output since 2016 to raise world oil prices, but not alone. They joined forces with Russia, Mexico, Malaysia, Kazakhstan, Oman, South Sudan, Sudan, Brunei, Bahrain, and Azerbaijan to form OPEC+, or the Vienna Group. OPEC+ agreed to curtail oil by , and as of January 2020, OPEC+ curtailment was at almost .[8]
OPEC+ includes 23 of the world鈥檚 approximately 100 oil-producing nations. The 13 additional non-OPEC members are important because they agreed to reduce their output and lessen the average reduction burden, but moreover, they also promised not to increase their output. Production restrictions lifts oil prices as it decreases market oil supply. High prices normally incentivize countries to produce more oil, which over time undermines OPEC鈥檚 reduction efforts. The more nations curtailing their oil production, the more effective curtailment is at keeping world prices raised.
Over the years, OPEC+ has faced opposing pressure from the United States and non-OPEC+ countries. In North America, between 2016 and 2018, the United States increased its oil production from to and Canada increased its oil production from to .[9]
Saudi Arabia-Russia鈥檚 Price War: What happened?
Russia has been a surprising contributor to OPEC+. When they first joined, they set their output reduction goal at a generous .[10] However, Russia鈥檚 relationship with OPEC has been difficult because Russia has spare capacity to increase its production and needs oil revenue while its economy struggles under U.S. economic sanctions. Saudi Arabia and Russia are also both powerful oil market players with large oil reserves and outputs. Conspicuously, Saudi Arabia and Russia are respectively the world鈥檚 4th and 5th largest holders of foreign currency reserves, with a market shock defense of about half a trillion dollars each.[11] The two countries are natural competitors and make odd allies.
On March 6, 2020, in response to the sharp drop in oil demand due to travel restrictions imposed to slow the COVID-19 pandemic, OPEC met with its non-OPEC members to agree to increase curtailment by with Russia鈥檚 agreement and reevaluate measures in June.[12]
At the time, China had over active COVID-19 cases.[13] Fifteen countries supply of oil sold to China, eight of which are OPEC members.[14] In 2019, of China鈥檚 total imported oil came from Saudi Arabia, followed by Russia at .[15] Even with the global demand uncertainty, Russia decided to end participation in the OPEC+ curtailment.
Leaving OPEC+ meant Russia was free to return to normal production levels and increase them as OPEC continued to curtail its oil. In response, Saudi Arabia promptly ended its oil restrictions, dropped its prices to , and promised to increase its oil output from 9.7 million bpd to come April, in order to flood the market and go after world market share.[16] Russia then changed course by announcing short-term production increases by 200k to 300k bpd that would eventually be ramped up to .[17]
The oil war ravaged oil markets for 28 days. On April 12, Russia and Saudi Arabia agreed to come together to stabilize prices by cutting output by each.[18] The other 11 remaining OPEC+ countries agreed to contribute 4.7 million bpd to curtailment as well.[19] Separately, on April 12, G20 countries also pledged to take actions to stabilize oil prices. As demand has dropped almost since the outbreak, it remains to be seen how effective OPEC+鈥檚 10% decrease in output and the G20鈥檚 eventual, largely market driven, actions will be at stabilizing world oil prices.[20] On April 20, WTI had a flash crash that reached , while WCS remained steady at .[21] WCS now sits at .[22]
Shocks to Canada鈥檚 Oil Industry
Canada is the world鈥檚 4th largest oil producer, and yet the low COVID-19 demand and oil war have pummeled the industry.[23] Canada鈥檚 production costs are high, and Canadian oil sells in its nearly sole export market, the United States, at a heavy discount.
Western Canadian Select (WCS) sells at a discount to North America鈥檚 oil benchmark, Western Texas Intermediate (WTI), known as the 鈥淐anadian Discount,鈥 which between 2008 and 2018 averaged b.[24] The narrowness of the two oil prices is a popular measure of the Canadian oil sector鈥檚 health. In March, the Canadian Discount rose to pb towards the end of the month but averaged .[25]
WTI is a light, sweet blend that does not compete directly with WCS, a heavy sour crude. Fortunately, there is a large market for heavy sour crude. However, due to limited transportation access to global markets, Canada sold of oil its exports to the United States in 2018.[26]
In the medium term, Canada鈥檚 oil industry will be in a stronger position once pipelines currently planned or under construction come onstream. Notably, pipeline projects continue to face legal challenges and the oil industry is hastening to reduce emissions 鈥 by demand from the public, federal and provincial governments, and the banking sector. With that pressure, there has also been notable breakthroughs for a couple of pipeline projects. In January, the United States approved the Keystone XL pipeline, and in late March, Canada and Alberta governments invested to continue the project, set to be onstream by the end of , which would open access to the U.S. Gulf Coast.[27] Canada鈥檚 federal government purchased the Trans Mountain Pipeline for .[28] Trans Mountain capacity is being tripled on an existing right of way from Alberta to the coast of British Columbia, giving access to Pacific rim oil markets. Construction is underway and projected to end by .[29]
Market Reactions from Canadian Companies
In the short term, low prices would normally drive o颅颅颅il companies to sell enough oil to meet their future cash flow needs and then store a portion of their oil until prices were stronger. As of April 28, Canada鈥檚 producers now have to sell almost more barrels of oil to secure the same amount of money as the beginning of March and more barrels compared to this time last year.[30] Canadian oil companies in 2020 have also inherited the 2019 storage glut that led to Alberta curtailment. Some companies have even started to store their oil across the border in the United States 鈥 where oil barrel storage is also scarce.[31]
Canada is almost at oil storage capacity and Canadian oil companies are looking to shore up their capital by reducing costs. Athabasca Oil Company announced in early April that it was shutting in one of their Canadian production sites. Their oil was selling below cost.[32] For Canada鈥檚 top three oil producers, Suncor Inc., Imperial Oil Ltd., and Canadian Natural Resources Ltd. have all announced cost cuts between and .[33] Suncor is also halving their oil output at one of their oil sites.
Government Boosts to Canada鈥檚 Oil Markets
Canada鈥檚 federal government is reportedly working with the relevant provinces and the industry to find the right policy measures to help oil producers survive COVID-19 and the price fall resulting from Russia and Saudi Arabia鈥檚 oil fight. The mining, quarrying, oil, and gas industry represents critical income for three provinces: Alberta, Saskatchewan, and Newfoundland and Labrador. The sector, for example, accounts for of Alberta鈥檚 GDP and of its exports.[34] In early March, the Alberta Government promised in loans towards reclaiming lands inhabited by abandoned oilrigs with the goal of creating substitute jobs for oil and gas industry workers as unemployment in the sector increases.[35] On April 17, Canada鈥檚 federal government announced a investment towards analogous land reclamation projects in the three gas and oil provinces.[36] The mining, quarrying, oil, and gas industry employed over people in Canada in 2019 and, in 2018, accounted for of Canada鈥檚 GDP and of its exports.[37]
In addition to pipeline investments, the Trudeau government aid will likely include financial support to Canadians caught up in the oil shocks and measures to stabilize oil companies鈥 liquidity. Provincial governments could also help the industry by postponing royalty payments and incentivizing companies to keep employees through royalty credit programs. In lieu of a costly oil sector bail, Canadian governments have access to a range of industry aide, including tax payment deferments, access to credit, pipeline toll reductions, other construction and research investments, and salary subsidies to retain workers.
Government aid is a short-term solution while Canada鈥檚 oil industry waits for more transportation capacity for access to more markets and better global oil prices. Paradoxically, increased world market access might also make the oil sector less sheltered from direct international conflict and foreign market shocks. Nonetheless, it would also come with more market flexibility and more alternatives for the future shocks.
[1] Reuters, 鈥,鈥 (March 2020).
[2] BNN Bloomberg, 鈥,鈥 (April 2020).
[3] Bloomberg News, "," (April 2020).
BNN Bloomberg, 鈥,鈥 (April 2020).
[4] Government of Alberta, 鈥,鈥 (April 2020).
[5] and , 鈥,鈥 Reuters, (February 2020).
[6] N. S枚nnichsen, 鈥,"Statista, (April 2020).
EIA, 鈥,鈥 (March 2020).
[7] EIA, 鈥鈥 (April 2020).
[8] Brian Wingfield, Samuel Dodge, Demetrios Pogkas, and Cedric Sam, 鈥,鈥 Bloomberg News, (April 2020).
[9] EIA, 鈥鈥, (April 2020).
Statista, 鈥 (April 2020).
[10] Brian Wingfield, Samuel Dodge, Demetrios Pogkas, and Cedric Sam, 鈥,鈥 Bloomberg News, (April 2020).
[11] World Bank, 鈥,鈥 (April 2020).
[12] Reuters, 鈥,鈥 (March 2020).
[13] Worldometers, 鈥,鈥 (April 2020).
[14] World鈥檚 Top Exports, 鈥,鈥 (April 2020).
[15] Ibid.
[16] Olga Yagova, 鈥,鈥 Reuters, (March 2020).
Rania El Gamal and Olesya Astakhova, 鈥,鈥 Reuters, (March 2020).
[17] Rania El Gamal and Olesya Astakhova, (March 2020).
[18] BBC, 鈥,鈥 (April 2020).
[19] Ibid.
[20] Emma Graney, "," The Globe and Mail, (April 2020).
[21] BNN Bloomberg, 鈥,鈥 (April 2020).
[22] Ibid.
[23] EIA, 鈥鈥 (April 2020).
[24] Matt Lundy, 鈥,鈥 The Globe and Mail, (March 2018).
[25] BNN Bloomberg, 鈥,鈥 (April 2020).
[26] Natural Resources Canada, 鈥,鈥 (March 2020).
[27] Press Herald, 鈥,鈥 (March 2020).
[28] Bill Chappell, 鈥,鈥 NPR, (April 2020).
[29] Geoffrey Morgan, 鈥,鈥 Financial Post, (April 2020).
[30] BNN Bloomberg, 鈥,鈥 (April 2020).
[31] Geoffrey Morgan, 鈥,鈥 Financial Post, (March 2020).
[32] The Canadian Press, 鈥,鈥 Global News, (April 2020).
[33] Dan Murtaugh, "," Bloomberg News, (March 2020).
Reuters, "," (March 2020).
Geoffrey Morgan, "," Financial Post, (March 2020).
[34] Statistics Canada, 鈥,鈥 (April 2020).
Statistics Canada, 鈥,鈥 (April 2020).
[35] Lauren Boothby, 鈥,鈥 Edmonton Journal, (March 2020).
[36] David Ljunggren and Kelsey Johnson, 鈥,鈥 Reuters, (April 2020).
[37] Statistics Canada, 鈥,鈥 (April 2020).
Statistics Canada, 鈥,鈥 (April 2020).
Statistics Canada, 鈥,鈥 (April 2020).
