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  • KPB & Co Research


As Canada's oil industry goes deeper into the calendar year, the recent widening of the difference between the price Canadian producers receive for their oil, and the price that oil is sold for in the USA is stoking fears of a collapse in industry profitability. The difference between the West Texas Intermediate (WTI) - the benchmark price for light sweet crude in North America for delivery at Cushing, Oklahoma - and Western Canadian Select (WCS) - the benchmark price for Canadian heavy crude for delivery at Hardisty, Alberta - widened to around US$16 per barrel last week, coming from US$9.0 the previous month. While it is still early to determine whether this a signal of a change in trends, of more concern is the approach that the government is taking towards creating more transport options for oil to move off the great white north.


The widening of the oil price differential occurred within the context of a build up of inventory at refineries, and a significant decrease in the transportation of crude by rail. There are reports that the major oil producers expect to ramp up transportation of crude oil by rail, which may lead to a reduction of the differential in the short term. Over the long term, as more supply comes on stream, the problem is likely to re-surface.



Lots of Supply Limited Transportation

The current set up of the Canadian oil industry has occasionally led to the build up of excess supply of landlocked Canadian crude in Alberta Canada, simultaneously as hydrocarbon exploration intensifies. Approximately 99% of Canada's 4.2Mn barrels of oil produced per day trickles through to North American consumers, with 1% going into foreign markets. There is a recurring pipeline capacity short fall problem, as many pipeline infrastructure projects are tied up or killed at the regulatory approval stage. The problem is further compounded as would be providers of capital for these projects are throwing in the towel, leading to a loss of C$100Bn in capital according to the CD Howe report. There are pipeline bottlenecks leading into the USA, Asia, and Europe. As such, it was no surprise when the oil price differential hit a 10 year high in November 2018, prompting the government to intervene to curb supply, and accelerate crude by rail in-spite of the safety concerns.



Politics

The government is putting out fires on one hand, but they are also making it more complex for companies to get oil to foreign markets on the other. So far two important bills: bill C-69 and bill C-48 have been tabled and one has passed, both of them serve to constrain energy producers' options. Bill C-69 serves to broaden the the scope of projects that would require regulatory approval before any investment can be undertaken. Already the time taken to make environmental assessments of certain projects significantly exceeds those in other countries such as Australia, according to the CD Howe report. With the expansion of the scope there will likely be further slow down of approvals on behalf of environmental concerns, as politics tend to conflict with the needs of investors. According to information provided by parliament, Bill C-48:


enacts the Oil Tanker Moratorium Act, which prohibits oil tankers that are carrying more than 12 500 metric tons of crude oil or persistent oil as cargo from stopping, or unloading crude oil or persistent oil, at ports or marine installations located along British Columbia's north coast from the northern tip of Vancouver Island to the Alaska border.The Act prohibits loading if it would result in the oil tanker carrying more than 12 500 metric tons of those oils as cargo. The Act also prohibits vessels and persons from transporting crude oil or persistent oil between oil tankers and those ports or marine installations for the purpose of aiding the oil tanker to circumvent the prohibitions on oil tankers.Finally, the Act establishes an administration and enforcement regime that includes requirements to provide information and to follow directions and that provides for penalties of up to a maximum of five million dollars.


Bill C-48 was passed on its 3rd reading in early May 2018 and will likely limit the ability to move large amounts of oil from off the coast of British Columbia into Asian markets.

As investors and CEO's of the oil majors continue to focus like a laser beam on the oil price differential between WTI and WCS, they also have to think about what the long term policies of the government may have on crude transportation. The tightening of the regulatory environment through Bill C-69 and Bill C-48 will likely lead to additional costs, while oil companies in Canada are already at a disadvantage. In the coming years, the government has a lot of work ahead to encourage more pipeline development as a sustainable way to reach foreign markets.




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