Alberta Intervenes To Halt Canada’s Oil Crisis

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By Nick Cunningham

Oil prices rose on Monday, buoyed by coordinated production cuts – cuts that did not come from Vienna (although that too could occur later this week).

Instead, the mandatory reductions were handed down by the provincial government of Alberta. “Perhaps OPEC should therefore consider inviting Canada to its meeting on Friday,” Commerzbank said in a note.

Alberta Premier Rachel Notley announced the production cuts “in response to the historically high oil price differential that is costing the national economy more than $80 million per day,” her office said in a statement. Western Canada Select (WCS) has plunged below $15 per barrel, representing a discount to WTI that has hovered at around $40 per barrel.

“The price gap is caused by the federal government’s decades-long inability to build pipelines. Ottawa’s failure in this area has left Alberta’s energy producers with few options to move their products, resulting in serious risks for the energy industry and Alberta jobs,” the Alberta Premier’s office said.

Alberta’s oil industry is producing roughly 190,000 bpd in excess of available takeaway capacity. The surplus is filling storage up quickly. Oil producers will be required to make cuts on the order of 8.7 percent, or 325,000 bpd, beginning in January. Once the storage glut is reduced, the cuts will narrow to just 95,000 bpd, which will stay in place through the duration of 2019.

The first 10,000 bpd for each producer will be excluded from the mandatory cuts, intended to avoid negatively impacting small producers. The baseline used to calculate the cuts will be the highest level of production for each producer over the past six months.

Notley expects the production cuts to boost prices for WCS by roughly $4 per barrel, adding $1.1 billion to government revenue between 2019 and 2020.

The provincial government went to lengths to describe the measure as temporary, and one that will be a benefit to government finances. “Every Albertan owns the energy resources in the ground, and we have a duty to defend those resources. But right now, they’re being sold for pennies on the dollar,” Notley said.

The production cuts come just days after Notley said that her government was considering paying for increased rail capacity in order to relieve the bottlenecks. That additional rail would add 120,000 bpd in takeaway capacity but wouldn’t be available for another year, and would take time to scale up.

Enbridge’s Line 3 replacement project is expected to be completed at the end of 2019, which will offer the first significant increase in takeaway capacity. However, since that is still a rather long time to wait, particularly with WCS having dropped close to $10 per barrel, the provincial government clearly felt it had to act.

The extraordinary intervention into the market was supported by some top Canadian oil executives. Some producers had already been slightly curtailing output in recent weeks because of painfully low prices, but there is a first-mover problem that goes into this thinking. Any effort to cut output by one company only stands to benefit another. As such, some oil executives argued that only government action could provide an orderly way to reduce output to narrow price differentials.

“While curtailments have been used before by previous governments, we believe they should only be used for a short period of time, and only in extreme cases,” said a statement by Cenovus CEO Alex Pourbaix. “This is an extreme case. It makes no sense for Alberta to stand by while its valuable oil resources sell for next to nothing, the provincial treasury loses up to 100 million dollars a day, job losses continue to mount and our industry suffers billions of dollars in long-term value destruction.”

The largest impact could come in the first quarter of 2019. The reductions will erase some of the inventory overhang, allowing the cuts to be phased out. More rail capacity could ease the midstream burden as well. “We interpret the phrasing of the announced cut as keeping production down 50 kb/d [year-on-year] in 2019 and 200 kb/d below our prior assessment with the greatest impact on 1Q19 (down 225 kb/d quarter-on-quarter) before new rail capacity gradually comes online from April onward,” Goldman Sachs wrote in a note.

It’s worth noting that years of pipeline fights from environmental groups, local communities and First Nations are bearing some fruit. The inability to build a major pipeline has put a ceiling on midstream capacity, and the bottleneck has swelled over time, ultimately leading to the latest announcement from Alberta ordering the shutdown of some oil supply. Industry groups and pundits scolded protestors, declaring that the oil would find its way to the market one way or another. However, pipeline delays and logjams are literally keeping oil in the ground.

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