This opinion piece presents the opinions of the author.
Within the last two weeks, the oil market delivered some bad news for oil and gas companies operating in Western Canada. The bad news can be summarized by the headline of an article on the commodity page of the Financial Times: "Canada's oil becomes cheapest in world amid glut in Alberta."
The forces that have created this situation include surging oil production, lower demand due to refinery maintenance and a chronic shortage of pipeline capacity to move growing volumes beyond the regional Canadian market. The impact of these conditions caused the price for Western Canada Select, the regional benchmark for low quality, viscous heavy oil, to fall below $45 a barrel, less than half the cost of other crude oil benchmarks. This price disparity is estimated to be costing the Canadian oil and gas industry about C$2.5 billion per month, or an annualized income loss of C$30 billion, or about 1.6% of Canada's gross domestic product.
With the price of Canada's heavy oil this low, it is selling for less than half the $111 a barrel price (December 26, 2012) consumers are paying for Brent oil, the global oil benchmark. Furthermore, Canada's oil is now selling at about $41 a barrel below the United States' benchmark West Texas Intermediate crude oil, which in turn is trading nearly $23 a barrel below Brent.
The gap between WTI and Canada's oil price is the most since December 2007. Prospects are that the situation is likely to get worse in the first half of 2013 before it improves. These low levels for the benchmark crude oils of North America reflect surging production in the United States that has been unleashed by the oil shale revolution and the rise in Canada's oil sands output. Based on the latest data available from the Energy Information Administration (EIA), Canada's oil production has climbed above four million barrels a day (mmb/d) while U.S. production is the highest it has been since 1998. Until oil consumption ramps up, or Canada finds another export market or the U.S. government liberalizes its oil export restrictions, the glut in North American heavy oil will continue to grow.
Since 2000, with the growth in oil sands output, Alberta's total oil production has increased by about 1.4 mmb/d. Plans call for an additional 100,000 barrels per day of oil sands output coming on line early next year from Imperial Oil Company's (IMO-NYSE) new Kearl mine. Canada's production growth is about equal to the output of Libya, a mid-sized OPEC producer, showing the significance of the country's new output in the global oil market.
Until this production glut is resolved, Canada' crude oil will continue to sell at a steep discount to other benchmark crude oils, costing Canadian producers significant cash flow. That means there is a growing likelihood that as this wide price gap continues producers will be forced to reduce their expenditures compared to what they would spend otherwise. That could be bad news for the Canadian oil and oilfield service industry in the second half of 2013 if the pricing gap doesn't shrink.
G. Allen Brooks works as the Managing Director at PPHB LP. Reprinted with permission of PPHB.
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