Trying to understand the critical situation Alberta faces with current oil prices is daunting for most people, especially if they’re not directly involved with the oilpatch.
So Calgary’s Business decided to make some sense out of this confusing scenario and sought the expertise of one of the country’s top experts in the field to explain in layman terms what’s going on.
Richard Masson has over 30 years of leadership experience in energy project development and governance, energy marketing, and finance. He has a consulting practice at Planning Solutions and was formerly CEO of the Alberta Petroleum Marketing Commission, as well as an executive with Nexen and Shell, and director of oil sands policy and development with Alberta Energy. He is vice-chair of the board of governors of the University of Lethbridge, a first vice-chair of the World Petroleum Council-Canada and was recently appointed an executive fellow of the University of Calgary School of Public Policy.
Here are Masson’s thoughts on what is going on with oil prices in Alberta:
Alberta produces over three million barrels per day of oil from conventional oil fields and the oil sands. This production can be grouped into three broad categories based on the quality of the oil: light sweet oil, diluted bitumen which is production from the oil sands that has not been upgraded, and synthetic crude oil (SCO) which is bitumen production from the oil sands that has been upgraded.The value of each type of oil is based on how much processing a refinery needs to do to turn it into products that consumers want like gasoline and diesel fuel.
- Light sweet crude oil is good for making gasoline and since it doesn’t contain much sulphur or heavy oil components it is relatively easy to refine. This means it tends to sell at a relatively high price.
- Diluted bitumen is production from the oil sands that has not been processed in an upgrader. It is very thick because it contains a high proportion of heavy oil components and a small proportion of light oil components. It also contains a higher amount of sulphur. It is much more challenging to refine into gasoline and diesel fuel. It requires more complex refineries which have specialized processing units. To get the bitumen to these refineries in a pipeline it must be thinned by adding very fluid components called diluent. This diluted bitumen blend can then be transported long distances to reach refining markets, but it receives a discounted price compared to light oil because it is more difficult to process.
- SCO is bitumen that has been processed in an upgrader in Alberta that has cracked the heavy oil components into lighter components and removed the sulphur, making SCO look similar to light sweet crude. In fact, refineries that can process light sweet crude are able to process SCO, and as a result the prices of the two products are similar.
The world oil price is based on two qualities of oil that are widely traded physically and financially. The international benchmark price is called Brent and it is based on crude oil produced in the U.K.’s North Sea. The price of Brent has been about US$65 per barrel recently. The North American benchmark is called West Texas Intermediate (WTI), which is a crude oil produced in Texas. The price of WTI has been about US$56 per barrel recently. This means WTI is selling at a US$9 per barrel lower price than Brent. In normal times, these two crudes sell for similar prices, but because the United States has increased its oil production very quickly, by two million barrels per day in just the past year to reach over 11 million barrels per day, the abundance of supply in the U.S. is resulting in weaker prices for WTI.
All other oil prices in North America are set based on WTI. Prices depend on two things primarily: the quality of the oil, and its location relative to Cushing, Okla., a key U.S. oil storage hub. In normal times, Alberta’s light sweet crude oil and its SCO sell in Alberta at prices that are about US$2 per barrel below WTI. This reflects the slightly higher quality of these two crude oils relative to WTI which earns them a higher price, but the long distance from Cushing results in a lower price. Diluted bitumen typically sells at a price that is US$12 to $15 per barrel below WTI to reflect its lower quality and the cost of transportation to reach Cushing.
But these are not normal times. Proposed export pipelines have been cancelled (Northern Gateway and Energy East) or delayed by regulatory issues and court decisions (Trans Mountain expansion and Keystone XL). As Alberta’s production has continued to grow from major oil sands projects being completed over the past couple of years (e.g., CNR Horizon, Suncor Fort Hills, Husky Sunrise) the volume of oil Alberta produces has overwhelmed the transportation system. Storage tanks have filled up. Even though refineries in the U.S. want to buy and process our diluted bitumen, we have been unable to get all of it to them.
The price of diluted bitumen has been getting weaker and weaker as a result – and was recently US$43 per barrel lower than WTI. This means that this oil that should sell for about US$42 per barrel was selling for just US$13 per barrel. Because of the pipeline constraints and over supply, even light crude oil has been selling at very weak prices, recently over US$30 per barrel below WTI. Larger and larger volumes of oil are being moved by rail, with recent figures showing 270,000 barrels per day being shipped in October and expectations that rail shipments will reach 400,000 barrels per day by next summer as industry seeks ways around the pipeline bottlenecks.
Until supply and demand come back into balance, these extremely price wide differentials are likely to persist, costing Alberta’s oil producers an estimated $100 million per day in lost revenue. Since governments earn corporate income taxes and collect royalties from our oil production, this lost revenue is resulting in much lower government revenues and increased deficits. Alberta has been losing up to $20 million per day, while our federal government has been losing up to $15 million per day from lower corporate income taxes.
As companies finalize their budgets for 2019 over the next few weeks, the low prices being received for Canada’s oil production are likely to result in reduced spending plans, which directly reduces business opportunities and jobs for suppliers to the industry. The pain associated with the low “made in Canada” oil prices is going to continue to be felt for months to come.