Canada’s great oil crash of 2018 could be set for a 2019 rerun.
Oil-sands producers including Canadian Natural Resources Ltd. and Imperial Oil Ltd. are pushing ahead with expansions in the face of record inventories. Pipeline bottlenecks are poised to persist into next year after Enbridge Inc. delayed the start-up of its Line 3 expansion until 2020. All this is happening as production curtailments imposed by Alberta’s government in January are winding down.
“Under the surface, we still have a crude takeaway capacity issue that’s yet to be resolved,” Kevin Birn, IHS Markit’s director of North American crude oil markets, said by phone. “We are not calling for a blowout but there is insecurity in the market.”
Surging production and a shortage of export pipelines caused storage tanks to fill last year and oil prices collapsed, with a barrel of heavy Canadian crude trading $50 below West Texas Intermediate futures in October. The situation became so dire that Alberta’s government took the controversial step of mandating production cuts totaling 325,000 barrels a day in January.
The curtailments supported prices. Western Canadian Select crude’s discount to WTI shrank to less than $10 a barrel early this year. But the price difference was so small it made local crude too expensive to ship by rail, a costlier alternative to clogged pipelines. That meant oil tanks started filling up again with Western Canada oil inventories rising to a record in late April, according to Genscape Inc.
With stockpiles full, new production is poised to enter the market. Canadian Natural has begun injecting steam into the ground at its 40,000 barrel a day Kirby North project and expects production to begin late this quarter. Imperial’s supplemental crusher project at its Kearl oil sands mine is on schedule to be complete by year-end, increasing production capacity by as much as 20,000 barrels a day. Meanwhile, the curtailment program is being relaxed, with cutbacks falling by almost half to 175,000 barrels a day in June and 95,000 barrels a day by December.
If the situation turns out well, heavy Western Canadian Select’s discount to WTI will widen out to just over $15 a barrel, enough to support a jump in crude by rail but not slam producers, IHS’s Birn said. The gap was at $13.80 a barrel on Wednesday, compared with as narrow as $6.95 in January.
The problem is that crude-by-rail is a fickle business. A bountiful fall harvest could mean crops displace crude on the railroads, as happened last year. Cold weather can slow down train traffic. If too little oil flows down tracks amid loosening curtailments, there is a risk prices could collapse, at least temporarily, Rafi Tahmazian, senior portfolio manager at Canoe Financial in Calgary, said by phone.
“Rail is a very delicate part of the equation that we have to play,” he said by phone. “You throw the curtailments out and you are definitely going to sink the market.”
Any sudden fall in local oil prices would challenge the position of Alberta’s newly elected United Conservative government under the premiership of Jason Kenney. While Kenney supported the curtailment program set up by his predecessor Rachel Notley, he opposed Notley’s C$3.7 billion ($2.8 billion) plan to lease rail cars and get more oil rolling on the tracks, saying it’s not an appropriate business for government.
To be sure, the situation now isn’t the same as last year. In 2018, rail volumes were slow to pick up as railroads demanded longer-term commitments from oil producers. This year, companies such as Cenovus Energy Inc. are locked into long-term contracts. Shipments should pick up more quickly when prices adjust, Mike Walls, an analyst at Genscape Inc., said by phone.
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“If the differentials were to widen, you would see a faster response to moving barrels out by rail,” he said.
Some oil companies are also more cautious about expanding production. Cenovus introduced steam to its 50,000 barrel a day Christina Lake Phase G expansion in January but the start of oil production is dependent on the lifting of curtailments and “sustained improvement in market access and heavy oil benchmark prices,” the company said this month. MEG Energy Corp.’s 13,000 barrel a day Christina Lake 2B brownfield expansion was initially scheduled to go ahead this year. That may or may not happen, Derek Evans, chief executive officer, said in a conference call Tuesday.
“We will need to see certainty around curtailment and egress prior to making that decision,” he said.