Overflowing production continues to dampen oil prices as Alberta premier mulls solutions

Oil market analyst Kevin Birn likens Western Canada's crude supply to a bathtub with a drain that's too small to keep up with the increasing volume pouring out of the tap.

As barrels of surplus oil lap the edge of the tub, desperate producers are forced to sell at rock-bottom prices to avoid a big mess.

Meanwhile, no one seems to agree on how to either turn down the tap or install a bigger drain.

"You can think of it as a bathtub that's full. And as long as the bathtub is full, the pressure on the (price) differentials is going to be bad," said Birn, the vice-president of North American crude oil markets for IHS Markit.

"So you've got to drain it. And building rail, it will help. You're seeing announcements around production curtailments and that's an attempt to accelerate the meeting between supply and demand to drain the basin."

Alberta Premier Rachel Notley announced this week the province would buy as many as 80 locomotives and 7,000 rail tankers to move the province's excess oil to markets, with the first shipments expected in late 2019.

She was scheduled to make a key announcement Sunday evening on oil production, writing in an op-ed sent to Postmedia that she is considering many options including production cuts.

Jason Kenney, leader of Alberta's opposition United Conservative Party, has said it would provide faster relief if all companies in Alberta were forced to temporarily halt 10 per cent of their production.

4.6 million bpd

Canada had total production of about 4.6 million barrels per day of oil in September, with 4.3 million bpd produced in the West, according to the National Energy Board.

That month, the country exported 3.47 million bpd of oil, with almost all of it going to the United States. Crude-by-rail exports rose to a record of almost 270,000 bpd.

After hitting highs of more than US$52 per barrel in October, the discount on Western Canadian Select bitumen-blend crude versus New York-traded West Texas Intermediate settled at about US$29 per barrel on Friday, according to Net Energy, about double the discount it typically fetches due to lower quality and transportation costs.

Upgraded synthetic crude from oilsands mines was selling at an US$18.50 discount to WTI (it typically trades near par) and Edmonton light oil was receiving about a US$23 discount, although it is of similar quality to WTI.

In an update report on Nov. 21, Scotiabank analysts said the wider-than-usual discounts will cost the Western Canadian oil industry $15 billion to $39 billion of earnings in 2019 compared with a scenario where pipeline capacity is adequate to take away export production.

It added the Alberta government could miss out on $1.5 billion to $4.1 billion (roughly $350 to $950 per Albertan) in royalty revenue in 2019.

$13-billion economic impact

The Canadian Association of Petroleum Producers officially estimates the cumulative economic impact of discounts nationally was at least $13 billion from the start of 2016 to the end of October this year.

The oil industry's problems are mainly due to the failure to build export pipelines to match increases in oil production, said Birn.

The 525,000-bpd Northern Gateway pipeline was approved in 2014 by the federal Conservative government and then rejected by the Liberal government in 2016. The 1.1-million bpd Energy East pipeline was cancelled by TransCanada Corp. due to "changed circumstances" in 2017.

That leaves the Line 3 replacement pipeline as the most likely to come into service next, adding more than 370,000 bpd of export capacity when it starts up in late 2019, after both the Trans Mountain expansion pipeline project and the Keystone XL pipeline were recently ordered halted by courts in Canada and the U.S.

A hint of the trouble ahead came late last year when the Keystone pipeline was shut down for 10 days due to a leak in South Dakota and the heavy oil discount doubled to as much as US$29 per barrel, Birn said.

The discount fell during the summer when oilsands production declined due to planned and unplanned project shutdowns in northern Alberta but rose again in the fall as refineries in the United States that use western Canadian heavy oil had their own maintenance shutdowns.

Meanwhile, production continued to increase, driven by projects like Suncor Energy Inc.'s 194,000-bpd Fort Hills oilsands mine which began ramping up in late 2017.

Birn said it's tough to say where prices will go from here. Winter is the most active season for drilling in Canada and production normally rises but early indications are that the industry won't spend as much as usual this year.

Voluntarily production cuts, increases in crude-by-rail exports and a plan by the 80,000-bpd Sturgeon Refinery to begin processing bitumen will likely help moderate discounts in the months ahead, he said.

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