"The Government's intent in the policy was to provide for the orderly development of the oil sands in such a manner as to supplement but not displace production from the conventional industry."
- Province of Alberta, Internal Memorandum, Oil Sands Development Policy, February 1968
At first it was just pushing and shoving by big companies in the oil sands sandbox. Now the heavyweight brawl has spread across the playground, into the conventional turf, affecting bystanders that are mostly lighter-weight companies, but large in number.
Everyone is getting beaten up.
With each shove to get new oil production into glutted pipelines comes a bloody nose to price. A barrel of the heavy stuff known as Western Canadian Select (WCS) sells for under $US 20 today. At peace, it should be fetching around $US 40, plus or minus, depending upon global markets (mostly minus these days).
A lot of people are talking about the "WCS" crisis. And that's what it is. To our Canadian economy and to our reputation as an orderly place to do business. Yet, few are mentioning another calamity: the beaten down prices for other Canadian oil products like "Edmonton Light". A barrel of this high-quality, conventional resource is getting less than $US 30, an insulting $US 20 plus discount to the North American market it sells into.
Canada's oil and gas industry is much more than the hackneyed photos of dump trucks hauling bitumen into mega industrial plants in a small corner of Alberta. In-situ companies play too. Then there are hundreds of conventional companies that collectively produce 2 million barrels a day of lighter liquids have nothing to do with the oil sands, its markets nor its imagery. Related: Natural Gas Drives Saudi Geopolitical Pivot
Conventional oil and gas companies play in a much larger geography called the Western Canadian Sedimentary Basin (WCSB), an area that stretches from North East BC, through central Alberta, down to Southeast Saskatchewan and even a small corner of Manitoba. The broad region spans different plays, different processes, different markets, different cost-structures-and different levels of investment.
This year, by the time the December calendar flips, the conventional side of the business will have spent around $C 27 billion; the oil sands $C 13 billion. The industry, both in the oil sands and conventional sides, is foundational to broad-based employment across Western Canada. And now, all of it is under siege.
Which brings me back to the memo of 1968. Fifty years later, "orderly development" has turned into a market melee and not wanting to "displace production from the conventional industry" has become a prophecy. Even within the oil sands, companies are trying to displace each other.
We don't need to get into the nuances of historical policy, nor the politics. What's important is that under the Canadian constitution all oil and gas resources-conventional and otherwise-are owned by the citizens of their provinces, and it's their governments' role to be the custodian of those resources.
Complicating matters, we know, is the frustrating inability to build pipelines to take the produced resources to markets beyond the western provinces. The arbiter of that bureaucratic process is largely under federal jurisdiction, but also includes provinces outside oil producing jurisdictions. So, provinces join with companies to produce the resources while the feds and other provinces arbitrate the takeaway capacity. Everyone knows what happens when geopolitics takes over.
Right now, the Government of Alberta is faced with a difficult dilemma. Should they interfere in the price fight-oil sands and conventional-to bring order back to all corners of the playground? To ease the glut, one supply-side tool they can use is mandatory production cuts.
But that doesn't go over well with everyone. "Let the market do its work," is the chorus from staunch capitalists, especially those who run some of the larger companies in the oil sands that have invested in fully integrated production and refining operations. As a free marketeer, I would normally agree that government should keep its heavy elbows out of capitalist business. If this was the airline industry fighting a seat sale, we'd all say, "may the best carrier win," for the benefit of all consumers.
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This isn't the airline business, where companies own the airplanes. This is the oil business where the citizens of each province own the resources. The playground called the WCSB belongs to the people, who are presently seeing their resources sold for cents on the dollar with no return on investment via royalties and taxes. In a public context, the government, on behalf of the citizens, is warranted if not obliged to mediate a solution.
The fight will end eventually. Markets are working to rebalance through a combination of voluntary production cuts and gradual expansion of rail takeaway capacity. Leaving $80 million-a-day on the table acts as a tasty financial chum for arbitrageurs.
But playing nice takes too long. Time is of the essence if the winter drilling season is to be saved. If the glut doesn't clear in the next few weeks, I expect we'll necessarily see government intervention. The hope is that order can be brought to the playground fast enough, lest this crisis turn into a financial catastrophe. Billions are being lost in revenue, royalties and taxes. More sobering is the potential of thousands of job losses from Fort St. John, BC, through a swath down Alberta, to Estevan, Saskatchewan.
Beyond the immediate term, the bigger virtue will be to ensure this type of devastating value loss at the expense of all Canadians doesn't happen again. Like it or not, we're in an era where technology-driven productive capacity is able to exceed government-regulated takeaway capacity. That means renewed scrutiny on orderly development and rules of play-in the spirit of a 50-year-old memo.
By Peter Tertzakian
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Peter is an economist, investment strategist, author and public speaker on issues vital to the future of energy. He has clocked over 30 years of… More