When Alberta’s previous government, led by Rachel Notley, instituted obligatory oil production cuts to arrest a serious discount in prices to WTI, some in the industry weren’t happy. Others, however, welcomed the move that aimed to alleviate the glut that had caused the vast discount, itself the result of insufficient pipeline capacity. Now, the cuts are paying off enough to make oil-by-rail lucrative again.
Bloomberg’s Robert Tuttle wrote this week that the excess supply of oil in Alberta had shrunk, according to data from Genscape, and shipments by rail were rising. Oil-by-rail was the only alternative for Canadian producers when the pipeline shortage became acute enough for everyone to notice. Yet it wasn’t an alternative of choice—oil-by-rail is more expensive for producers. The Notley government lent a hand and bought 4,400 new rail cars to boost this takeaway capacity by 120,000 bpd.
Yet at the time there were warnings that the railway alternative to pipelines would dampen refiners’ taste for Canadian crude as producers would undoubtedly pass some of the additional costs to their clients. However, that was before the U.S. tightened the sanction noose around Venezuela—one of the world’s largest producers of heavy crude—and heavy crude supply shrunk. As a result, oil buyers have had to adjust their perspective on what’s affordable and what’s not, and it seems that Canadian producers have benefited from this adjustment.
Alberta’s new government headed by Jason Kenney recently extended the oil production cuts into July. Canadian crude is currently trading at about US$14 below West Texas Intermediate, which is apparently the sweet spot, as Tuttle puts it, for the commodity. Inventories that hit a record in April are on the decline, and things are looking up. Related: Why Is China Pouring Money Into The Arctic?
Alberta currently produces 3.71 million bpd under the production cut program. Initially, the cuts totaled 325,000 bpd, but they were only in force for a short while: the quota for January was 3.56 million bpd, but the announcement itself pushed prices up so high that the actual cut of this extent quickly became unnecessary.
So, the government began relaxing the cuts, so the total eventually reached 3.71 million bpd as of this month. This amount of daily production should be maintained through next month as well despite the fact that there still is a shortage of pipeline capacity. The only change here was the passing by the Canadian Senate of two bills that would make it even more difficult to defend the case for the Trans Mountain pipeline expansion: the only new capacity project on the table.
On the flipside, with Venezuelan and Iranian sanctions unlikely to go away any time soon, the global supply of heavy crude will remain tight for the observable future. Tens of billions of dollars are necessary to adapt refineries to processing light crude only—in line with growing U.S. production of light crude—and these will be a long time coming. In the meantime, the market for Canadian heavy will remain favorable for pipeline-constrained producers. What’s more, production will continue to rise after the cuts are removed. By 2030, it could reach 4 million bpd, according to IHS Markit.
By Irina Slav for Oilprice.com
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Irina is a writer for Oilprice.com with over a decade of experience writing on the oil and gas industry. More