This is one of those weeks where there was a lot of stuff getting under my skin or poking at me. Irritatingly tapping me on the shoulder to the point where I almost felt the need to turn around and scream “What!?!?!?!” until I realized of course that my co-workers might very well have me committed!
That little voice in the back of my head was pretty insistent, but not overbearing and what it kept repeating over and over was the same phrase – “we’re not out of the woods yet, eh?”
Yes I know that oil prices are in the mid $60s, the highest level since 2014. Yes I know that NYMEX gas is at $3.50, the highest level since 2016. Yes I know that money and cash flow is starting to grow again, at least for the majors. And governments all around are patting themselves on the back about what a great job they did standing on the sidelines and watching the market come back. OPEC has done their thing with supply, the world is great and it’s time to move on to other things.
But there’s that voice. “We’re not out of the woods yet, eh?” And it’s clearly a Canadian voice.
What do I mean? Well from the Canadian perspective, sure, we are spending money again. But I feel bad being the one to say this – we aren’t in a Texas style Permania recovery. Not even close.
I think what really got me started thinking about this was a call that I received a couple of weeks ago from someone wanting to get my perspective on why oil price differentials had blown out so wide between Western Canadian Select (super low) and WTI ($60+) (ignoring Brent for now). The explanation is always of course the same – a discount for heavy oil vs light sweet, a discount for the distance it has to travel to a Gulf Coast refinery, a discount for tight pipeline capacity exacerbated by a spill on the TransCanada owned Keystone pipeline, the universal discount for having only one customer… You get the picture – Marsha, Marsha, Marsha.
Fine, I get it. Pricing is a headwind. Wait, let me rephrase that. More than headwind – call it a typhoon for producers. In the current environment, we are selling WCS at about a $26 discount to WTI. Our realized price is lower now than it was when oil prices were $50. How does that make the slightest amount of sense?
And, as always, we have no one aside from ourselves to blame.
In January 2013, then Alberta Premier Alison Redford had a televised address where she pointed out what she referred to as the “bitumen bubble” because at that time WCS was receiving on average $30 to $40 less than the comparable WTI benchmark – at the time in the $80s. The reason? Lack of pipeline access. Single market. Heavy vs light. At the time, Ms Redford was widely mocked, in particular for her choice of terminology.
Almost five years to the day later, we face the same bubble, for the same exact reasons. I don’t think anybody is laughing now. Alison Redford has moved on, we’re stuck in the same place we have always been. And as a province and country we have completely dropped the ball on the few things we can control that would have mitigated this mess.
Infrastructure
Canada has a massive energy infrastructure problem and we will never get over that problem without leadership on the file from committed partners at all levels of government.
Kinder Morgan is currently in a pitched battle with the City of Burnaby over their already approved pipeline route in front of the NEB because, among other things, the pipeline is crossing through a green space that wasn’t indicated in the map the City provided to Kinder Morgan which is conveniently different than the one the Burnaby lawyers are using.
Excuse me? Are we children? The City of Burnaby is determined to obstruct, delay and inconvenience the TransMountain project at every turn until either Kinder Morgan gives up or oil is completely replaced by renewables. Right now my money is on Burnaby. Why? Because we have a feckless federal government that doesn’t get it and in all likelihood, doesn’t want to get it. The BC provincial government is stuck in Green muck and no one really listens to the Alberta government now that we’ve done all that environmental stuff.
We knew we had a pipeline problem five years ago. We knew how much production was going to grow. We knew we would be pipeline constrained. We knew we had a single market. There were at least five proposals to address this. Two are dead thanks to the Federal government changing the game mid-way by declaring a moratorium on tankers off the BC coast and via NEB rule changes. Three are still alive, although sometimes it seems the prognosis is tenuous. One is TransMountain which may or may not get built. The others are likely to move forward but none can possibly be in service until 2020. What do we do until then?
Railways
The traditional shipper of last resort for landlocked ugly stepsister Alberta oil are the railway companies, but they are refusing to step up in any significant way this time, with the main excuse being why should we invest in additional capacity when you’re going to have a pipeline soon anyway? And can you blame them? Clearly holding out for price, but there ain’t much left to discount anymore as we’ve already discussed. But hey, let’s pay extra to ship oil via what has proven to be the least environmentally friendly way possible.
So on access and price? Not out of the woods.
Single customer
We have one customer for our fossil fuels. Ironically, they are also the largest importer into Canada. This is NEVER going to fundamentally change during our lifetimes. We can tinker at the margins, but the behemoth to the South is our sugar daddy so we should be doing all we can to placate, curry favour with and protect that wonderfully unique trading relationship. What we should not do is obstinately try to introduce weird and idealistic clauses into them. Right? Right??? Build another pipeline.
An aside about natural gas
Not content to concentrate all our problems in the oil market, we’ve managed to create the perfect storm for the natural gas market as well. I was telling someone the other day that the only reason I do my gas price forecasts as a NYMEX price instead of AECO is that the latter is so depressing and that no one likes a forecast with a negative number.
The price of Alberta gas has been negative as recently as this summer, and it’s depressing. The current AECO price is just a shade under 60% of the NYMEX price adjusted for currency. That’s a ridiculous discount. Gas is always discounted the further away from the distribution point, but this is ridiculous. Part of the problem? Too little infrastructure, the wrong infrastructure and too much supply in the United States with a lot of it coming into Canada. Again, head shake time. Canada produces enough gas to meet its needs, but we import from the United States. In fact, we encourage the Americans to build pipelines. Why? Because we’re dumb. That’s why.
How dumb? We have the cheapest gas in North America and are closest to the most rapidly growing gas markets in the world (China grew by almost 50% last year), LNG prices are rising (hey – big surprise there) and we are absolutely no closer to building an LNG export facility on the coast as we were 5 years ago or in 2013.
In the meantime, gas producers are in a protracted feud with TransCanada, the company that owns most of the pipeline network for natural gas, because they feel that an expansion project in NE BC (which isn’t shipping gas to LNG, because well, see above) is going to result in a further glut of gas in Alberta without any additional off-take investment. But the North Montney Mainline was approved in 2013 (there’s that year again) because of all the LNG intended gas that was going to be shipped to the coast. In that context, TransCanada needs to build its infrastructure because there is a lot of gas behind pipe in NE BC. There is a lot of gas looking for a pilot light.
Jeez, wouldn’t it have been great if there was some LNG action happening. All this cheap gas with nowhere to go.
Moving on from the pure price and infrastructure issues, we are starting to see other developments pop up as headwinds. Just a few to consider.
Carbon tax
We have it, our biggest market doesn’t. That’s right. There is no carbon tax in the United States. Never has been, probably never will be. But we have one! Go Canada! Intriguingly, not only are we happy to receive a magnificently discounted price for our fossil fuels, and have no compunction to build the required shipping to export it, we are happily going to make it that much more expensive to produce. This is, as they say, a great plan. If your goal is a shrinking industry. On the other hand, the eggheads at the UN like it. Isn’t it cute seeing little Canada do its part.
Declining US dollar
The US dollar has begun to lose a lot of strength lately on inflation expectations which pushes up oil prices a bit but more importantly makes the Canadian dollar stronger. This also incidentally makes the mind-bogglingly discounted price that WCS receives even less lucrative. Just saying.
Interest rates
The Bank of Canada is on a definite tightening cycle. Rates are starting to rise, further cutting into Canadians’ sense of financial well-being. Virtually bankrupt Canadians are soon to be certainly bankrupt. While rising interest rates should fill a roll in cooling the housing bubble, the rise in interest rates raises the Canadian currency, hurting trade and prices received for US dollar denominated goods. Like oil. In particular oil that doesn’t get anything close to the world price.
Runaway capex in the United States
While Canada fiddles, and studies, and builds only half the infrastructure we need to not execute on a what should be a no-brainer energy strategy across the country, the United States is on fire, heading into a relative feeding frenzy of capex.
Driven by predictions of Saudi-rivalling production numbers and a commitment to pipeline, refining and export facilities, US drillers are again set to spend money in a way that would make the typically conservative Canadian energy executive reach for the Rolaids. Look, when your goal is energy independence and the regulatory road is being paved in front of you, you follow the bulldozer. Maybe, someday, Canada can give it a try.
Activity in the United States is going to dwarf Canada this year and for years to come. There were 60,000 wells drilled in the world last year and the vast majority were in the US.
They have a strategic resource they want to capitalize on and do it now. I hate the slogan “Make America Great Again” and all its dog-whistly connotations, but taken in the context of the energy sector – at least in the short term – it’s really mission accomplished (if I can mix Presidents a bit).
Meanwhile in Canada, number one exporter to the United States, blessed with a much larger asset pool, we have no such exploitation agenda. Our leaders fudge, play games, allow this while banning that, play one side off the other, raise costs, add red tape, ban tankers, change rules and when all else fails, say it’s because of the spirit bear. Mexico and Venezuela – major exporters to the United States have declining output, with Venezuela’s output in fact cratering. What an opportunity to become the defacto secure US supplier of choice – does it even register with anyone?
Probably not, because it seems like there is no one home at the top. Literally and figuratively.
Which leads me to my last point. Where exactly are the people that should be giving a damn? The ones who spend our money, raise our taxes, tell us how to think and live. Oh wait, I forgot. They’re in Switzerland.
Given everything that is going on at home with such a critical industry for the Canadian economy, is there anything more off-putting than the fatuous display of obsequiousness that the Canadian delegation put on at the Davos World Economic Forum?
Let’s step back a minute. As people I know will attest, I have very little time for any conference or forum that has the word “global” associated with it or that takes place in a world class tourist destination and has people like Nicole Kidman, Bono, Elton John or P Diddy as a keynote speaker.
That said, a special place of disdain is reserved in my mind for the annual gathering of the top 1% of the top 1% dilettantes that occurs in Davos Switzerland. Never mind that I never get an invite, is there anything more offensive than the jet-setting global elite gathering under armed guard in a luxury setting to debate such things as income inequality and progressive trade and all the other uber-important things that are on the agenda?
All of this of course attended by media darling Justin Trudeau and his oh-so-serious rubber ducky socks specifically selected to appeal to his millennial audience and oh-so-cheekily remind everyone there that he is the very model of a modern progressive Canadian and not that red-tied old guy from “America.”
Anyway, a gathering of hot air, accomplishing nothing, signifying nothing. Why bother.
Stop being so blasé about Western Canada and try governing your own country for a while. We aren’t out of the woods yet. Not even close.
Stuart Parnell is a Managing Director at Stormont Energy Advisors, an independent advisory firm specializing in Sell-Side M&A, Corporate Finance and Transaction Advisory Services for North American energy service, diversified industrials, and energy technology companies. Read more Crude Observations from Stuart here.