The Canadian energy industry continues to persist in the face of opposition and adversity. Although a lower Canadian dollar helps to soften the blow of large differentials on prices received, Canadian oil and natural gas continue to be heavily discounted compared to benchmark American prices. There is some truth though, to the old adage; “that which does not kill us, makes us stronger”. Many producers have been able to reduce operations and development costs through improvements in efficiency and are now well prepared to stay the course and weather the next two or three years, at which point there should be increased pipeline capacity to ease oil price differentials. As we heard this week with the news from LNG Canada, there will be long-term improvements in natural gas demand and prices in Canada; these projects take many years to become operational but there is still a case for some long-term optimism.
Recently, the Canadian dollar appears to be losing steam compared with its American counterpart. The US Federal reserve raised its key interest rate last week for the third time this year. Along with this move, the Fed also signaled one more rate hike for 2018 while removing language that was “accommodative”, signaling a more aggressive or “hawkish” outlook for future increases. On this side of the border, the Bank of Canada is expected to raise rates only once this year, with less clarity for monetary policy into 2019. Although the fresh news of the new North American trade deal is a beacon of positivity for the Canadian economy, there is still some uncertainty about how it will affect the Bank of Canada’s policy moving forward. Overall, with what appears to be a growing disparity between the US Federal reserve and the Bank of Canada’s policies, there is reason to expect some softening in terms of the Canadian dollar’s relationship to the Greenback. On top of this, it is notable that the recent rally in oil prices, which would normally help strengthen the Canadian dollar, has had a dampened impact due to reduced prices received for Canadian oil because of both lack of market access and increasing US oil production.
World oil prices continue to rise as consumption continues to increase and supply concerns begin to grow as well. Iranian sanctions take effect in early November, and there are reports that OPEC (with Saudi Arabia acting as the swing producer) is unable to increase supply enough to cover the displaced volumes. Additionally, crude storage inventories are at the lowest levels since late 2014 (as shown in the chart below). These combined factors have added upward pressure on prices and are expected to lead to strong Brent and WTI pricing for the rest of the year and into 2019.
With the increase in oil prices, Canadian producers continue to suffer from large differentials due to market access constraints. As outlined in “The conundrum of the Canadian Oil Differential” the three major pipeline projects that can help to alleviate these steep differentials are still not anticipated to be complete until the end of 2019 (Line 3 Expansion), 2022 (Keystone XL), and later (Trans Mountain). The commitment of more rail capacity is of limited benefit; though over 200,000 bbl/day are now shipped by rail, the transportation cost premiums are in the realm of $3 to $6 per barrel (compared to pipelines). With a larger percentage of oil being shipped by rail, it is expected that Canadian prices will continue to be discounted significantly in comparison to WTI prices well into 2019. Until recently, large differentials in oil price were constrained to heavier Canadian oils such as WCS, Hardisty Heavy and Bow River, but concerningly, these larger differentials are beginning to affect the prices of Edmonton Light and condensate as well. If this trend continues to worsen, we could see devastating effects to our energy industry and in turn the Canadian economy.
The North American natural gas market continues to be well supplied by the US shale gas. Surprisingly, lower natural gas storage levels (now below the 5-year average), do not appear to be influencing the price of natural gas going into the heating season. This may be due in part to a more efficient supply system, with abundant production readily available to meet demand even in high demand markets. The Canadian natural gas market continues to see a sharp discount compared to US gas, as market access and consumer diversification for Canadian producers continue to be an issue. As the US continues to produce more gas, the need for Canadian gas has decreased, and AECO prices have lowered to about 35% of the Henry Hub price in recent months. However, some nimble producers are getting around AECO pricing with hedges or contracts into other markets, but the light at the end of the tunnel for all comes in the form of LNG Canada’s recent final investment decision, which should offer higher natural gas prices that are more reflective of world gas markets by about 2025.
With market dynamics ever changing, GLJ has released our updated October price forecast. GLJ’s oil price forecasts have positive revisions, with WTI and Brent long-term forecasts increased to 70 USD/bbl and 72.50 USD/bbl, respectively (in real 2018 dollars). GLJ’s gas price forecasts are adjusted to remain reflective of current and long-term market expectations, with Henry Hub and AECO long-term forecasts remaining at 3.40 USD/MMBtu and 2.95 CAD/MMBtu, respectively (in real 2018 dollars).
Justin Mogck is GLJ’s Director of Commodities Research