For those that don’t pay much attention to markets, I submit the following for your consideration. It is a small picture of the markets, as of last week. You may have heard this message in the news recently, but seldom this starkly, which is what might make it interesting if you find talk of Cushing storage levels equivalent to listening to a blender. In particular, notice the little Canadian flags, representing two Canadian crude oil grades that are recognized internationally, and the first column of numbers to the right of that flag.
You may have noticed a pattern there. In fact, your five-year-old would pick out the pattern. Your six-year-old would ask what’s wrong with Canada.
To be honest, you’d have to answer that it depends who you ask. Some people don’t mind this situation much at all. What you are seeing here is a surreal revival of the National Energy Program. The NEP, you’ll perhaps recall, was a federal program to equalize the benefits of western Canada’s (primarily Alberta’s) oil resources shortly after several global crude oil price spikes. The program largely capped oil prices that producers would receive, in an attempt to spread the benefits of lower-than-global energy prices across the country. It was of course more complicated than that, but the program essentially prevented Alberta oil from receiving full world oil prices.
Does that sound familiar?
Of course there is no overt NEP in place, but the end result is the same. Realized Canadian oil (and natural gas) prices are far below, well, anyone’s, and while this is infuriating and demoralizing in western Canada, central Canada doesn’t mind too much. In fact, the view according to a recently-visiting Toronto-based bank economist is that low oil prices are a net positive for the Canadian economy.
This is not a crazy view from the national perspective, and particularly so in Ottawa. High oil prices are like a tax added to almost everything, because almost everything uses oil. At the same time, a carbon tax is a tax on everyone, which the government wants to put through. Things get boiled down to stark simplicity when the feds look at macro variables. Gauges of health get boiled down to simplified Gross Domestic Product (GDP) numbers. Alberta’s health can be seen by its rate of economic growth, as can any other province or region, in the eyes of economists. In these simplistic terms, low oil prices hurt one region, but help many others including the economic mass of southern Ontario.
At a stage like this, where Canada’s commodity prices are so grossly undervalued compared to any other nation (and we can’t just blame Canada’s low quality crude, Mexico’s is similar yet twice the price), an efficient market would lead to solutions: the product should either be allowed to move to those world markets, or ways should be found to upgrade the value of those products. But producers face nearly insurmountable road blocks to achieving either. We can’t really move natural gas or oil, like anyone needs reminding, the Shell LNG terminal notwithstanding (and it won’t cure low natural gas prices anyway; by the time it comes on stream in 2022 or whatever, can you imagine how many wells will be drilled between now and then in anticipation of filling those valuable ships?), because pipelines are nearly impossible to build. The other option, to add value to natural resources, is some sort of cruel joke also.
A sustained low natural gas price should lead to development of petrochemical plants and/or other businesses that can thrive on cheap natural gas. This phenomenon has happened in the US Gulf Coast region, where over $190 billion has been invested since 2010 in businesses that feast on cheap natural gas. In Canada, we could be doing the same, but we aren’t (with exceptions like Inter Pipeline’s $3+ billion facility near Edmonton) on any meaningful scale. The same for the oil side; there seems to be little to no interest in building new refineries or upgraders or anything one might expect from an oddly cheap source of oil. The Reuters article mentions a few encouraging developments among smaller businesses, which is great to see (as one fertilizer manufacturer in Medicine Hat put it: “At times it’s free,” said Bert Frost, CF’s senior vice-president of sales, of Alberta’s gas. “We have the lowest-cost gas in the world today”). But these are so small that they don’t do much to help equalize prices with world levels. Even environmentalists mock the petroleum industry for not doing more to add more value to products, though the irony that they are the reason the industry can’t seems to be lost on them.
There are any number of reasons why these new petrochemical facilities aren’t materializing as one would expect. The general global apathy towards investing in Canada may be one. Another might be the decade-long process required to design, engineer, consult, permit and construct new infrastructure in Canada. Who wants to commit capital to a project that will not be functional through the entire next business cycle? The Inter Pipeline and Shell projects are notable exceptions, but also are indicative of the problem. Neither was proposed last year, not by a long shot, and neither will be providing relief in the short term.
On top of this problem, the benefits to Canada of low oil prices are probably an illusion in the mind of some economist anyway. Recall that eastern Canada imports a lot of crude oil from elsewhere in the world, including Saudi Arabia among others, and those imports are at the full global price, not any discounted Canadian metric. Thus, consumers are not seeing any screaming bargain on gasoline either.
At any rate, western Canadian energy producers are on their own in their own peculiar world. Few outside the business seem overly perturbed by these ridiculous discounts. A big reason for this is one that governments seem utterly unable to understand: it is impossible to measure how much Canada (or any country) loses when those who could invest here choose not to.