Lacey: Ignorance is bliss – curtailment and other market misconceptions

Previously I wrote about the need for the Government of Alberta to enact legislation to curtail the oversupply of crude oil in the province and try to restore more ‘normal’ differentials. Last Sunday, Premier Rachel Notley took the bold step of telling producers they need to reduce production by 325 MBpd or roughly 8.7% of total production starting in January 2019.

When layered together with an exemption for producers who were below 10 MBpd, this translated to approximately 25 producers in the province being impacted, and the vast majority of the impacted production was focused in the oil sands. Make no doubt about this, these actions were highly unusual and not typically welcome, as government action in the face of free market dynamics reflects the symptoms of a much larger problem.

The response by the market was swift and saw an immediate tightening of near term differentials for Western Canadian Select (WCS) to the high end of normal ranges. For those who are not aware, WCS has typically traded at a discount of CAD$20/barrel to WTI, and the standard deviation around that number is CAD$7/barrel.

So imagine my surprise when I saw commentary in the news that people are concerned that Alberta may be at risk of retaliatory measures by people such as the President of the United States. Specifically, I note that Gary Mar said to the CBC: “if he (the President) sees that there is a change in the price because of a curtailment of production, he might not treat that very favourably.”

Huh? Let’s be clear about one thing. The amount of supply that is making its way to the United States is unchanged. The only thing that is changed (hopefully) is the price that Albertans are receiving for it, as the differential should tighten somewhat to reflect “balance” between supply and demand. As a result, government royalties should increase, cash flow to the producers should rise, investment in the province should be less impacted and the net benefit to all Canadians should increase.

To hear the bemoaning of the potential impact to Americans as a result of the Government of Alberta curtailing production is ludicrous. In the last quarter of this year the province has literally been giving away its resources to the benefit of others, typically located in the United States. They were receiving the benefit of years of inaction, stalling and political interference that created a situation where productive capacity outstripped the ability to move the product to market. The resultant impact was a ‘crisis mode’ reaction where provincial deficits were about to grow materially higher, layoffs were being discussed, capital programs were pulled back and fear was beginning to grip the province. Whiffs of desperation were finally being sensed out east and an entourage of politicians made their way to Calgary to express their understanding, though came with no help towards finding a solution.

All that the recent curtailment of production did was restore balance to the market and attempt to reduce some of the excess storage in Edmonton and Hardisty. To imply that supply to the markets has been reduced not only is disingenuous, it is misinformed.

To Mr. Trump and his ‘America First’ policy I say this, should he think of acting. The actions of the Alberta government are in no way subsidizing the producers nor is it in any way getting the market back to ‘normal’. Industry is being forced to produce less in hopes of getting closer to market pricing. Light oil remains challenged, with differentials hovering closer to rail economics at CAD$20/barrel versus the normal differential when pipeline access was available of closer to CAD$5/barrel (+/- CAD$ 5/barrel).

The unnatural discounts that were being reflected in the markets not only hurt the United States’ strongest trading partner, it was enriching the bank accounts of despots and governments that support terrorism as crude slates such as Maya heavy, an equivalent crude to WCS, are often trading at or above WTI and are supplied by countries such as Venezuela. If we really want to do what is right, let’s get the pipeline infrastructure built and get our product to market. Let’s get global pricing for our production and continue to invest in the social infrastructure of our country. Let’s stop letting our industry and our country be dictated by foreign influences and let’s be proud of the contribution that we make domestically and around the world.

I am proud of who we are and what we are doing, and I’m done with apologizing about doing what is right.