Optimistic or delusional?

Oil producers keep ramping up output forecasts.


Oil and gas

The world may have turned against Canadian crude, but you wouldn’t know it in the oilpatch. The prevailing outlook for Canadian oil production remains aggressively expansive, bearing no hint of the doubt and risk that loom over the industry.

The annual forecast from the Canadian Association of Petroleum Producers (CAPP), released in June, anticipates a 30% increase in oilsands production over the next three years and a tripling over the next two decades. Output from all sources will double over that time to 6.7 million barrels per day, up from 6.2 million in last year’s forecast.

Such optimism must somehow reconcile with all the forces conspiring against Canadian oil: the lack of pipeline infrastructure or “takeaway” capacity, the occasionally gaping price discount applied to Western Canada Select, the renaissance in oil production unfolding in the U.S., rising Canadian production costs and the flight of investor money out of commodities. The deadly July 6 derailment and explosion of a crude-laden train in Lac-Mégantic, Que., also promises to alter the picture—although exactly how remains unclear.

“CAPP assumes that prices will be high enough to elicit this production growth, and that transportation capacity will be there,” says Judith Dwarkin, chief energy economist at ITG Investment Research. As far as assumptions go, those are a couple of whoppers. The price differential against West Texas Intermediate, which peaked at $40 late last year and reduced profit margins at some projects to near zero, has narrowed in recent months. But it will persist if producers continue to struggle to access preferential markets, chiefly the U.S. Gulf Coast. And more production coming on stream could exacerbate the discount.

The additional production CAPP expects over the next five years or so depends on the prompt commission of the Keystone XL pipeline, which would channel 830,000 barrels of bitumen a day from Alberta to the Gulf Coast. The Lac-Mégantic disaster will likely aid the cause of the pipeline advocates, as governments reconsider the safety of carrying so much crude by rail, says Mark McClelland, head of North American research for Maplecroft, a global risk analytics firm. The derailment is “powerful imagery in terms of changing public opinion on these issues,” McClelland says, although the fate of Keystone XL is still very much uncertain.

If none of Keystone XL, Northern Gateway and the Trans Mountain expansion gets built, there is a Plan B, but it’s messy. Discounting of Canadian crude will become entrenched, threatening the economic viability of some of the higher-cost oilsands mining projects. Projects will be deferred, others will be killed, thus limiting excess production. Already, oil companies are bracing for bad pipeline news, says Rafi Tahmazian, a portfolio manager at Canoe Financial in Calgary. “It’s very unlikely they’re moving forward with any aggression until they know they can move their product.”

Ultimately, the market will manage, Dwarkin says. “Producers and refiners will find ways of meeting each other. They always do.”

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