It has been, for Alberta, a dismal new year. With pipelines out of the province effectively full, Canadian crude has become a discount brand, and once-expected money is evaporating. The future looks little better. Alberta’s Finance Minister has taken to dramatic language to describe the financial duress striking his province.
“This is not an ordinary storm,” Doug Horner said this week. The dipping price of Canadian oil will strip some $27-billion from the Canadian economy this year, he said in a speech to the Calgary Chamber of Commerce that was designed to soften the ground for what is certain to be a grim provincial budget on March 7.
Mr. Horner’s argument hinges largely on “differentials.” It’s an industry term that describes, in the current context, price discounts. So for example, Canadian heavy oil – which is often traded as a blend called Western Canadian Select – has seen a differential of as much as $42 (U.S.) a barrel below the headline oil price numbers. In North America, the headline number is typically the “benchmark” West Texas intermediate (WTI) blend. A big dip away from West Texas intermediate means that Canadian oil is selling on the cheap – and cheap oil for buyers mean low prices for sellers, the reason Alberta is facing such dire straits.
Not everyone is buying it, though. Gil McGowan, president of the Alberta Federation of Labour, for example, says “the differential has been around for years, it’s just now being used as a scapegoat to draw attention away from the government’s failed revenue policies.”
And it’s true that differentials are nothing new. Canadian heavy oil takes more energy – and therefore more cost – to process into fuels like gasoline or diesel, so it’s always sold for cheaper. According to Patricia Mohr, the Bank of Nova Scotia economist, that discount averaged $18.19 between 2005 and 2009. (Alberta budgets on a $15.97 differential.)
So a $40 discount for Canadian heavy oil is big – but nearly half that discount is perfectly normal. And over the past 12 months, the differential has averaged just over $25, which means it hasn’t been much bigger than average.
Still, the current differential is obviously much bigger – and there are ways to sort out what it could be if there was plenty of space on pipelines. Take, for example, the differential between Louisiana light sweet oil (LLS) and Maya oil. Those two blends of crude traded on the U.S. Gulf Coast are roughly comparable to Canadian light oil and Western Canadian Select, respectively. In recent trading, the gap between LLS and Maya has been roughly $13. Some argue that in a logical world, the Canadian heavy oil discount would look more like that – a possibility that emphasizes how much is being lost today.
But the many different ways of calculating things have led to widely varying estimates of the missed revenues for energy companies today. The Canadian Association of Petroleum Producers did a back-of-the-envelope sketch and came to roughly $15-billion, based on current pricing. Martin King, a commodities analyst with FirstEnergy Capital Corp., pegs it at $18-billion.
The numbers are necessarily guesses, since they are based on estimates of what oil prices could be if pipelines weren’t effectively full and product went to market unobstructed.
That said, the numbers can also be crunched to show much larger losses. If Canadian crude could make it to tidewater, it would access the kind of international prices that drive LLS and Maya. Compared to that, far more revenue is being forfeited – Mr. King puts it at nearly $30-billion, in the vicinity of the Alberta estimates. Still, that’s far more hypothetical, since it’s less certain that Canadian oil will achieve international prices, given the troubles industry has encountered building pipelines to the West Coast.
And at least part of the story is that the Alberta government didn’t just underestimate differentials. It also overestimated the headline oil prices, expecting a WTI price of $99.25 when it’s actually been about $93 over the past 12 months.
Either way, Mr. King said, current differentials are adding up to missed government tax and royalty revenues of about $4-billion to $6-billion. Most of that pain accrues to Alberta.
“You take the mid range of that; $5-billion that’s wiped out just because we’re taking a hit on spreads,” he said.