A World Awash in Oil
Opinions as of December 11, 2018
The SLGI Portfolio Management Team looks at what happened in the oil market in 2018 and what may lie ahead.
Supply and demand - it’s the only equation that matters in the oil industry. And in November the world’s key oil benchmarks, North Sea Brent and West Texas Intermediate (WTI), put in their worst month in 10 years, falling by more than 20% after trading close to US$80-a-barrel on Oct. 31. The reason: the world’s leading oil-producing countries were pumping oil at a record 100 million barrels a day - a rate that was swelling inventories and pushing prices lower.
For Canadian oil producers, (particularly in the heavy oil sector) falling prices were an even greater concern. The Canadian heavy oil benchmark price, referred to as Western Canadian Select (WCS), trades at a discount to WTI. The discount, which reflects the higher cost of refining heavy oil widened, and at one point the Canadian price was trading below US$14 a barrel – almost a US$40 discount.
Rising production, slowing demand
The flood of oil washing through world markets resulted from sharply increased oil production primarily by the United States, Russia and members of the Middle East-dominated Organization of Petroleum Exporting Countries (OPEC). Politics also played a role, when the U.S. imposed sanctions on Iran. Initially, primarily Russia and Saudi Arabia stepped up production to replace Iranian oil. But the U.S. then granted waivers to a number of countries including China that import Iranian oil, causing a sudden glut of oil when Iranian supplies came back on the market.
With a forecast for slower growth in demand and further price drops, OPEC and Russia (which is not a member of the oil cartel) met in Vienna on December 7. Saudi Arabia, OPEC’s largest producer, made the biggest cut, with Russia accounting for much of the rest. In total, the agreement will reduce output by 1 million to 1.4 million barrels per day.
The U.S., the world’s largest oil producer, opposed any intervention in the market, with President Donald Trump urging the Saudi government to leave the taps open to keep prices low. But the Vienna agreement ultimately caused world oil prices to immediately jump by almost 6%.
Alberta builds an oil railway
The day prior to the OPEC meeting, Alberta Premier Rachel Notley said at US$14-a-barrel, Alberta was giving away its oil. And she ordered a mandatory cut in production amounting to 350,000 barrels a day, about 8.7% of output. The OPEC and Alberta cuts combined to send the WCS oil price sharply higher. On December 10, WTI was trading in the US$51-a-barrel range compared to almost US$33-a-barrel for WCS.
While the OPEC agreement offered some relief for Canadian oil producers, other problems persist that could erode prices – most notably the lack of pipeline capacity, which caused inventories to build as output grew. Alberta estimates it is producing about 250,000 barrels per day more than can be shipped using existing pipeline and rail capacity. About 35 million barrels of oil were in storage in Alberta — about twice the normal level.
Canada is the world’s fourth largest oil producer, with 98% of Canadian oil reserves located in Alberta. With Canadian output expected to rise to 5.6 million barrels per day by 2035 (a 33 per cent increase over 2017 levels) it will only add to the transportation problem. Some relief will come when Enbridge’s Line 3 project, from Alberta to the U.S. Midwest, comes online late next year. But the Trans Mountain pipeline to Vancouver, and Keystone XL, which would carry Alberta oil to the U.S. gulf coast, remain in environmental and legal limbo.
In an attempt to ease the supply problem, Alberta will spend up to $350 million to purchase 7,000 rail cars and 80 locomotives, which will move an additional 120,000 barrels per day of oil. Analysts say while this will help ease the problem over the short term, the issues surrounding pipelines has to be resolved to end the supply crunch.
Long-term, demand is expected to rise
In the meantime, the International Energy Agency expects demand for oil to remain largely flat in 2019, at 100 million barrels per day. However, global demand is expected to rise steadily over the next 20 years as the need for oil, particularly in China and India, drives demand higher.
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