Alberta’s Oil Production Cuts Have Unintended Effects

Alberta Premier Rachel Notley took a big step in December last year when she announced that the province is ordering mandatory oil production cuts to the tune of 325,000 barrels per day to tackle oversupply and boost prices. The restriction came into effect in January this year and amounted to 8.7% of Alberta’s total raw crude oil and bitumen output.

The Government of Alberta has further clarified that the restrictions will remain in force until Dec. 31, 2019, but the production cuts will be monitored and evaluated on a monthly basis. Premier Notley said that the province was forced to take this step as the Canadian economy was losing C$80 million each day thanks to a pipeline shortage.

Alberta Taking Measures to Reduce Oil Glut

Alberta generates 3.7 million barrels of oil on a daily basis, but that exceeds the province’s shipment capacity by 190,000 barrels and creates a supply glut. With 35 million barrels of oil already in storage before the mandated cuts were announced, Canadian oil producers were forced to sell crude for rates as low as $10 per barrel.

The price of Western Canadian Select (WCS) crude oil has risen substantially since the cuts came into force. The commodity was trading at an average of $17.71 per barrel at Hardisty in November 2018, but it averaged more than $51 per barrel in January. That allowed the government to relax the production cuts by 75,000 barrels per day for the months of February and March.

Premier Notley also clarified that storage levels have dropped since the cuts came into effect, but the industry is still on shaky ground due to lack of pipeline capacity. The province of Alberta is looking to overcome that problem as it plans to buy 7,000 rail tankers and 80 locomotives to move out the supply glut starting late 2019.

Oil Companies Response to Price Cuts

Canadian oil companies, however, haven’t been unanimous in their support of the cuts. The likes of Suncor (TSX: SU), Husky Energy (TSX: HSE), and Imperial Oil (TSX: IMO) have opposed the government intervention as it hurts their integrated operations on account of the narrowing WCS-WTI (West Texas Intermediate) differentials.

The differential between Canadian and American crude oil is down to just $11 per barrel. So it doesn’t make economic sense to ship oil to the U.S. from Alberta as it involves a cost of $15-$20 per barrel. Not surprisingly, crude-by-rail shipments have declined substantially. Imperial Oil believes that its crude-by-rail shipments would drop to nearly zero in February as compared to 90,000 barrels per day in January.

Such a development could derail Alberta’s goal of reducing the oil inventory glut that has come down to some extent post the mandated cuts came into force. The government said that crude oil inventories are down to 30 million barrels since the announcement to curtail production was made, with stockpiles at Hardisty in January this year dropping to their lowest levels since November 2017.

However, the government’s intervention in a free-market economy isn’t being seen as a positive step across the board despite some of the positives. Industry watchers believe that oil companies probably fear a dent in investor confidence because of the overreach, as it could potentially hurt their integrated operations in the downstream segment. The temporary production cuts might be working for now, but the government needs to establish a long-term solution by building pipelines to improve market access.