Alberta Announces Oil Curtailment Plan 

Brian DePratto, Senior Economist | 416-944-5069

Omar Abdelrahman, Economist | 416-734-2873

Date Published: December 3, 2018

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Albertan government aims to restore balance to oil

  • Yesterday evening, the Albertan government announced that it would be mandating curtailment (production cuts) for oil producers in that province. The action is intended to address near-term supply-demand imbalances that have resulted in wider-than-normal discounts, not only for heavy oil blends, but also for 'lighter' grades (See our earlier report).  
  • The plan consists of two stages:
    • First, production curtailment of roughly 325k barrels per day (bpd) relative to peak production over the last 12 months. In practice, this means almost a 9% cut to production. This will be enforced starting January 2019 and is expected to last for three months. The goal is to reduce above-normal levels of inventories; the government states that current inventories, at 35 million barrels of oil, are roughly double historic norms. So, by the end of the first quarter, inventories should be down to about 14 million barrels.
    • Second, the level of production cuts will ease to roughly 95k bpd and will be maintained through the end of 2019. This stage is intended to keep production balanced against export capacity.
  • The curtailment requirements will take existing production cuts into account. As noted in our earlier report, it was already anticipated that 160k bpd of production will be 'shut-in' by the end of 2018Q4, meaning the net impact of this government-imposed change will be a further 165k bpd drop in output.
  • End-2019 was chosen to conclude these actions for two reasons. One, the Albertan government anticipates having an additional 120k bpd of rail export capacity through its purchases of rail cars and related facilities by this time. As well, takeaway capacity should be improved via Enbridge's revamped Line 3 pipeline. 
  • It is worth noting that the curtailment requirements will exempt the first 10k bpd of production, a move that will help ease the burden for smaller producers.
  • The government will maintain the flexibility to adapt its approach as market conditions dictate.

Key Implications

  • Drastic spreads call for drastic measures. The Albertan government has announced some of the most significant regulatory measures impacting the Western oil sector in decades. Production is up roughly 10% year-to-date, but committed takeaway capacity is not materially different. This leaves oil producers feeling the pinch on prices. These curtailment plans should help address pricing issues, notably the discount that Albertan oil currently faces vs. U.S. benchmarks.
  • At first blush, the plan seems to have had the intended effect. Pricing for the heavy Western Canada Select benchmark was up more than US$8/bbl at the time of writing, to roughly US$33/bbl. This is a dramatic change for a price that had been below US$14/bbl in mid-November. Indeed, the spread to the Western Texas Intermediate (WTI) benchmark tightened nearly US$10/bbl today, to fall below US$20/bbl for the first time since July of this year.  
  • The persistence of these pricing developments remains to be seen. It should always be kept in mind that oil is a global industry, and moves in the benchmark WTI price can outweigh changes in the spread, leaving Canadian producers in the lurch. 
  • From a macro perspective, pricing improvements already seen will help mitigate income shocks. However, from a real output perspective these plans will have a marked impact, both in Canada and Alberta, in particular. At a first read, the direct impact be to reduce Canadian real GDP growth in 2019 by 0.1 to 0.2 percentage points, with only a partial recoup expected in 2020 of roughly 0.1pp. For Alberta, the impact is much larger: 2019 growth could be between 0.6pp and 1.3pp lower than previously anticipated as a result of these output cuts. All negative impacts will be heavily front-loaded in the year, in line with the curtailment plans.
  • Where does this all leave the Bank of Canada? All eyes will be on this Wednesday's monetary policy decision, where we (and the market) expect a hold. Governor Poloz's speech the following day will be closely parsed for signs of how oil sector developments are affecting his view of the path forward. Recent pricing dynamics and the temporary nature of the output impacts should provide some solace that this episode will be contained. At the same time however, the path of global oil prices is highly uncertain, and any negative developments may lengthen the curtailments and their economic impacts.
  • The bottom line: monetary policy 'should' look through a temporary shock, but a risk management framework implies staying on the sidelines through the January meeting as well. There is little to be lost by taking a 'wait and see' approach. Economic momentum outside of the energy sector has faded somewhat while core inflation remains firmly at target. Waiting until the March interest rate decision to hike again offers more time to observe that price dynamics, take-away capacity, and general economic dynamics are all sending the right signal.