Only Trudeau government can fix pipeline problem, so industry and Alberta need to pressure Prime Minister for solution

With 10 months to go until the Alberta election, energy issues are being hotly debated, none more so than the question of why oil sector capital investment fell off a cliff after 2014. Have investors soured on Alberta? Are Notley government policies to blame? A new study from IHS MarkIt has the answer: not enough pipeline capacity for rapidly growing crude oil supply.

The Canadian Association of Petroleum Producers, for instance, blames federal and provincial climate policies: “Carbon leakage occurs when investment – and therefore oil and natural gas production – shifts from places with high regulatory standards and other costs (i.e., Canada) to places with lower or no standards and associated costs (i.e., Saudi Arabia, Russia, U.S.).”

Opposition Leader Jason Kenney regularly blames Premier Rachel Notley for driving capital out of the industry.

The IHS study blows this canard out of the water.

“Pipeline constraints have exacerbated price discounts for Western Canadian heavy oil relative to global benchmarks. Over the past 12 months alone, the difference in price compared to a barrel of West Texas Intermediate (WTI) has fluctuated just under $10 per barrel to more than $30,” says Kevin Birn, executive director, Oil Sands Dialogue, and author of the report.

“This sort of price volatility is weighing on investment decisions in western Canada and will likely continue to do so until greater certainty can be achieved.”

Production growth in the Alberta oil sands will accelerate through 2019, adding up to 500,000 b/d of supply, before slowing significantly, and will be 1 million b/d higher by 2027 thanks to higher crude oil by rail shipments – currently around 170,000 b/d – to US markets.

While the Trans Mountain Expansion (590,000 b/d), Line 3 (390,000 b/d), and Keystone XL (830,000 b/d) pipelines will provide enough capacity from now until 2030, the question weighing on producer investment decisions is when projects are completed.

“Over the long term, the timing of the new pipelines will be key,” Birn said. “Even when greater certainty on infrastructure is achieved, it will take time for the impact of subsequent investment decisions to play out on production growth because of the lead time involved in oil sands development. The current growth trajectory was a long time in the making, it has taken a time to slow, and it will take time to recover.”

Economist Kent Fellows adds another wrinkle to the supply growth prediction. He says oil sands producers have evolved from hunters (searching out new resource, expanding production) to farmers (maximizing output from the existing resource and facilities).

“Investing in exploration doesn’t make as much sense as it did pre-2014 because US shale is heavily influencing the extensive (quantity) margin,” he said in an email.

“Spending on cost reduction to improve the intensive (price less cost per barrel) margin makes a lot more sense. This is a sentiment I have heard expressed a lot in recent years.”

Lowering production costs, as oil sands companies have been frantically doing since crude oil prices collapsed in late 2014, also has an effect on investment volumes, says Fellows.

“Investment in cost-reducing research and development is a funny thing. It if is successful that means that the combined capex and opex per barrel of production actually ends up falling, otherwise the R&D investment isn’t really cost reducing,” he said.

Bernadette Johnson, VP of market intelligence for Denver-based Drillinginfo, says there is a global trend of under-investment in long lead-time conventional supply projects, too.

“Many projects were shelved during the downturn, and we haven’t seen it rebound much. These types of projects are tough to commit to when prices are very volatile, like they have been,” she said in an email. “There’s also more pressure now from shareholders.”

Energy economist Ed Hirs of the University of Houston says the under-investment also plagues the American industry, which is contrary to the Canadian industry narrative.

At the moment, I think darn near everybody’s having trouble accessing capital unless they can demonstrate significant well economics and capital discipline. The capital that’s coming into the market is really coming in to clean up balance sheets and restore financial stability,” he said in an interview.

The irony for Canadian producers is that higher prices and a concerted effort to lower operating costs during the period of low prices has left them with billions in cash that could be ploughed back into expanding production.

Given the degree of volatility we’ve seen, it’s causing hesitation among those producers who may well be getting in the financial position to be able to do something,” Birn said in an interview.

“When they choose to decide to sanction, they’re going to want to be sure that by the time that project is brought online, that the adequate pipeline capacity will be in place.”

 Birn argues that pipeline approvals aren’t enough, producers need to see shovels in the ground and feel confident that projects will be completed in a timely fashion. Until then, oil and gas CEOs will be put their cash to better use elsewhere.

Since inter-provincial pipelines are exclusive federal jurisdiction, the question of construction timing for the three existing projects on the books (TMX, Line 3, KXL) and new projects that need to start planning in just a few years, puts Prime Minister Justin Trudeau and the federal government in the hot seat.

After a promising start, the Liberals have stumbled and fumbled the pipelines file – for both regulation and environmental assessments – for the past 12 to 18 months.

Two things need to happen to fix this problem.

One, industry must stop picking up pennies and stepping over dollars. The Canadian Energy Research Institute calculates emission compliance costs at 67 cents a barrel, while a wide discount between Western Canadian Select, the heavy crude benchmark, and West Texas Intermediate can cost producers many dollars per barrel.

Market access is far and away the most important issue affecting the growth of the Alberta oil sands and that should be the focus of trade groups like CAPP.

Two, the Notley government must use its long cultivated influence with the Trudeau government to apply pressure on the pipeline file. If that includes public criticisms of the Prime Minister and Natural Resources Minister Jim Carr, then so be it.

My sources suggest that the balance between environmental advocates and pipeline supporters within the relevant ministries and the Prime Minister’s Office has shifted in favour of the former, which is bad news for Alberta.

It’s time for the Premier to put the credibility she has accumulated on climate policy to good use.

Birn and his team at IHS have demonstrated that oil sands capital investment is tied to the fate of market access. Now industry and the Alberta government must pull together in the traces by insisting that Ottawa find a solution.

This isn’t about politics, partisan or otherwise. It’s about the long-term health of the Alberta economy and by extension the Canadian economy.

Get after it, as they say in the oil patch.