Western Canada's Oil Problem

Diane Francis column Post Wednesday April 19:


NEW YORK CITY - Western Canada's oil producers may not capitalize on record-setting oil prices in future because they are solely dependent on the U.S. market, says a British-based oil market expert.

"The problem for Canadian producers is where to market their crude," said Lesley Owens in a recent presentation to investors. She is an economist and partner in oil consultancy CITAC Global LLP in London. "Until Canadian producers find alternative markets their supply will put pressure on prices and that differential [between heavy and light crude oil]. Spreads are lower than normal."

Too much heavy oil from Western Canada to the U.S. fetches lower prices, reducing the viability and profitability of upgrading.

But there are other challenges facing Canadian oil producers such as:

* Supply increases in Canada, announced and underway, have outpaced U.S. refinery investments and this trend will continue to put downward pressure on prices.

* Western Canada's companies have focused on production rather than marketing which hurts prices.

* High natural gas prices have increased oil production costs for Canadian upgraders in the oil sands.

* Canadian dollar increases are also adding to production costs.

* Manpower shortages in Canada, and commodity price increases in steel and other materials, are contributing toward inflation in oil production costs.

Despite Canada's unique issues, oil producers as a whole will continue to enjoy higher prices.

Ms. Owens said that records in oil prices, such as this week's US$70 a barrel, will continue to be set thanks to fundamental trends in supply and demand.

"US$60 a barrel is a solid floor when demand is at its weakest," she said. "If that price slips, OPEC will take action."
Underpinning her price scenario are projections of solid economic growth.

"We are looking at growth worldwide of 3.6% in 2006 and 3.3% in 2007," she said. "Our view is based on the concensus view from several forecasts recently published by the International Monetary Fund and others."

Growth figures dictate that the net increase in demand will total 1.6 million barrels a day in 2006 while her market research has determined that the net increase in supply should tally only 1.3 million barrels per day.

"All this increase in demand is for transportation fuels," she said. Roughly speaking, 70% of all oil is refined into transportation fuels.

China figures greatly in these forecasts. Estimates are that within a decade China will have five times' as many vehicles as now, going from 20 vehicles per 1,000 persons to 100 per 1,000.

(This contrasts with 650 vehicles per 1,000 persons in Europe and 1,100 vehicles per 1,000 Americans.)

On the supply side, OPEC held production steady in 2005 while supplies provided by non-OPEC nations ebbed. Last year, production declines in the U.S., Norway, Britain, Mexico and Canada was slightly greater than production increases in Russia, Angola, Brazil, Azerbaijan, China and others.

This year, Canada's projected supply increases represent a huge turnaround. Inn 2005, production declined by 38,000 barrels a day, but this year it is expected to jump by 250,000 barrels a day, thanks to production from new fields in the oil sands and heavy oil deposits in Alberta and Saskatchewan.

Meanwhile, OPEC will keep production level in 2006 in order to keep upward pressure on prices.

There are supply wild cards which could create huge price increases. Iraq is plagued with terrorist attacks on its oil fields as is Nigeria. And Iran faces United Nations' sanctions over its nuclear ambitions which may result in supply declines.

"If we lose Iranian production [currently 4 million barrels daily], or the equivalent amount, prices could hit US$100 a barrel," she said.

What's perplexed many is that economic growth has remained strong despite increasing oil prices. But energy price increases have not kept pace with inflation or economic growth, in large measure due conservation, alternatives and fuel efficiencies.
Growing popularity of hybrid cars as well as the deployment of clean coal gasification fuels, will keep demand reasonable. China, for instance, is mandating such technologies and other countries may follow suit.

Clearly, Canada is in a great position in future.

Offshore production in the Atlantic is poised to grow from 303,000 barrels daily to 375,000 in 2006 and fetches world prices because of geographic locale.

The west must diversify its customer base by backing a pipeline to B.C.'s coast. By having a Pacific Ocean outlet, customers from anywhere will be able to bid for Canadian crude thus creating an auction for crude in order to guarantee world prices.

It should be an industry priority to address the distribution issue in order for Canada to realize top dollar for this non-renewable resource.