By John Mayes and John Auers
While the 1983 Canadian movie “Strange Brew” won’t go down in movie annals as a classic, it does make for some easy watching entertainment as it follows the misadventures of Bob and Doug McKenzie while they somehow save the world from an evil brewmaster played by Max Van Sydow. The Canadian oil industry has undergone similar twists and turns over the past few weeks and months, with some related to the misguided attempts by environmentalists to save the world from oil sands, while others coming as a result of both “Acts of God” and acts of the marketplace. And just as in the process of brewing beer, these events (ingredients) will have important impacts on the resulting prospects (flavor) of future oil sands production. Actual output in future years will be result of the interplay of all of these and other developments, some positive, stimulating further production growth, while others work to cap and even reduce output.
Certainly, the current Alberta wildfire, the largest in recent Canadian history, is having the biggest and most immediate impact on production levels. After starting on May 1, for yet to be determined reasons, the blaze spread rapidly to threaten facilities throughout the extensive oil production regions in the north of the province. By May 4, the full evacuation of Fort McMurray was ordered along with a shutdown of a succession of production sites which reduced output by nearly 1.3 million BPD at its peak.
While it appears that the worst is over, the fire is still not fully contained and the damage is extensive. The nearly 90,000 residents of Fort McMurray are being allowed to return home on June 1 (depending on air quality) and most of the production sites are already restarting. While lives of many Albertans were dramatically impacted by the fire, the long term effects are likely to be minimal and may actually yield some benefits.
The wildfire has already consumed 1.2 million acres (approximately 1,930 square miles) and has recently moved into Saskatchewan. In Fort McMurray, more than 2,400 buildings were destroyed or about 10% of the total structures. Many of the most important facilities (the hospital, airport and water treatment plant) survived relatively unscathed. While the short-term reduction of oil output was massive, none of the production sites were directly impacted, although many suffered extensive collateral damage. On May 17, a 665 room lodge for oil sands workers was destroyed, with 19 sites having been evacuated by May 23. Nearly 2,000 fire fighters, 29 air tankers and over 200 helicopters were part of the efforts to control the fire. Even with 90,000 evacuees, there was no loss of life.
The monetary impact of the fire is likely to be staggering. The Conference Board of Canada estimated the value of the lost output in the first two weeks at slightly under $800 million. The Bank of Canada recently lowered its Canadian GDP growth for the second quarter from 1.0% to a negative 0.25% because of the fire. Many are speculating that this may be the costliest disaster in Canadian history.
There are always lessons that can be learned in any tragedy and this is certainly the case for Alberta. Most of the output from the SAGD facilities went to the Cheecham South terminal which was one of the first sites to be shut down. This forced the rapid closure of several SAGD operations which had only limited storage capabilities. While the pipelines were safely underground, the power lines to the pumping stations remained vulnerable, as were the large number of work camps in close proximity. While increased optionality may be more expensive initially, the benefits can be significant in the longer term. Improved logistics and more storage capacity could have prevented many of the closures.
Many lessons are learned the hard way, however. In 2015, the Cold Lake fire reduced production by 230 MBPD, but the industry failed to take any substantive action as a result. The threat of fires is constant, with Suncor Energy CEO Steve Williams stating, “We live in a region where forest fires have been on for thousands of years.” In spite of this, Albertan Premier Rachel Notley recently reduced Alberta’s wildfire budget by C$15 million for fiscal 2016/2017. Time will tell as to what corrective actions, if any, the industry will take to prevent a recurrence of the shutdowns following the next wildfire.
While the short term effects of the fires in Alberta were constrained production, the long term effects of rising crude oil prices were setting the stage of a resurgence of growth. Capital budgets in Canadian production companies have been slashed as in other regions, but the prospect of higher prices could easily reverse these recent trends. Canadian output is highly vulnerable to low prices in that oil sands yield some of the highest incremental cost barrels in the world. A growing belief in the long term strength in rising oil prices would provide a solid basis for the development of expensive new oil sands projects resulting in rising Canadian output.
Even as wild fires were constraining oil sand production growth, the industry was pushing forward with new plans to expand output well into the next decade. On May 19, Canada’s National Energy Board approved plans for the expansion of the Kinder Morgan Trans Mountain Pipeline from its current capacity of 300 MBPD to 890 MBPD. The line runs westward from Edmonton, Alberta to Vancouver and then to the Anacortes refineries. While the decision was expected, it represents an additional step in the sequence of events necessary to begin construction.
Not only would the expanded pipeline be able to supply additional volumes of Canadian grades to U.S. West Coast refineries, but would also be invaluable in tapping into the rapidly growing refining centers of eastern Asia. The approval was not without conditions however; 157 conditions to be exact. Most of these relate to safety and design issues, as well as requirements for First Nation consultations. The NEB expects construction by late 2019.
Formal approval by the Canadian government is far from certain however. There remains considerable voter dissatisfaction with the project, with the mayors of several major cities (including Vancouver) decidedly against the expansion. The Vancouver mayor recently described the NEB decision as “a sham.” The NEB expects the Federal decision by December of this year.
While rising oil prices and the NEB can stimulate oil sands development, other internal developments within Canada may restrict growth. Federal scientists have recently quantified the impact of oil sands development to rising levels of “secondary organic aerosols.” These findings run counter to initiatives by the provincial government in Alberta and the Federal Government to curb greenhouse gas production growth. Recognizing the impact that the oil sands industry has had on Canadian economic development, there is considerable political pressure on both sides of the issue of renewed production growth.
All of these issues come together (and in conflict) with the question of when and where new exit pipelines should be constructed. Before the oil price collapse in 2014, Canadian production growth indicated a new major pipeline would be necessary around 2019 or 2020. Lower oil prices have slowed production growth and have pushed off the need for new pipelines. The prospect of higher prices, however, and as a result rising production forecasts, has resurrected the pipeline debate, a discussion we covered in more detail in our April 12th blog, “Blame Canada – Keystone Leak/Canadian Takeaway Capacity.
So what will happen in the future – will we see a happy ending for the Canadian oil industry like what happened in “Strange Brew,” where the McKenzie’s dog, Hosehead, not only saved Oktoberfest from contaminated beer but also gave Bob and Doug access to unlimited Elsinore brew? It likely won’t be that clear cut (or far-fetched). The factors that will shape future oil production growth in Western Canada are many and complex. They include economic, environmental, and political forces, in many cases working against each other in pushing production higher or pulling it lower. Turner, Mason & Company continually monitors developments to assess the future of Canadian oil prospects. Considering the importance of Canada in not only the North American supply/demand environment, but also on global balances, they are an important part of the analysis we do in our biannual Crude and Refined Products Outlook. Our next issue, to be published around the middle of July, will further discuss the various forces at play in Canada and their likely results. More information on this product can be seen by visiting our website at turnermason.com.