At the beginning of December, the premier of Alberta, Rachel Notley, took the uncommon step of mandating that Alberta’s oil companies cut oil production. This move was nearly unprecedented because Canada’s free market economy generally does not get involved in regulating oil production so directly.
The government of Alberta mandated production cuts of 8.7% in order to reduce ballooning oil inventories. The plan was designed to remove about 325,000 barrels per day from the market, which would help alleviate Canada’s extreme pipeline bottleneck.
Canada’s inability to move its crude oil out of Canada, either to the United States for refining or to Asia, had caused prices for the Canadian benchmark oil, called Western Canadian Select (WCS), to drop significantly in comparison to other oil benchmarks. In October, WCS traded for $50 per barrel less than West Texas Intermediate (WTI), the U.S. benchmark oil. Now, due largely to the production cuts in Alberta, the gap between WCS and WTI has narrowed significantly. It is now only about $13 per barrel.
However, production cuts are not a long-term solution for Canada – pipelines are. The current cuts are only designed to last until mid-2019, when companies can increase production so that they are cutting only 95,000 barrels per day from November production rates.
What about a long term solution? The pipeline situation in Alberta is complicated. The two largest pipeline projects, the Keystone XL pipeline and the Trans Mountain pipeline, are both stalled with no timeline for construction. A third pipeline, the Enbridge Line 3 pipeline, which is designed to replace a current pipeline, is under construction and is expected to open by the end of 2019.
The point of the production cuts was to alleviate the transportation bottleneck and draw down stored oil in Canada. Although the cuts are intended to end in mid-2019, that plan may be reevaluated if stored oil has not been sufficiently drawn down. Extending the cuts could have long-term implications for Alberta’s oil industry, including dis-incentivizing investment in future production and dis-incentivizing investment in needed pipeline infrastructure.
The Canadian government is walking a fine line with these production cuts and will face a difficult decision if the cuts continue to prop up prices in 2019. Will the Alberta government be able to relinquish the control it has exerted over the market when conditions are no longer so severe, or will it see that success as a reason to further manage the market?