Oil Market Report March, 2015

Whilst the world looks on amazed at the durability of the American shale oil industry, another major oil producing sector of North America is faring considerably less well. Canada’s tar sands were happily producing 1.5m barrels of oil per day (about 2% of global oil production) prior to the 2014 price crash, but fast-forward 6 months and the situation looks bleak. By mid-March 2015, the price of Western Canadian Select (a bench-mark crude oil grade for the Albertan heavy oils) had dipped below $30 per barrel and that is no price to prosper or perhaps even survive in the cold, frozen plains of the North. Moreover, unlike shale oil, this is absolutely not an industry that can be switched on and off when prices are unattractive (see last month’s report). Shutting down means shutting down for good…

Canadian tar sands have always been an unloved method of oil production. Firstly vast open pit-mines are required to access the underground tar. Then the world’s largest dump-trucks (pretty cool machines it has to be said) transport tar infused “tailings” (rubble) to separation plants that require vast amounts of energy, water and chemicals to create a bituminous sludge that is “ready” for refining. To get to the deeper tar reserves, constant steam is required to melt the tar, before it is suction pumped upwards for extraction. Environmentalists hate the tar sands with a vengeance, and I suppose if you are going to be against anything from an environmental perspective, then the tar sands probably deserve their place at the top table! The landscape created by tar sand extraction could be generously described as bloody awful and the industrial treatment involved in stripping the product down so that it is ready for the standard refining process, (ie, pre-refining refining!) is a huge CO2 emitter.

So it shouldn’t surprise us that historical opposition to the tar sands has been significant and there are several US States such as California, which ban the use of tar sand oil in their refineries. The most publicised example of opposition to the tar sands is President Obama’s refusal to sanction the Keystone XL pipeline, which would transport Albertan tar sand oil to US Gulf Coast refineries. The President has been unusually vocal in his opposition to this pipeline on two counts; firstly that it is filthy stuff (this tends to win over the Green wing of the Democrat party) and secondly, he takes the slightly more nuanced view that the provision of a route for Canadian tar sands to reach the US Gulf refineries will do little – if anything – to directly benefit US consumers. Most of the refined product will not go inland (so the argument goes), but will simply hit world markets via export instead.

The tar sands then, were already on the back foot when oil prices started plummeting and do remember that this type of oil trades at significant discounts to the widely published benchmark grades. When WTI is worth $50 per barrel, then the tar sands have to trade at $35-$40 – such is the poor quality of the product when compared to the lighter US crudes – to attract refinery buyers. Add to that the logistical problems in getting the product thousands of miles across the US continent without a significant pipeline (thus requiring dedicated rail trucks which once used for tar sand oil, cannot easily be switched to other products), then it should be no surprise that West Canadian Select is hitting such low prices and pushing operators (particularly smaller ones) over the edge.

Many Canadians however will not get over-concerned by what some will see as a short-term blip in oil prices. Yes, the falling value of oil has certainly hit parts of Canada hard, but the corresponding drop in the value of the Canadian $ (see graph) will also see Ontario’s long-suffering manufacturing base grow as their goods become significantly cheaper for export. Plus with 13% of the world’s oil reserves (3rd largest in the world) and 50% of available reserves outside of the OPEC countries – largely thanks to oil sands – the Canucks would be forgiven for viewing their oil sands as an asset worthy of patience and long-term development.

Furthermore, whilst the environmental record of the tar sands should justifiably come under public scrutiny, significant oil sand reserves can also be found in states such as Jordan, Madagascar, Congo and Venezuela – all of whom will likely be far less scrupulous in their exploration methods than Canada. And whilst no amount of spin can portray the oil sands as a clean form of energy, it should be noted that CO2 emissions from this industry make up only 5% of Canada’s total CO2 emissions and are dwarfed for example, by the emissions generated by coal fired power stations in the USA.

As for Keystone, the Republicans may win the Presidential election in 2016 and on doing so have promised to fast track the legislation needed to build this pipeline. But even if this Republican promise is not fulfilled (or the Democrats win), such is the continued Chinese demand for oil, that export channels for the tar sands via the Western Canadian sea ports will almost certainly soon spring up. If and when that happens, US politicians from both sides will have the devil’s job in explaining to their electorate why cheap crude oil from such a vast reserve and located just over the border in a friendly neighbouring country, is now finding its way to a potentially malign, economic rival that is 6,000 miles away.