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A Brief History of the Alberta Oil Curtailment

Randen Pederson / Flickr – Creative Commons

Do you remember the great oil price crash of 2014-2016? I sure do. A 70 per cent drop in global crude prices brought the expansion of Alberta oil sands projects to a halt. I worked in the industry at the time, and the crash severely curtailed my employment options. I was unemployed for nine months — an unprecedented experience in my working life.

My employment options weren’t the only thing subject to restriction. The Alberta oil curtailment order of December 2018, imposed a production cut of 325,000 barrels per day (b/d), which amounted to 8.7 per cent of Alberta’s production at the time. The orders were binding on all operators producing more than 10,000 b/d, although operators had some flexibility in allocating production levels among themselves.

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Reasons for Alberta Oil Curtailment

Why did the Alberta government order production cuts? The simplest explanation is that Alberta was producing more oil than it could transport or sell, but to appreciate this explanation, we have to take a closer look at the details.

Oil prices dropped around the world at that time because supply exceeded demand. The World Bank has a pretty good explainer about this situation. Technology gains lowered the break-even price of U.S. shale, which touched off a production surge in that sector. 

To counter the U.S. gain in market share, OPEC increased its own production, driving prices even lower. The idea was to drive high-cost producers off the market, ensuring a larger slice of the pie for OPEC. Alberta crude has a high break-even point, so Alberta producers were especially vulnerable.

Still, the supply glut doesn’t completely explain Alberta’s curtailment experiment. To understand, we have to consider the price differential between two prominent crudes — Western Canada Select (WCS) and West Texas Intermediate (WTI).

Crude Oil Price Differentials

Many people know that WCS sells for less than WTI, but why? The Alberta government lays that out for us in this piece on price differences (PDF icon). Two factors influence price — quality and transportation costs.

Alberta oil is considered to be low quality. WCS is heavy, gunky stuff, with a high sulphur content, which makes it difficult and expensive to refine — so difficult that Koch Industry, a longtime key buyer of Alberta oil for its Pine Bend Refinery, once referred to our oil as “garbage crudes.” WTI, by contrast, is light, sweet and easy to refine. Quality accounts for part of the WCS-WTI price differential, but only a small part.

The second (and more important) factor is transportation costs. Alberta oil travels by pipeline or railcar. Because bitumen is solid, or at best a highly viscous liquid, it must be thinned by diluent so it will flow through a pipeline. The resulting diluent-bitumen mixture is called dilbit. Transportation costs therefore consist of pipeline (or railcar) operation and diluent.

So why did the WCS-WTI differential grow so large that the Alberta government had to curb production? The missing puzzle piece is production. It’s common knowledge that production has grown over the last couple of decades, but by how much exactly? The following chart makes that clear.

As you see, Alberta crude production has grown rapidly in recent years. The oil sands account for all of the growth. Some time in 2018, production exceeded pipeline capacity. It threatened to exceed storage capacity as well.

By May 2018, the situation had reached crisis proportions. The Notley government convened talks between the largest producers and the largest railways to discuss shipping crude by rail. It costs more to move oil by rail than by pipeline, which means rail shipment widens the WCS-WTI differential. But the government had no other solution.

Alberta Oil Curtailment Rules

In October 2018, Rachel Notley asked Ottawa to help pay for railcars, but her request was turned down. By November, the government was talking about buying railcars — enough to move 140,000 barrels per day.

In the face of opposition from British Columbia and other commodity shippers, the Notley government scaled back its railcar ambitions and signed contracts with Canadian National and Canadian Pacific to lease 4,400 cars, which would move about 20,000 barrels per day.

But it was not enough. Production continued to exceed the combined pipeline and rail capacity, and the WCS-WTI differential grew so large that it pushed WCS into negative territory, rendering excess Alberta oil worthless. On December 6, 2018, the Alberta government issued Curtailment Rules (PDF icon), citing the Oil and Gas Conservation Act, the Oil Sands Conservation Act, and the Responsible Energy Development Act as its authority.

Beyond the immediate goal of adhering to transportation and storage limits, the Curtailment Rules were an explicit attempt to reshape the market. By restricting supply, the government (and presumably industry itself) intended to lower the WCS-WTI differential by limiting the supply of WCS, according to the basic economic law of supply and demand.

Industry Reaction

Industry reaction was mixed. Cenovus Energy supported the order, noting that it had already asked the government for curtailment a few weeks previously. Imperial Oil CEO Rich Krueger “respectfully disagreed” with the order. But in March 2019, CNRL executive vice-chairman Steve Laut hailed the order during an earnings call. “With curtailments imposed by the Alberta government, market order has been established,” he said. CNRL executives also voiced their expectation that the order would be lifted soon.

They had to wait a while, but not long. The government lifted its curtailment rules at the end of December 2020. By then, the WCS-WTI differential had narrowed to $17.62. Still, markets remained shaky, and the government retained its authority to reimpose production cuts until the end of 2021.

By the way, the Alberta curtailment order had nothing to do with politics. The order came in under the NDP, but then-Premier Jason Kenney supported it, although he (predictably) criticized the Trudeau government for creating the conditions that required it. When the UCP took power in April 2019, it kept curtailment in place for 19 months. 

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The Lessons of Curtailment

The Alberta oil curtailment provides many lessons, but the most basic one is that governments have the power to restrict production. In all the industry protests, no one asserted that curtailment was illegal. Nor were producers penalized for shortfalls in delivery. Their contracts defined government action as force majeure, and producers were absolved of responsibility.

This power is not absolute, but it is available under certain circumstances. An Alberta government can restrict production when the public interest demands it. Or when its own interest demands it.

In the current circumstances, Alberta producers will not exceed transport and storage capacity. Nor are they likely to do so in the future. The industry has grown since the curtailment era. It has acquired a pipeline route to the U.S. Gulf Coast through a so-called “Carefree Highway,” which allows it to re-export oil via Gulf Coast terminals. The Trans Mountain Expansion will probably come online this year. The industry has also developed greater storage capacity.

At some point, this capacity will go unused, stranding assets. All credible forecasters predict decline. We can draw no comfort from OPEC’s prediction of global demand growth, because Alberta does not service a global market. It may ship some oil to China and India while oil demand grows in those countries, but this growth will not last for long. The Chinese national petroleum company, Sinopec, has announced its own forecast of peak oil demand by 2030.

We will have extra oil on our hands again, and soon. How will future Alberta governments manage the situation? Will they simply let producers fight for market share? Will they attempt to manage the decline on other, more rational bases, such as profitability or emissions intensity? Or will they at long last curtail production on grounds of the climate emergency ravaging our own province and nation? If we consider the ethics of oil production, there’s a good case to be made for it.

If a future Alberta government chooses to intervene, curtailment will  be one of the tools at its disposal. We hardly think it possible today, but we may one day see the issue in a new light. The boundaries of the possible shift with circumstance.

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