Canadian crude discount squeezes oil patch

Canadian crude discount squeezes oil patch

NATHAN VANDERKLIPPE

CALGARY— From Wednesday's Globe and Mail

Published Tuesday, Mar. 06, 2012 7:31PM EST

Last updated Tuesday, Mar. 06, 2012 7:37PM EST

Canadian crude has become the poor cousin of the oil world, as a confluence of transportation and market factors threaten oil patch profits for months, if not years, to come.

Amid an explosion in oil sands growth, surging Canadian energy output has combined with pipeline problems and rocketing U.S. production to create a supply glut that is severely depressing prices, and profits. Concerns are now rising that the export pipes that sustain Canada’s energy industry are rapidly filling up.

The effect has been severe and broadly felt. Canadian prices, relative to the rest of the continent, are taking one of the largest hits they’ve ever seen.

And it will likely take some time for prices to recover. Major new projects in the oil sands and the red-hot Bakken play in North Dakota are pumping out an extra 400,000 barrels a day every year, according to estimates by Cenovus Energy Inc.

That growth is coming at a time when new pipelines to move oil, such as Keystone XL and Northern Gateway, are experiencing serious opposition and delays. In addition, the existing network has experienced problems, such as the traffic accident that shut down a major Enbridge pipe Saturday. That pipe is expected to be back in service by Thursday, but the outage comes amid broader worries about available pipeline capacity.

Analysts have suggested that the current pipeline system can support growth until some time between 2014 and 2017. But the current discount pricing of Canadian crude is so deep, it suggests the system – including both available pipes and the ability of refiners to consume what’s coming down them – is nearing capacity today, said Stephen Brink, chief of market fundamentals and hedging for Cenovus.

“We’re getting very close,” he said. “Price is as good a signal as anything of how tight you’re getting.”

He added that inventories of Canadian crude are beginning to grow, and “there’s a very real risk” oil will begin to back up. Canadian producers could see “weakening” prices until mid-2014, when new pipelines from Enbridge, for example, could start carrying away more oil, Mr. Brink said.

The impact is hard to overstate: Canada produces some three million barrels a day of oil and virtually all of it is facing deep discounts, with the exception of relatively small quantities that flow to places like Vancouver and other coastal markets with higher prices. The 1.5 million daily barrels of Canadian heavy crude have been especially hard-hit: March prices saw their third-highest discount in the past five years.

Crude oil comes in different types of blends. In North America, the most traded and most visible is West Texas Intermediate. It is the trend setter, and other blends are priced off it. On Tuesday, WTI closed at $104.87 (U.S.) a barrel.

On the same day, Western Canadian Select, a heavy Alberta oil, dipped $34.50 under WTI. In the past few weeks, it has sold as much as $38 below the WTI benchmark, according to Net Energy Inc., a Calgary firm that operates an important oil trading system.

Canadian synthetic oil, meanwhile, fell $10 under WTI. It has in the last month fallen as far as $25 below. Synthetic blends are made by oil sands companies that pre-refine their product into a lighter oil. Under normal circumstances, they trade close to the benchmark price.

New heavy oil refining capacity coming online from Midwestern refineries in the next year could help alleviate the problem, said Andrew Potter, an analyst with CIBC World Markets. Even assuming that, however, “this situation may not be completely fixed until the second half of 2013,” he said.

In the meantime, the oil patch could see some pain. The first three months of 2012, Mr. Potter said, are “clearly not going to be a good quarter. Between blowouts in heavy pricing, blowouts in synthetic oil pricing, weak natural prices – it’s across the board. The only thing that’s working, really, is downstream.”

Downstream refers to refineries, which have seen hefty profits as they transform the cheap crude into more expensive end products like gasoline and diesel. That will mute the impact of the oil price discount on companies with refining capacity, like Suncor Energy Inc., Imperial Oil Ltd. and Cenovus.

It’s still a large impact, however. In 2009, FirstEnergy analyst Martin Molyneaux calculated that a single-dollar drop in the heavy oil discount bled $340-million a year from Canadian oil patch top-line revenues. Oil production has increased since then, so that number is almost certainly conservative by today’s standards. And light oil is now trading down, too.

Still, global commodity prices are immensely difficult to predict, and the price of smaller, regional commodities are even more so. Those who have endured the whiplash from previous shifts in Canadian oil pricing, which has a tendency to whipsaw rapidly, say this, too, shall pass.

“I’ve counted 30 per cent plus [discounts] four times over the past about three years. And every time they’ve gone back so far,” said Tony Marino, chief executive officer of Baytex Energy Corp.

He pointed to a series of reasons why the current spread shouldn’t last. For one, those refinery profits should help drive demand and eventually eat away at the discount. Companies like Baytex are also flexing their new ability to move oil by rail, a recent development. In March, 12 to 15 per cent of Baytex crude will move by train, allowing it to skirt oversupplied markets like the U.S. Midwest and sell instead to places like the Gulf Coast and California, where prices are so much higher that they more than compensate for the double-digit increase in transportation costs over pipe.

“It’s a definite improvement,” said Mr. Marino, who said Baytex intends to push for a “meaningful” increase to its rail volumes this year.

Fixation with manufacturing is missing the big picture

ECONOMY LAB

Fixation with manufacturing is missing the big picture

STEPHEN GORDON

Globe and Mail Blog

Posted on Monday, March 5, 2012 7:05AM EST

Note to the blog readers: I respectively disagree with this author.

The ‘Dutch disease’ story goes like this: an appreciating dollar increases the price of Canadian exports on world markets, and the resulting fall in the quantity demanded reduces export volumes as well as employment in export-oriented industries.

That’s good enough for all-too-many politicians and pundits: it sounds plausible, and -- perhaps more importantly -- it can be expressed in one sentence. But if you look more closely at this argument, it falls apart very quickly.

Firstly, the prospect of fewer Canadians making things for foreigners is to be welcomed: what matters for Canadian economic welfare is consumption by Canadians, not making things that will be consumed by non-Canadians.

The Dutch disease story also supposes that the employment losses in the export sector are not offset by employment gains in other sectors. This has clearly not been the case in Canada: the resource boom of 2002-2008 saw a steady reduction of unemployment rates to their lowest level since the Labour Force Survey started collecting data in 1976. Nor were these jobs systematically lower-paying: after stagnating during the 1990s, real median wages saw significant growth during the resource boom -- even in Ontario.

It is important to remember that wages are set at the national level, and not by sector: an increase in the demand for labour in one industry will increase all wages. As long as workers can move from one sector to another, employers in other industries will be obliged to pay higher salaries in order to retain their workers. They won’t be able to keep all of them of course; some workers will end up moving to the expanding sector.

A higher exchange rate forces employers to pay higher wages. Producers that serve the domestic market will generally benefit from the increased demand generated by the increase in Canadian wages and will be able to accommodate pay increases. But export-oriented firms outside the expanding sector will be faced with an exchange rate that provides lower prices in terms of the Canadian dollars they are obliged to pay their workers, and they will find it harder to compete in a labour market in which wages are rising.

Somehow, politicians and pundits insist on seeing a problem when employment in one sector falls in the face of a general increase in wages. Perhaps the best one-sentence explanation of the logic behind the Dutch disease argument is Yogi Berra’s. “Nobody goes there anymore,” he once said of a St Louis restaurant, “it’s too crowded.”

Banks hit by global volatility

Banks hit by global volatility

GRANT ROBERTSON AND  TARA PERKINS

From Friday's Globe and Mail

Published Thursday, Mar. 01, 2012 7:29PM EST

Last updated Thursday, Mar. 01, 2012 7:41PM EST

Canada’s two largest banks are seeing profits fall as their capital markets businesses feel the pinch of global economic uncertainty, most notably in Europe.

Both Royal Bank of Canada (RY-T56.770.370.66%) and Toronto-Dominion Bank (TD-T81.850.070.09%) reported first-quarter profits Thursday that were down slightly from the same period last year. The banks’ earnings both dropped by roughly 5 per cent – to $1.86-billion and $1.48-billion respectively.

Still, the results were a relief for investors. Given the headwinds the banks are facing from low interest rates and volatile markets, analysts had actually expected a worse performance this quarter.

And both banks hiked their dividends, offering a sign they are comfortable their future profits will be resilient. Investors reacted favourably, sending shares of both companies up.

The core Canadian consumer and business lending operations of both banks posted solid growth, but their capital markets divisions reported significant profit declines compared with a year ago, when trading revenue soared amid uncertainty in Europe that ignited a frantic bond market. Since then capital markets revenue has fallen steadily.

“I still don’t believe that we’re in markets that could be even remotely described as normal,” Mark Standish, RBC’s co-chief executive officer of capital markets, told analysts on a conference call.

RBC was particularly exposed to the volatility, given its large capital markets business. That operation made $448-million, a drop of 30 per cent. The decline overshadowed record earnings for the Canadian retail banking business, which made $994-million, up 7 per cent.

The bank had previously told analysts what range of profits they could normally expect from activities such as trading, but Mr. Standish refused to give a range this time around. While there have been signs the market is improving, he suggested the environment simply remains too unpredictable.

RBC’s $1.86-billion profit was equal to $1.21 a share, down from a profit of $1.95-billion, or $1.27, last year.

TD’s earnings of $1.48-billion amounted to $1.55 a share, down from $1.56-billion, or $1.67, a year ago. Though TD’s retail banking, wealth and insurance units reported higher earnings, profit at its capital markets division fell 17 per cent.

TD’s results were also impacted by a number of one-time items, most significantly a litigation reserve that amounts to $171-million after tax, which TD is setting aside after it was ordered to pay $67-million for its role as a third-party bank in a $1.2-billion Ponzi scheme operated by Scott Rothstein, a disbarred Florida lawyer.

Despite the earnings drops, both TD and RBC kicked more money back to investors in the form of a dividend increase. TD raised its quarterly payout 5.9 per cent to 72 cents, while RBC announced a 6-per-cent hike to 57 cents.

TD CEO Ed Clark and RBC CEO Gord Nixon both said that they are feeling more optimistic about the markets and economy.

However, the banking sector is expected to see some challenges in the next year or two, as Canadians seek fewer loans while low interest rates squeeze profit margins.

“Our message is that the economy does feel a bit better, certainly the U.S. economy feels better and I think Europe has taken out a bit of the tail risk,” Mr. Clark told analysts on a conference call.

Given that low interest rates appear to be here to stay for quite some time, Mr. Clark said he is operating on the premise that margins will be pressured. As a result, he’s embarking on projects to permanently lower the cost structure of the bank. He added that TD will have to work hard to meet its goal of boosting annual profits by 7 to 10 per cent.

RBC is also seeing growth in consumer lending slow. “In terms of Canada, generally, clearly we are starting to see some slowdown of the consumer side,” Mr. Nixon said.

Spurred in part by the low interest rates, Canadian consumers have racked up record high debt levels. There are fears that many borrowers are taking on more debt than they will be able to afford once interest rates rise, and both the federal Finance Minister and central bank governor have been warning consumers to rein in their debt loads.

As a result, bank executives say they are looking elsewhere for growth, and are putting new muscle into areas such as insurance. Mr. Nixon said there is also some momentum in business lending. “We’re starting to see a pickup in commercial loan demand, which is a good thing, it’s a sign that companies are investing,” he said.

All the signs point to a falling oil price – except supply

All the signs point to a falling oil price – except supply

ERIC REGULY | Columnist profile | E-mail

ROME— From Saturday's Globe and Mail

Published Friday, Mar. 02, 2012 7:05PM EST

Last updated Friday, Mar. 02, 2012 8:13PM EST

If you want a recipe for falling global oil prices, you would think this would do the trick.

The 17-country euro zone, which includes three Group of Seven countries, is back in recession. The shale deposits in the United States are gushing oil. Libyan supplies are coming back with a vengeance. Iran has not been bombed and, if the blathering Beltway pundits are right, will not be bombed before the U.S. election. The Strait of Hormuz is wide open. The latest generation of cars makes the fuel economy of your dad’s old banger look like the Exxon Valdez’s. European austerity-related taxes on gasoline and diesel are pushing down demand.

Why, then, are oil prices so high, to the point they threaten the tentative economic recoveries in debt-bombed Europe and elsewhere?

This week, oil prices went to their highest level since mid-2008, just before the collapse of Lehman Bros. triggered the same response in oil prices. Propelled partly by dubious rumours of a pipeline explosion in Saudi Arabia, Brent crude (the better global proxy than West Texas intermediate(CL-FT106.56-0.16-0.15%)) went above $128 (U.S.) a barrel on Thursday. On Friday, oil was at $124.

In the first two months of 2012 alone, prices have climbed by almost a third, after a 21-per-cent rise last year. In early 2009, when investors seemed convinced that only planetary annexation by cash-rich Martians with MBAs would save us, the price went as low as $34 from a pre-crisis peak of $147.

In spite of the sharp price increase, there is no shortage of economists and analysts who think that sinking prices are more likely than the opposite. Their theory is that the euro zone debt crisis, which has already put three countries on life support and could end with the eradication of the common currency, still has ample potential to take down the global economy. Sorry United States and China, Europe is still the world’s biggest economy and if it fails, the repercussions would be ugly.

What they forget, or at least play down, is that global demand is rising in spite of sluggish demand in tapped-out Europe. But that’s not really the point; the point is that it’s rising when oil producers themselves seem close to tapped out. Spare production capacity is razor thin. Production in the non-OPEC countries has been hugely disappointing. The American shale deposits are overhyped. And we haven’t even talked about potential supply disruptions in Iran and Iraq.

Given the tight balance between supply and demand, any disruption could send the price soaring. The capable oil analysts at Barclays Capital in London have put their Brent forecast at $115 a barrel this year. But they think quarterly averages as high as $150 “are distinctly possible” even if the Persian Gulf doesn’t turn into a pool of blood and oil.

Oil has been climbing pretty much steadily since early 2009, one of the strongest sustained rallies on record, in good part driven by relentless demand in Asia and the former Soviet Union states. When the commodity price chart takes off at a 45-degree angle for that long, you normally get a compelling supply response – more of the commodity is produced. In the oil markets, that response has not come, at least globally speaking. To be sure, it has in the United States, where surging shale oil production, combined with rising imports from Canada, home of the Alberta oil sands, have pushed down offshore imports as a share of consumption to about 45 per cent from a high of 60 per cent in 2005.

Why hasn’t the high price triggered a production surge? The biggie, it seems, is that the non-OPEC countries are simply not up to the job. As Barclays points out, non-OPEC supply last year landed at a full one million barrels a day less than forecast by the International Energy Agency. The North Sea (whose production is shared by Britain and Norway) continued its terminal decline. Brazil and Azerbaijan were also the scenes of production disappointments.

Meanwhile, OPEC, dominated by Saudi Arabia, is sweating exceedingly hard. OPEC production volumes are at three-year highs, to the point that the cartel has only about 1.6 million barrels a day of spare capacity, and still prices are climbing.

All of which raises the question: What happens when demand really takes off?

It could, easily. Note that the U.S. economy is on the mend. And Europe? In spite of the euro zone recession, business and consumer sentiment indicators are bottoming out, or rising. Germany, the engine of European growth, is a juggernaut and Greece has been bailed out for a second time, removing the immediate threat of default and exodus from the euro.

Japan, meanwhile, is importing vast amounts of oil to replace crippled nuclear generating capacity, putting upward pressure on prices.

In the United States, shale oil is welcome, but it will never eliminate the country’s reliance on imports or make it a net oil exporter.

One final point. While we can debate until our gums bleed whether the world has reached, or is close to reaching, peak oil, we can say with some confidence that triple-digit prices are here to stay. Note that Saudi Oil Minister Ali al-Naimi recently said his goal is to stabilize prices at “around $100.”

Sounds like a price floor, doesn’t it?

Oil sands fuel a new manufacturing boom – in Alberta

Oil sands fuel a new manufacturing boom – in Alberta

GORDON PITTS

NISKU, ALTA.— From Tuesday's Globe and Mail

Published Monday, Mar. 05, 2012 6:58PM EST

Last updated Monday, Mar. 05, 2012 8:24PM EST

At the Pipeline Alley Café, a sign in the busy diner promotes its signature dish – the Pipeliner, a monster two-patty burger heaped with bacon, cheese and mushrooms, complete with fries, for less than $10.

They think big in Nisku, a sprawling industrial complex just south of Edmonton – and they think a lot about pipes, which are fitted here into configurations that, in labyrinthine complexity, overshadow even the local eatery’s layered burger.

In the pock-marked roads outside the café, truckloads of raw steel pipe rumble in, and intricately connected pipe modules roll out, most of them destined for the oil sands near Fort McMurray, 600 kilometres to the north.

In the past few decades, Nisku, with a work force approaching 15,000, has grown from flat moose pasture to the pipe fabrication capital of Canada – and the massive marshalling yard for the great oil sands supply chain.

Just a stone’s throw from the diner, construction giant PCL operates one of the biggest pipe plants, running an integrated production process that creates $100-million of value a year. It practises manufacturing, Alberta-style – one engineered-to-order module at a time, not the mass-produced cars and trucks that roll off assembly lines in the old industrial heartland of eastern North America.

“This isn’t a bunch of Ford Escorts,” Gary Trigg, vice-president of fabrication for PCL Industrial Constructors Inc., says proudly, as he surveys his yard full of huge, twisting modules of pipe, valves, components and electrical wiring.

The modules assembled in Nisku are the basic building blocks of modern energy complexes, such as refineries, petrochemical plants and oil sands extraction sites. The contraptions in the PCL module yard are destined for Imperial Oil’s Kearl oil sands project and the Consumer Co-operatives refinery in Regina.

This constant stream of new Canadian energy projects means that, while manufacturing seems on the ropes in Eastern Canada, it is thriving in the flat land around Nisku and neighbouring Leduc. The oil sands boom, by super-charging the value of the Canadian dollar, is often blamed, most recently by Ontario Premier Dalton McGuinty, for unemployment in the East, but it is creating explosive demand for welders, pipefitters and electricians around Nisku.

Manufacturing is not dead in Canada, but its focus has moved west to meet surging demand for energy gear, including transportable modules that, like Lego pieces, can be made in Niksu and fitted into remote oil sands sites. “Eighty per cent of what pushes our business is heavy oil,” Mr. Trigg says.

It has propelled Nisku’s industrial park to its status as the second-biggest energy-focused park on the continent – behind a Houston location – and it’s all just a short drive from the site of 1947 Leduc strike, where the post-Second World War oil boom began in Alberta.

These days, it is part of the sprawling industrial region south of Edmonton that comprises thousands of hectares of industrial land, close to 3,000 companies and almost 30,000 workers – almost half that number in the Nisku Business Park alone.

Besides the massive fabrication complexes run by Edmonton-based PCL and rival construction firm Ledcor, a lot of other things happen in Nisku – including energy services of all kinds, from drilling firms to small welding shops to Ritchie Brothers, the world’s largest industrial auctioneer which does a big business selling used equipment out of its Nisku site.

“It’s crazy what’s going on around here,” says Jim Rothlisberger, the regional sales manager for Ritchie, as he surveys the hectic scene on the roads around the company’s facilities.

A lot of that activity stems from Nisku’s ideal location, he says, with easy rail connections, access to the major thoroughfare, Highway 2, connecting Edmonton and Calgary – the northern leg of a corridor extending to Mexico – and, across the highway, Edmonton International Airport, in the midst of a major expansion. And, he adds, “We’re right on the road to get to Fort McMurray.”

When the oil sands are booming – as they are now – so are Edmonton and its hinterland. John Rose, chief economist for the city, says the rise of manufacturing jobs helped power Edmonton’s rebound from the 2008-2009 recession. Manufacturing jobs were up almost 50 per cent year-over-year coming out of the recession, before tailing off to lower double-digit gains. “The contrast with Ontario is quite startling,” he adds.

That’s evident in Nisku, where commuter traffic bunches up in the morning, with jams spilling out onto Highway 2. “It’s a quiet sleepy industrial hollow, “ Mr. Trigg jokes, while in the next breath worrying about whether the choked infrastructure will frustrate valuable and highly mobile trades people. There are about 20 companies in the Edmonton area that make pipe modules, and many more in other fabrication roles.

According to Rolf Mirus, a professor of international business at University of Alberta, the region has benefited from agglomeration or clustering, whereby companies with similar activities attract each other, making it easier to share information and to hire, or poach, the skills they need. Linked into transportation routes, Nisku becomes a one-stop shopping mart for fabrication capabilities.

Cost is a big factor in Nisku’s rise. PCL’s Mr. Trigg has a rule-of-thumb scale of costliness: He assigns a rating of one to his fabrication plant, where pipes are welded together; three to PCL’s nearby production yard, where they are “glued” into complex modules; and five to remote Fort McMurray. The cost gap explains why PCL builds the modules in Nisku and moves big loads of steel – up to a legal load limit of 345,000 pounds – by hydraulic trailers in slow northward treks to Fort Mac that can take about two-and-a-half days.

Mr. Trigg says Edmonton’s labour pool is relatively deep compared with Fort McMurray, but he strives for efficiencies through lean manufacturing and computer-assisted fabrication, while driving continuous process improvements. He has, for example, extended the plant’s mobile factory cranes into the supply yards to create a seamless manufacturing operation.

PCL supplies the pipe modules as part of its integrated service to construction clients. The pipe itself is often sourced by client companies, and it comes from everywhere, including Argentina, Japan and increasingly China. A decade ago, Chinese pipe lacked the necessary quality, but now it makes up about 10 per cent of the steel inputs.

Mr. Trigg also knows that what the oil sands give, they can also take away. At the peak of the pre-2008 boom – which saw the price of oil price approach $150 U.S. a barrel – his work force soared to almost 1,000 people, but after the market collapse, it was down to 200. Now, it has bounced back to 650, and growth seems only limited by the labour market.

And there is no end in sight, with Imperial Oil expanding at Kearl, and Suncor talking about massive module needs – and, of course, the Northern Gateway pipeline, if approved, could mean work for Nisku. The lunchtime diners at the Pipeline Alley Café will not be thinning out any time soon.