Much of the Canadian economy is dependent on commodity prices. They have a big impact on the foreign trade balance. And they are a key determinant of the mega project investments initiated by resource sector owners. Due first to the recession, then to the subsequent slower-than-usual improvement in the world economy, most commodity prices have been flat for the past couple of years. That gives rise to an important question for the construction industry. What’s the outlook for resource projects?
Much of the Canadian economy is dependent on commodity prices. They have a big impact on the foreign trade balance. And they are a key determinant of the mega project investments initiated by resource sector owners.
Due first to the recession, then to the subsequent slower-than-usual improvement in the world economy, most commodity prices have been flat for the past couple of years.
That gives rise to an important question for the construction industry. What’s the outlook for resource projects?
There are two major factors that are having an impact. The first is specific to the energy sector. The second is of a more general nature, having to do with firms from emerging nations trying to lock up their raw material supplies by buying stakes in resource-sector firms in Canada, Australia and elsewhere, such as Africa. (I’ll have more to say on this in future Economy at a Glances, but for today, let’s concentrate on the oil price effect.)
The oil price effect begins with three different benchmarks for crude oil.
The current price of Brent crude, which governs half of the oil traded world-wide, is about $20 U.S. per barrel higher than West Texas (WTI) Intermediate. WTI is the U.S. standard.
The Brent price originally derived from an offshore field in the North Sea. It governs oil sales in Europe and Japan and in most emerging nations, including China and India.
For Canada, a third benchmark has become critically important – the price for “Western Canadian Select” (WCS). The composition of WCS is different than for Brent and WTI. It’s mainly “heavy” oil, with some admixtures to make it flow more easily, whereas the other two are “lighter”.
Lighter crudes can be processed (i.e., refined) into gasoline more easily.
WCS needs an intermediate stage of refining – i.e., from “heavy” to “light” – to render it suitable for final stage processing. The intermediate stage is usually done in heavy oil upgraders. (Due to their high cost of construction, Western Canada has only a handful of upgraders).
There should be a price differential between the lighter crude varieties and WCS, but at this time, that separation has become much greater than normal. It’s having a major impact on the outlook for the Canadian oil industry.
The price of WCS is $40 U.S. per barrel lower than for WTI and $60 per barrel less than for Brent.
WTI is currently falling below the Brent price because the U.S. has a glut of supply. Hydraulic fracturing isn’t just opening up new supplies of natural gas. It’s also freeing up a great deal more oil.
The only way for U.S. producers to realize the Brent price is to ship oil to refineries on the coasts (Atlantic, Pacific or the Gulf of Mexico) that can sell to customers offshore, mainly in emerging nations.
Canadian producers are operating under an additional set of handicaps. They basically have customers in only one country other than at home, the U.S. And they have only limited access to coastal refineries.
Most WCS is piped to refineries or transportation hubs that are inland in the U.S. For example, TransCanada Corp.’s current U.S. pipeline ends at Cushing, Oklahoma. Due to the surfeit of product from American sources, the price offered at Cushing for Alberta crude carries a large discount.
This is negative for our national interests in several ways. Canadian producers are being paid far less than they should be. The U.S. energy sector is being subsidized by Canadian producers. And the government of Alberta’s financial coffers, due to lower than expected royalty payments, are suffering.
Also, weaker tax revenue for Alberta hurts the rest of the country through reduced transfer payments.
What’s the answer? We’re seeing corporate responses in the headlines every day.
Later this year, TransCanada will complete the southern portion of its XL pipeline – from Cushing to the Gulf Coast – and that will help.
There’s also a major push underway to proceed with the northern portion of the XL line. This needs approval from Washington because it crosses the border with Canada.
In the run-up to the Presidential election, Mr. Obama placed the northern portion of XL on hold to appease the environmental lobby within the Democratic Party. The potential threat to a sensitive aquifer in Nebraska was the excuse.
The company has since filed a revised route circling most of the sensitive region to the east. Legislators in Nebraska are now expected to endorse the project.
Better access to American markets is only part of the answer. We need more foreign customers, and for the most part, that means in Asia.
Hence the impetus behind Enbridge’s new Northern Gateway Pipeline to Prince Rupert, B.C., and Kinder Morgan’s TransMountain pipeline expansion to Burnaby. Both are in the midst of hearings.
There are also proposals to make better use of some existing pipelines. This might involve switching some underutilized lines from natural gas to oil. Or there might be some flow reversals. For example, rather than taking foreign oil from the Atlantic Coast and shipping it to refineries in Ontario and Quebec, it might make more sense to send Alberta crude all the way across country to find customers along the U.S. seaboard or in Europe.
There’s also another response that’s shaping investment dramatically in North America. The railroads have spotted the potential for their alternative delivery systems.
What are the positives for oil tanker-car delivery by rail?
The railroads already reach almost everywhere. This includes refinery capacity on the coasts, as well as in large urban centres where new pipelines would have little chance of finding public acceptance, never mind that their cost of building would be prohibitive.
The railroads can increase volumes in easy incremental stages, in most cases without environmental hearings. Oil spills from tanker cars are more common than from pipelines, but the damage is smaller and can be contained more easily.
Both the railroads and the oil companies are rapidly increasing their investments in storage tanks along railroad lines. Orders for tanker cars have increased to the point where delivery dates are now running two years into the future.
The oil market in North American is in considerable flux. While the industry is showing itself sensitive to environmental and native land claim issues, it’s also been quicker on its feet than many might have expected.
The industry’s executives are demonstrating commendable flexibility in seeking imaginative solutions.
Find Canadian construction-related economic articles in Canadian Construction Market News and in the Economic Outlook section of Daily Commercial News.