A pumpjack clouded in smoke from recent wildfires in Drayton Valley, Alta. on May 17.JASON FRANSON/The Canadian Press
A stellar run in the price of heavy Canadian crude, much of which comes from the oil sands, is testing investor commitments to environmental, social and governance (ESG) principles, forcing would-be buyers to weigh sublime cash flows against human-induced climate change that has contributed to Canada’s worst wildfire season on record.
In global oil markets, Canada is best known for its abundance of heavy crude that is thick and sour, and its most commonly quoted price is a benchmark blend known as Western Canadian Select (WCS). Since the start of the year the price of WCS has jumped 16 per cent, while the price of West Texas Intermediate (WTI) oil, the broader North American benchmark, is down 5 per cent.
Because WCS has soared, shares of many Canadian energy producers have also jumped – particularly for those that focus on oil-sands production. Shares of MEG Energy Corp. MEG-T have gained 25 per cent this year, while shares of Athabasca Oil Corp. ATH-T are up 39 per cent. Shares of U.S. behemoth Chevron Corp., meanwhile, are down 14 per cent.
Historically, heavy Canadian crude has traded at a discount to WTI, and that gap has widened to US$40 per barrel during periods of severe stress, such as when pipeline outages trap oil in Canada. In July that discount has been around US$10 to $15 per barrel, and some structural shifts in global oil markets, including the near completion of the Trans Mountain pipeline expansion, could help to keep it there.
Rafi Tahmazian, a portfolio manager at Canoe Financial in Calgary, has an analogy for Canadian oil producers in the current environment: “It’s like there’s a broken bank machine and it’s spitting hundreds out, and there aren’t enough people to pick them up,” he said in an interview.
For some, the mere thought of owning shares of an oil-sands producer is abhorrent, especially with wildfires burning and southern Europe getting scorched by another heat wave. Mr. Tahmazian doesn’t see it that way. “Should I feel guilty about doing this? The answer is no.”
Mr. Tahmazian said he is isn’t for or against energy from fossil fuels; he’s being rational about the current state of things. For one, the world is still in the very early stages of an energy transition. For all the hype around electric vehicles, recent sales figures show they aren’t selling all that well just yet. Heavy oil also has some specialized uses, such as creating shipping fuel for the boats that ferry the endless stream of goods from China to North America.
WCS’s recent rally is multi-faceted, but a major driver is the recent production cuts by the Organization of the Petroleum Exporting Countries (OPEC). Saudi Arabia, an OPEC member, is the world’s second-largest oil producer and its cuts “have been especially hard hitting on Arab Heavy and Arab Medium, the Kingdom’s two heaviest export grades,” oil analyst Rory Johnston recently wrote in the Commodity Context newsletter. “That reduced supply of heavier crudes benefits other producers of similar grades, which manifests as a narrowing of the discount between the heavy and lighter crude varieties.” (North America’s WTI is lighter than WCS.)
The state of global oil refineries has also had an impact. Heading into the pandemic, many aging refineries that specialize in processing heavy oil had been retired, and during the pandemic some that were supposed to come online were delayed. That situation is now reversing and new refineries are opening, such as Kuwait’s Al-Zour operation.
As well, China’s economy has reopened after years of hard lockdowns, and although growth there has been anemic of late, it is still a major economy that has what analysts at Royal Bank of Canada called a “voracious appetite” for heavy barrels.
A major catalyst for WCS pricing is also on the horizon, with the Trans Mountain pipeline expansion that will nearly triple the amount of crude transported from Edmonton to an export terminal in Burnaby, B.C., expected to be mechanically complete by the end of 2023, and in service during the first quarter of 2024. At the moment, 97 per cent of Canada’s exported crude goes to the United States, but heavy crude will soon get shipped directly to China and elsewhere in Asia.
“The optimism around Calgary regarding the outlook for WCS has seldom (if ever) been this strong,” RBC commodities analyst Michael Tran wrote in a note to clients after visiting the Calgary Stampede last week.
Of course, commodities are susceptible to wild price swings, no matter how great the outlook seems at any given point. Only three years ago the price of oil briefly turned negative. If the Keystone pipeline that transports Canadian crude through the U.S. goes down again, there’ll be a glut of heavy oil in Canada, Mr. Johnston from Commodity Context noted.
He also explained that expanding the Trans Mountain pipeline could be a double-edged sword at times. For instance, the atmospheric river that pummelled British Columbia with rain in 2021 shut down the existing pipeline for more than one month. At the time it was not disastrous for Western Canadian Select because the pipeline currently transports a fraction of total output. Once its capacity is roughly tripled, however, WCS will feel that kind of disturbance more.
But the long-term supply and demand fundamentals are hard to ignore. Historically, intense demand for heavy crude, like there is today, would spur production growth. That’s not happening any more. RBC estimates that oil-sands production will grow at a compounded annual rate of just 2 per cent between 2022 and 2027.
Energy companies used to get hammered during downturns because they had overexpanded during boom times, and often that growth was funded with debt. In this boom, said Mr. Tahmazian, the portfolio manager at Canoe, debt loads are shrinking and the money leftover is often flowing to investors in the form of dividends.