The Problem with Junk Oil

Canada seems likely to get knocked off its perch as the world's fourth largest petroleum exporter.  We've milked it for all it was worth but today it's worth way less than its weight in milk.

It was only a few years ago that our then freshly-minted prime minister appeared before an audience of oil men in Houston assuring them that "no country would find 173 billion barrels of oil in the ground and leave them there." Hey, Justin, wanna bet?

He is a betting man, at least when he's playing with house money. That's how we got saddled with the government's bad bet on the Trans Mountain pipeline. The bandits who owned it, former EnRon alumni, were threatening to just shut it down. They wouldn't budge even when Ottawa offered to guarantee their return on the asset. Nobody in the private sector wanted to touch it. And so Ottawa's money man reached for the government cheque book and wrote those cowboys a cheque for far more than the pipeline's actual value. Way more. Billions more.

Canada would have a massive new pipeline to "tidewater."  Justin would see to it and no solemn campaign promises would get in his way.  He got bruised and battered by the courts along the way but now he's poised to drive that puppy through all the way to Burrard Inlet and the BC coast.

The prime minister didn't foresee a pandemic that would sweep the world. No one did. I didn't. I'll bet you didn't either. Scientists did and they gave plenty of warnings but they were vague warnings of contagions, epidemics, maybe even pandemics of one sort or another, here or possibly there, at some point in the near or intermediate future.

Even though we saw emerge a glut of conventional, inexpensive oil, we had other reasons, political reasons not to give up the ship, HMCS Athabasca II. It might have been shipping water and listing by the stern but it wasn't sunk yet. If world oil prices rebounded it might even reach the safety of a port. We doubled down.

Then Covid-19 showed up and threw a wrench in the global economy that, in turn, put a big dent in the demand for oil just as a couple of major producers had weaponized oil to drive others out of the market. As their wells kept pumping oil at record speed they got ahead of recessionary markets and began running out of places to store the stuff. They had to do something with it and so, yesterday, they wound up paying about $37 a barrel to anyone who would take it off their hands. You could fill five oil tanker trucks and drive away with a cheque for $37,000 for your efforts. Pretty sweet deal.

Meanwhile, in the land of garbage oil, bitumen, it was even worse. That's not cheap oil. It's expensive oil. Some countries can produce conventional oil for $10 or $15 per barrel. Bitumen, dilbit, that costs $45 per barrel for extraction, processing and transmission to a refinery on the Gulf coast. This doesn't sound like a wonderful prospect when US refineries are paying customers to haul their superior product way.

Does this mean the end of oil? Hell no.  Globally, we've gone from a 100 million bpd habit to around 65 million bpd. But that shrinkage means there is less room to accommodate all of today's players. It's not a good time for high-carbon, high-cost, low-value junk oil such as bitumen. It's also a lousy time to have political leaders with feet of clay.

If you walk into the barn and find your prized mare lying dead in her stall, ordering a pricey new saddle won't help anything. But our government seems to have run out of ideas. Are they to blame? No, not really. They didn't trigger the oil war. They didn't create the pandemic. But they did plenty of things that were pretty damned dumb.

Andrew Nikiforuk looked at some of the collateral damage a few days ago, well before oil prices went negative.

Art Berman, one of North America’s most astute and consistently reliable oil analysts, admits the pandemic is compounding the problems of an industry and global economy already in waning health. 

“Energy is the economy, and oil is the largest and most productive part of world energy. The global economy has been dying of accumulated debt for 50 years. Coronavirus has sent it to the intensive care unit. 

“If the economic patient survives the ICU, it will need a long period of recovery and therapy before returning to its previous life.” 

Wood Mackenzie, the British consultancy, now estimates that 10 per cent of global oil production is uneconomic insanity at prices below $25 a barrel. 

Heavy oil of the sort Canada produces requires extensive upgrading and pricey transportation costs. It’s always the first to feel the pinch of any volatility because of its high cost — about $45 a barrel.

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Canada, the world’s fourth largest oil exporter, banked its destiny on the export of low-grade bitumen with no strategic risk planning. As a result it will experience huge economic losses and roller-coaster volatility for its currency.

Alberta promoted over-production and pressed for new pipelines to carry the increased flow. Now, as global demand plummets, it can no longer fill the pipelines it has.

Rystad Energy, the proficient Norwegian-based analyst, has already noted that of all the world’s oil producers, Canada will be “the most affected so far.” Lacking buyers at a suitable price, it will produce well below its capabilities this year, “shutting in” nearly 1.1 million barrels per day.

Canada’s six largest banks, which loaned $58.8 billion to the Canada’s overleveraged oil industry in 2019 — a 59 per cent increase in the last five years — might quietly be panicking in board rooms at an appropriate physical distance. 

Robyn Allan is an independent economist who before the pandemic and oil price wars persistently challenged the economics touted to support the Trans Mountain pipeline. She foresees much trouble ahead for the industry. 

“After this crisis, things will not return to where they were. All economic activity is affected by the virus outbreak. And just like some people who catch it and move from home to hospital to ICU because of weak systems or pre-existing conditions, the tarsands were already an aging and compromised activity that was on the downside of its life cycle. Big Oil in Canada was going to be hard hit without COVID-19. With it, many companies are going to go under — and go under quickly.”

"Gasmageddon"

Natural gas, whose price is often tied to oil, is another sick patient on oxygen. Many analysts refer to that fuel’s price collapse as “gasmaggedon.”

Rystad Energy predicts that if low prices persist — and most forecasts suggest low prices for years — “nearly 42 per cent of Australia’s gas resources would be rendered uneconomic — a scary thought to the world’s largest gas exporter.” 

Such prospects must weigh heavily on B.C. Premier John Horgan. His government has actively subsidized the province’s faltering fracking industry, along with Shell’s LNG Canada terminal.

His province’s billion-dollar subsidies include the construction of the Site C dam to provide cheap electricity to the LNG industry. Horgan and his predecessor Christy Clark promised that an LNG windfall of revenue and jobs would justify the low royalties, loosened environmental restrictions, strained First Nations relations and gambled taxpayer money on the emerging export industry. 

Now that promise looks undeliverable, as the pandemic rocks B.C.’s economy and a healthy global LNG market recedes from view.

The Kitimat LNG project is floundering. Chevron, the lead partner, has been trying to unload its half interest for some time. Chevron took a $1.6 billion USD write down on the asset, admitting Kitimat can't compete. Chevron's partner, the Australian LNG giant, Woodside, followed by taking a $720 million after-tax writeoff.  That's the project that Christy Clark pegged as a trillion-dollar revenue windfall for the government of British Columbia.

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Alaska, which garners about 34 per cent of its revenue from oil, thought the resource would be selling for $66 a barrel right now. Alberta, which depends on oil to cover 10 per cent of its budget, said it needed $58 a barrel. Nigeria, Texas, New Mexico, Iraq, Iran, Algeria, you name it — all made similar projections. 

All face plummeted prices — U.S. crude, for one example, tumbled to an 18-year low of $18 a barrel on Friday. (It went to negative $37 a barrel yesterday)

Newfoundland once boasted, in 2009, that 30 per cent of its revenue came from offshore oil. Now it is less than 10 per cent, and as runaway debt due to its hydroelectric megaproject takes its toll, that province sits on the verge of bankruptcy. 

Add Newfoundland to the list of petro-states small and large that were already wheezing before Code Blue. Now the pandemic has put them on economic ventilators with no guarantee of quick recovery.

Meanwhile Russia is racing to squeeze out North American competition from Asian gas markets. Bank of England, ex-Bank of Canada governor, Mark Carney, gave us plenty of warnings that bitumen, like coal, was in jeopardy of becoming a stranded asset - uneconomic, valueless. That was more truth than our leaders could handle. Reap the whirlwind, I suppose.