Blame Canada for Making the Oil Glut Worse
Some of the world's most expensive crude lies trapped inside Canada's oil sands. But the lingering legacy of $100 barrels means the nation is destined to exacerbate, rather than alleviate, the global crude glut over the next two years.
Morgan Stanley analysts project that Western Canadian crude volumes will rise at a compound annual rate of 4 percent through 2017. Increased production at recently completed facilities, and five major projects slated to be finished this year, will push total volume yet higher, they estimate. Canadian crude volume is expected to continue increasing through 2018 with the Fort Hills mine and Horizon expansion.
"Oil sands is the main driver, adding ~225 million barrels per day, or 8 percent year-over-year," they wrote. "Furthermore, we don't expect near-term oil sands curtailment, even at current low prices."
This view stands in contrast with that of JPMorgan's Daniel Hui, who warned the price of Canadian heavy crude is coming dangerously close to falling below marginal operating costs.
While Morgan Stanley expects production activity to remain robust, however, the analysts anticipate the downturn in oil investment will continue to be a drag on the Canadian economy—more than monetary policymakers planned for.
On Wednesday, the Bank of Canada indicated that capital expenditures in oil and gas are projected to fall 25 percent this year. Consensus estimates for business investment in fossil fuel production are unjustifiably rosy, says Morgan Stanley, given the leg downward in crude thus far this year.
"Street estimates and company guidance are budgeting for outdated crude price outlooks,'' the bank's strategists wrote. Updated price assumptions show capital expenditures should fall by as much as 40 percent year over year, they say.
Support activities for mining and oil and gas extraction have been cut by almost half during the 12 months ending October 2015. Morgan Stanley's bearish outlook for investment implies "material downside to services estimates as well."
The so-called royalty review in Alberta, Canada's biggest energy-producing province, is a wild card that may serve as an additional weight on capital spending, the analysts noted. After the New Democratic Party managed to capture a majority in last year's provincial election, the party formed a panel to examine possible tweaks to the tax framework governing the energy industry. The results of this review are expected to be published this month.
Meanwhile, production in the lower 48 U.S. states is up 0.5 percent year over year for the week ending Jan. 15, with American imports of Canadian crude rising almost 11 percent in that period. The resilience of North American production amid lower crude prices has befuddled analysts, who are waiting for curtailed supply to bring the market back into balance.
"In an oversupplied market, investors are looking for production decline in relatively high cost regions like Canada due to reduced investment," Morgan Stanley's team concludes. "However … Canada is defying such expectations."