NYMEX WTI crude traded at over $100/Bbl for most of March through May this year. With today’s close at $79.21/Bbl, the price is down 28 percent from this year’s highs. Canadian heavy crude bitumen postings fell to $64/Bbl last week. Could a press release from a small Canadian oil exploration company last week be the first indication of investor concern? In today’s blog, we ask whether Canadian Oil Sands production costs are too high to justify new investment.
Longview Oil a small Canadian producer reduced their 2012 capital expenditure program by $27 million. The company pointed to weakness in global oil markets, lower oil prices and supply logistics problems caused by a lack of takeaway capacity for Canadian crude. Let’s take a look at the fundamentals to understand whether these concerns are justified.
Global oil markets are certainly weak right now for two reasons. First economic weakness is not only affecting the richer OECD countries where oil demand has been anemic lately but also now threatens China. While China hasn’t stopped growing its economy has slowed down enough to reduce oil imports. The second reason for global oil price weakness is that Saudi oil production is at a 30-year high and the recent OPEC meeting made no adjustment to production quotas. It is not clear if the Saudi’s are keeping the taps wide open to replace barrels blocked by sanctions on Iran or whether they fear that growing non-OPEC production in places such as North America threatens their market share. Could be both. The result is falling international crude prices.
But why should Canadian producers in particular be worried? We have written here frequently (see The Bakken Buck Starts Here Part I) about how Western Canadian crude producers are suffering alongside their brothers in the Bakken Shale from heavily discounted posted prices compared to WTI at Cushing. The reasons for that in case anyone has forgotten is the lack of adequate pipeline infrastructure to get crudes beyond the Cushing hub to the Gulf Coast. The consequence is a supply glut that places downward pressure on prices.
However, we believe that it is not small Canadian producers such as Longview that are most vulnerable to lower crude prices in the long term. Instead it is larger Canadian heavy oil sands producers. When Canadian oil sands producers look at their monthly average posting checks this month, they will likely be receiving less than $70/Bbl for their crude. That doesn’t look set to change until both global oil market woes and the infrastructure logjam at Cushing are reversed. The longer this situation continues the greater the consequence for future heavy sands production investment.