Last December, the Canada Energy Regulator (CER) released its Canada’s Energy Future 2021 report,
Alberta is no stranger to the boom-and-bust cycle of oil prices.
Many Albertans reminisce about the “good times” when oil prices were high, wages rose, unemployment was low, and government coffers were overflowing. And, as in recent times, we are acutely aware of the inverse situation as well.
Whether in good times or bad, have Albertans—the collective owners of our oil—been capturing the maximum value of our resource? And what does the future hold?
Oil price differential data can provide some insight.
What is the oil price differential?
Crude oil is in a constant process of being bought and sold on the spot market. Spot markets help set the marginal price of oil at a particular location and at a given point in time.
Some spot markets are recognized as benchmarks because they are representative of the price for a given region’s oil quality, marketability, and transportation characteristics. For the oil sands, the two most consequential benchmarks are Western Canada Select (WCS)—representing the price of a heavy, highly sulphuric blend of oil—and West Texas Intermediate (WTI)—a lighter, less sulphuric oil closer to tidewater.
The price of WTI, acting as the North American benchmark, helps set the price of WCS. The difference between these two benchmark prices is the WTI-WCS oil price differential.
WCS trades at a discount to WTI for several reasons, including, but not limited to:
- The relative quality of the oil;
- Supply and demand dynamics driven by specific refiners and by end use products;
- The relative cost of different refining processes;
- The costs of transportation, including relative distance and modes;
- The relative access to global markets.
Some of these reasons—like oil quality, refinery and end-use product demand, refining process differences, and unavoidable transportation costs—cannot be changed. They create a natural discount between WTI and WCS, which one study suggests has historically been approximately $11.35 (all figures are in $US unless otherwise stated). But other factors—like transportation constraints and the fact that Alberta has only one international customer to speak of—usually mean that the actual differential is much larger.
What’s the current situation, and how does it compare to the past?
January 2022 saw the differential average approximately $12.73 per barrel or just $1.38 more than the natural discount.
In past periods of high oil prices, like 2011-2014, the differential has been much larger. In December 2013, when WTI averaged $97.98 per barrel, WCS was selling for $38.94 less per barrel, or $27.59 more than the natural discount. In November 2018, when WTI averaged a more modest $56.96, WCS was selling for a staggering $45.93 less per barrel, or $34.58 per barrel more than the natural discount.
Why does the differential matter?
Regardless of the price of oil, a smaller differential means Albertans are capturing more of their resource’s full potential value.
Alberta’s Budget 2021 provides a good indication of the negative impacts of a wide differential. The Budget suggests that a sustained $1 annual increase in the differential equates to a staggering CA$185 million in foregone government revenue.
For context, in 2018 the average differential sat at approximately $26.38, or about $15 more per barrel than the natural discount. Under today’s Budget assumptions, this would represent about CA$2.78 billion in foregone government revenue, diminishing Alberta’s ability to pay for services like healthcare and education.
How can Alberta capture more value?
While the natural discount is built in, other factors that have historically widened the differential can be mitigated.
One of these is pipeline capacity. Alberta’s oil production has steadily increased over the years, but its capacity to transport it to market through pipelines has sometimes been limited. When pipeline takeaway capacity is tight, transportation costs rise, and relative overproduction devalues our oil.
Alberta experienced this acutely in 2018 when pipeline bottlenecks led to oversupply relative to takeaway capacity. Differentials widened tremendously, government revenues suffered, and Alberta took the unprecedented step of curtailing production and purchasing rail takeaway capacity to help shrink the differential.
What does the future hold?
As Alberta heads into what looks like another multi-year oil bull market, there is good reason for optimism about the price differential. Enbridge’s Line 3 replacement project has improved the pipeline bottleneck and the addition of the Trans Mountain Expansion Project within the next couple of years will further alleviate transportation constraints while opening up new markets.
One analyst anticipates that strong U.S. heavy oil demand and improved takeaway capacity should keep the differential between $12 – $13 in 2022—a much-improved situation compared to the recent past.
While the future is impossible to predict, it looks as if Alberta will capture more of the value of its resources than it has in the past.
