The Slippery Slope of Oil

By November 23, 2018Economics
The Hutch Report

WTI Oil has been falling steadily from the October high of $76.9, trading currently at $50.96. That is a 33.7% decline in just over a month and a half. Although this may be good news for the end consumer it is causing serious problems elsewhere.

One of the more complicated situations regarding the price of oil has arisen in the province of Alberta. In fact, Alberta is currently in a crisis as the province’s oil is being sold at a discount of about $45 a barrel to WTI. Alberta Premier Rachel Notley has said the price gap between Canadian and U.S. crude is costing the Canadian economy $80 million a day.

You would think that oil being sold for that much of a discount would be bought up in no time, however the reality is more complicated. Where the oil is produced geographically matters, because it needs to be transported from its point of production to a refinery. This impacts the price received for the oil.

Tim McMillan, president and CEO of the Canadian Association of Petroleum Producers, said the main issue is there isn’t enough pipeline capacity. In late August of this year, a Federal Court of Appeal ruling put a halt on the Trans Mountain expansion project; in 2017, the federal government scrapped the Northern Gateway pipeline; and Keystone XL is still hung up in legal wrangling in the United States.

A Scotiabank Economics report ,released this week echoed that point where they said, “Alberta’s oil producers are facing an extraordinary challenge caused by pipeline bottlenecks combined with growing production.” As of 2017, the oil sands were filling up some 2.7 million barrels per day, according to Natural Resources Canada. When that’s combined with other oil sources, the oil awaiting export is roughly the same as pipeline capacity from Western Canada, and so there’s a pinch point: If pipeline capacity is reduced for maintenance, or if companies book pipeline space, but don’t actually send oil — so-called air barrels — then there’s a backlog.

So not only is the falling price of oil exacerbating the current situation in Alberta, we may expect to find a similar situation south of the border. The Permian Basin, which covers 75,000 square miles over West Texas and southeast New Mexico, is the most prolific oil producing basin in the country – so much so that it’s become difficult to find ways to get the product to market. Wells Fargo recently projected that oil pipeline constraints in this area may last until 2020, versus its previous prediction of the third quarter of next year. That means more transport by rail or truck.

The International Energy Agency (IEA) wrote just recently in a report on energy investment that, “Higher prices and operational improvements are putting the US shale sector on track to achieve positive free cash flow in 2018 for the first time ever.” How quickly things can change as the sector may be forced to relive the last downturn where the ink on the chapter 11 filings has hardly had time to dry.

In 2014, the market downturn forced a bunch of companies operating on the edge out of business. Nearly 100 shale companies filed for bankruptcy in 2015 and 2016. Oil was trading around $40 at the time. Although this downturn forced drillers to become more efficient, the BNEFestimated that break-even prices still range from $31.61 a barrel for the best Permian Midland wells to $188.25 for the weakest Permian Delaware wells.

GlobalData Energy came out with an interesting report in June that analysed recent wells drilled by 26 operators in the area. It found that the break-even oil prices for wells with lateral lengths of 4,500 to 10,500 feet ranged from $21 to $48 per barrel. So if you assume somewhere from $30 to $50 breakeven then we can expect to soon see another flood of bankruptcies as oil continues to tank.