Alberta's Big Oil Shock

Canada abandons free-market capitalism...

DESPERATE times call for desperate measures, writes Jody Chudley in Addison Wiggin's Daily Reckoning.

That is the justification for Canada's most right-wing Province abandoning free market capitalism last week.

The Alberta Government announced that it will be enforcing a mandatory production cut of 8.7% for all oil producers operating in the province.

There is an exclusion for the really small operators, many of whom could be bankrupted by such a cut.

For all other producers, however, there is no option. Starting January 1, 2019, the production reduction is mandatory. These private sector companies have no choice.

This is a shocking measure – but to appreciate how bad things have gotten, you need to understand that Alberta is Canada's version of Texas.

I'm talking about big trucks, cowboy hats and very conservative politics.

In Canada, Alberta prides itself on being the home of the free market – the province of privatization.

Alberta is a hotbed for libertarianism and the view that less government equals better government.

So what happened? What has shocked the Alberta Government into this oil patch intervention?

The answer is that the Province was tired of seeing it most valuable commodity (oil) being given away almost for free.

In Alberta, the most common blend of oil produced is called Western Canadian Select (WCS).

This is a heavier blend of oil which means that it is denser and the refining process is more complex than it is for lighter blends.

In the month of October, WCS sold on average for $45.48 per barrel less than West Texas Intermediate (the most common American light oil blend).

That meant that for much of the last two months, Alberta producers have been selling their oil for not much more than $10 per barrel. That means that every company producing it is losing money.

The economic cost of giving away oil production at this price is enormous. Not just for all of the companies that are losing money on production, but for the province of Alberta as well.

It has been estimated that on an annual basis, the recent discount costs the province of Alberta $7.2 billion on production royalties, oil producers $5.3 billion on production sales, and the Canadian federal government $800 million for its royalty take.1

It is a ridiculous amount of money being lost for the sale of a commodity that is going for multiples more elsewhere.

The cause of this massive problem for conservative Alberta is that the province is landlocked.

Being landlocked means that the province needs to ship its oil through pipelines that run through other provinces and American states.

As you are likely aware, these days getting major pipelines built has been virtually impossible. The political left and environmental groups keep putting up roadblock after roadblock.

With all pipelines out of Alberta already full and the resulting glut of oil only forecasted to get worse, the Alberta Government decided to act to deal with this problem.

Starting January 1, 2019, producers will be forced to adhere to 8.7% production cuts.

Combined, those cuts will reduce Alberta's oil production by 325,000 barrels per day. Over the course of 2019, that production restriction should clear the existing glut.

As a more permanent fix, the Alberta Government is going to take matters into its own hands and work around the pipeline problem. The Province is going to purchase 7,000 rail cars that will carry Alberta's oil production to its end markets.

The companies that will be the biggest beneficiaries of the wide Western Canadian Select discount being eliminated will be those that have the biggest%ages of their production exposed to that pricing.

These companies are going to benefit over both the short and long term as the Alberta Government has moved to implement a long-term solution to this pricing problem...

A problem that has been a drag on the share prices of these producers for years.