This year got off to a bang-up start for the energy sector when the benchmark West Texas Intermediate (WTI) crude hit US$100 a barrel " a record in nomi- nal dollar terms. At this level, oil is nearly five times its value at the begin- ning of 2002.
Energy economists keep insisting that the fundamentals of supply and demand do not support oil at this lofty level. But that’s akin to the guy on the IT helpline telling you that your com- puter problem is irrational. ”œYour com- puter shouldn’t be doing that,” they keep saying. Well, no, it shouldn’t.
And maybe the price of oil should- n’t be at a hundred bucks a barrel. But it is. So what are the implications of high and rising oil prices for Alberta? And why haven’t there been cham- pagne corks popping all over down- town Calgary?
Clearly, because a lot of crude oil comes out of Alberta, there is a definite upside to the high price. Producers and energy stockholders are getting more dollars for their commodity.
Yet it’s easy to overstate how good high oil prices are for Alberta’s overall economy.
Conventional crude oil produced in Alberta is priced at a discount relative to the headline-grabbing WTI crude. Alberta crude tends to be heav- ier and sour (more sulphur), and involves more upgrading and trans- portation costs. That makes it less valuable than the light, sweet WTI. Bitumen from the oil sands is less valu- able yet. And with the high Canadian dollar, those US-dollar-priced barrels of crude are not as valuable as they would have been back when the loonie lan- guished in the 65-cent range.
Simply put, no oil producer in Alberta is getting C$100 a barrel. Not yet, anyway.
The other factor is the shifting dynamic of Alberta’s energy econo- my. The Western Canadian Sedimentary Basin is described as ”œmature” " not a lot of new crude oil left to find, and declining reserves in the existing fields. Production of crude in Alberta has been declining for years. Most of what the provincial government generates in royalties is from natural gas production. And unlike oil prices, gas prices are soft.
And then there is the non-con- ventional crude oil in Alberta " the bitumen from the oil sands. Investment activity here has been running at 100 percent for the past few years, so even with oil prices ris- ing, there is not much more activity that can be squeezed into play. The high prices are good news for pro- ducers’ profit margins, but they like- ly won’t translate into increased economic activity. The pedal is to the metal " it can’t really go any faster.
So while high oil prices are helpful, the upside is limited for Alberta’s economy.
The downside of higher oil prices will land on the consumer in the form of higher prices at the gas pump. (The correlation between crude oil prices and gasoline prices is steeped in mystery " lots of things about refiner margins, transportation costs and the price of oil ”œalready in the pipe” " none of which ever pro- vides a satisfactory answer as to why gasoline prices react immediately to rising oil prices, but it’s never the other way around.)
Mysteries aside, like all Canadians, Albertans will have to pry their wallets and purses open wider in the coming months as they fill up their vehicles " Smart Cars, pickups and SUVs alike.
More worrisome is the impact that high and sustained crude oil prices could have on the US economy. Weak employment numbers, sagging hous- ing markets and fall out from the cred- it market meltdown have likely pushed it off the cliffs of recession already. High oil prices could be the final blow to the US consumer, and that would be bad news for Canada and Alberta.
The other negative that high oil prices could have for Alberta is what economists call ”œdemand destruc- tion.” That’s what happens when prices rise so high that eventually people are forced to look for substi- tutes. If consumers around the world decide en masse to look for alterna- tives to gas-guzzling automobiles, the price of oil could end up falling hard. (The search for substitutes and energy efficiency is already happening due to well-founded worries about climate change.)
This demand destruction could take several years " perhaps even decades " to drive the price of oil very low. But it will also take a few decades for Alberta’s oil sands to real- ly ramp up production to the fullest extent. The worst-case scenario would be for a lot of bitumen to start flowing out of those projects in northern Alberta just as the world finally decides it doesn’t need or want it anymore.