Experts have warned of ‘bitumen bubble’ for years

EDMONTON – The Alberta government blames the “bitumen bubble” for the province’s current fiscal woes, but oil industry players have been warning about the phenomenon for more than a decade.

A review of historical markets shows the gap between what Alberta oil sells for and the benchmark price for West Texas Intermediate has repeatedly hit $35 in the past two years.

Premier Alison Redford first used the term “bitumen bubble” in her Jan. 26 television address to Albertans, and her government has characterized the oil glut as a “sudden” and “unprecedented” development that has driven down the price of Alberta oilsands products.

She said the discount will cost the provincial treasury $6 billion in lost royalty revenue in the coming fiscal year.

But industry experts have long predicted the province’s oilsands producers would one day face backlogged pipelines and an oil-saturated American market, key triggers for the steep discount on Alberta bitumen.

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“These are predictable events,” said Pentti Karkkainen, an oilsands industry veteran who publicly warned of a bitumen bubble in 2005. “It has happened many times before … in different places throughout North America, as a consequence of resource development.”

Back in 2005, Karkkainen was pressing to build a pipeline from Alberta to Texas, and told the Calgary Herald that the pipeline was necessary to prevent a bubble.

“The differential is already huge,” he said at the time, “and that’s before another million barrels comes on.”

In an interview Thursday, Karkkainen said producers delay building pipelines until they are certain they will have the supply to ship, and such certainty is hard to come by in a risky business such as oilsands development, so the bubble is all but inevitable.

“Resource development occurs first, and the result is too much supply in that geographic area, which has an economic impact, and that creates the incentive for the producer community to find a solution,” Karkkainen said.

Only then do producers support a pipeline.

“It almost necessitates the production to be there, which means the problem must be there, before the pain is severe enough for people to realize we’d better get on with it, and get this (pipeline) built, because we are losing significant revenues as a consequence.”

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Many Albertans may have assumed the catchy, alliterative “bitumen bubble” phrase was whipped up by political spin doctors, but industry players have been publicly warning about it since the late 1990s.

Neil Camarta was among the first to sound the alarm. The veteran oilsands executive was working as a key architect on Shell Canada’s Athabasca Oilsands Project when he first warned in 2002 that unchecked oilsands development would eventually trigger a bitumen bubble by saturating U.S. markets.

The term was derived from his experience with Alberta’s “natural gas bubble” in the late 1990s, which was deflated by the construction of the Alliance pipeline in 2000.

In May 2002, Camarta told the Calgary Herald he expected Alberta would ship two million barrels a day by 2012.

He was close. In 2011, Alberta produced 1.75 million barrels of crude bitumen a day, according to an Alberta Energy report.

“We saw it coming – we’ve been talking about it for a long time,” Camarta said Thursday, noting oilsands projects take years to start producing and that both pipeline and upgrader capacities are well-known during that time.

“People can read the tea leaves. It doesn’t happen quickly, so you’ve got years to see where it’s going.”

Most of Alberta’s bitumen is piped to Cushing, Okla., and that’s where Camarta and others predicted an oil-saturated market would develop.

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What nobody saw coming was the 2011 boom in U.S. domestic oil production. That higher-quality oil flows out of the Bakken formation in North Dakota and is also piped into Cushing, further fuelling the oil glut in Oklahoma.

Deborah Jaremko, editor of Alberta’s Oilsands Review, said even without the boom in North Dakota’s “tight oil,” the Canadian Association of Petroleum Producers “knew years ago that the issue of market access was coming.

“The tight oil boom in the United States has really exacerbated a problem that industry knew was coming, and that governments should have known was coming as well, because of the increase in production,” Jaremko said.

“To be fair, there are other things at play. The Alberta government and the province probably expected the Keystone XL pipeline would be built by now.”

Getting Alberta bitumen to refineries on the Gulf Coast through the Keystone XL pipeline is essential, Jaremko said, because those refineries are set up to process heavy oil like Alberta’s.

Gulf Coast refineries have typically processed heavy oil from Mexico and Venezuela, but the former supply is dwindling and the latter is politically unstable. Now they are eager for Alberta oil, and if producers can get it there it will command a higher price.

The royalties producers pay to the government are tied to that price, so any change makes a big difference to Alberta’s treasury, and to the programs and services the province is able to provide.

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That’s why Redford travelled to Washington this weekend to promote the Keystone XL pipeline, and why she wants Albertans to understand the bitumen bubble and the differential it creates.

The public education campaign is new, but the differential isn’t. A review of the historical oil prices shows that since Redford started her run for the premier’s chair, Alberta’s western Canadian Select grade oil has repeatedly sold at a discount of more than $35 compared to the North American benchmark grade, known as West Texas Intermediate.

The discount hit $44 in March 2011, three weeks after Redford launched her bid for the leadership of the Progressive Conservative Party; it fell to $21 by the time she introduced her pre-election budget on Feb. 9, 2012, then started to climb again.

On the day of the election – April 23, 2012 – the discount had again spiked to $34 a barrel, and days later peaked at $38.

David Percy is the chair of Energy Law and Policy at the University of Alberta. On the first day of his oil and gas class in September, he made a bold declaration.

“In the last two years, the assumptions on which the Canadian energy industry has been based for 50 years were stood on their head,” he told he students.

He explained that U.S. demand for Alberta’s oil has decreased, partly because of increased domestic production and partly because consumer demand is down. Natural gas prices have collapsed. Those problems are compounded by the fact that pipelines have become the “absolute focal point” for environmental groups. It is, he said, a perfect storm.

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“Peter Lougheed used to say that having one customer is as dangerous as having one supplier; he said that for years,” Percy said. “As I look back on it, it’s astonishing. Our whole infrastructure is designed to take our oil to the US and suddenly, whoops, we’ve got a problem.”

How Alberta will solve that problem remains to be seen.

“It’s going to be very painful in the short term, but … when there is this big a differential, people are going to find ways to realize a higher price,” Percy said.

“Oil runs toward money.”