The novel coronavirus pandemic has ushered in many “firsts” in modern economic history. That includes the impact on the oil market, where the benchmark price for U.S. oil dipped below $0 on Monday for the first time ever.
But what does that mean for Canada and its oil-producing provinces?
“It really brings home how real the decrease in demand is, how real the oversupply is, how big the price adjustments are going to have to be,” said Andrew Leach, an economist at the University of Alberta.
What went negative on Monday was the price contracts for delivery of West Texas Intermediate (WTI) crude, the benchmark for North American oil prices. With planes grounded and cars sitting in driveways in locked-down economies, global oil demand has collapsed faster than oil producers have been willing or able to adjust.
The result has been storage facilities quickly filling up around the world.
That’s what caused prices to fall below zero on Monday, experts say. Contracts for May delivery of WTI were set to expire on Tuesday, and many who held those contracts were desperate to to avoid having to take physical delivery of oil for which they had no space — desperate enough to be willing to pay buyers as much as US $37.63 per barrel to take the crude off their hands.
We may well see the same thing happen again when June and July, WTI contracts come due, said Blake Shaffer, an economist at the University of Calgary and former energy trader. And that’s bad news for Alberta’s oil producers, as much of the pricing of western Canada’s crude oil is based on WTI, Shaffer said.
“There’s definitely a lot of physical barrels here that change hands based on a set differential to WTI,” he said.
The degree to which individual producers are directly affected depends on how much of their production they’ve already sold, how they’ve hedged prices and other factors, said Leach.
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The largest players in the oilpatch, for example, rely on their own supply chains, with little, if any, of their barrels traded with the contracts that saw the sell-off on Monday, he added.
Still, the key question for oil producers of any size, anywhere is how quickly and how strong the world’s demand for oil will come back, Leach said. And that, he added, depends on the speed and strength of the economic recovery.
Canadians are used to hearing that the problem is western Canadian oil trading at a discount because there aren’t enough pipelines to get landlocked crude to market, Shaffer said.
In this case, though, it’s much of the world’s oil supply that has nowhere to go.
“There will be lasting impacts from this,” Schaffer predicted. “There will be companies that don’t make it through.”
For smaller producers, shutting in traditional oil wells is going to be relatively easy, Leach said. For larger oilsands producers, the process is more complicated. For them the focus is more on production slowdowns and not bringing new projects online, he added.
As for jobs, the impact may be less significant than one might expect, but only because the energy industry already went through ferocious cost-cutting during the downturn of 2015, Shaffer said.
Still, the top priority for both provincial and federal governments should be to provide support to workers so that they are able to stay home for as long as the health emergency lasts, Leach and Shaffer said.
Beginning April 27, employers whose business has been significantly affected by the pandemic will be able to apply for the Canada Emergency Wage Subsidy, which is meant to help companies retain or re-hire their employees.
Since April 6, Canadians have also been able to apply to the Canada Emergency Response Benefit, which provides income support to workers who lost all or most of their income amid COVID-19.
The second order of priority should be providing financial support to the energy industry, Leach and Shaffer said.
However, both warned against governments doling out cash or cheap loans directly to companies.
The goal should be to help the industry as a whole through the rough patch, not to prop up every single struggling business, Leach said.
If the crisis leads to industry consolidation, with some companies taking over weaker ones, “the government doesn’t need to care,” he added.
One way in which either Ottawa or provincial government could throw a lifeline to the industry without bailing out single companies would be to guarantee loans made by financial institutions, Schaffer said. That way, it would be private-sector lenders who decide who is credit-worthy, he added.
So far Ottawa has instituted loan guarantees and co-lending programs working with private lenders to provide credit to individual businesses, including in the oil and gas sector.
On Wednesday, a new report called for stronger oversight of proposed energy-sector bailouts after finding that millions of dollars previously spent or invested by Alberta since 2015 have helped pay high salaries for executives and dividends for investors at several companies in or near bankruptcy.
The Alberta Investment Management Corporation “has been engaging in this bailout of Alberta’s oil and gas industry for several years, losing tens of millions in the process,” Duncan Kinney of Progress Alberta, a left-leaning non-profit research and advocacy group, said in a press release.
“This should serve as a clear warning to the federal government as it works out the details of its own financial bailout of oil and gas companies,” he added.
Prime Minister Justin Trudeau has said the federal government is working to provide aid to medium-sized oil and gas companies through Export Development Canada and the Business Development Bank of Canada.
The federal government is also investing $1.7 billion to clean up orphan wells in British Columbia, Alberta and Saskatchewan to keep people working during the COVID-19 pandemic.
“The challenge of our provincial and federal governments here is to … support the heart of the industry that’s going to make it through while allowing parts of the industry to wither and support workers who are negatively affected through that process,” Shaffer said.
“That’s no easy task.”
— With files from Mike de Souza and Caley Ramsay at Global News
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