Impacts of Crude Oil Price Changes
October 2010
Global Impacts
The IEA estimated that global upstream exploration and production investment budgets for 2009 totaled around $388 billion, down more than $90 billion or 19% lower compared with 200828. In February 2009, OPEC reported that its member countries had delayed the completion of 35 of 150 planned upstream projects, due to falling oil prices. As a result, the planned addition of 5 Mb/d of gross oil production capacity will be delayed from 2012 to sometime after 2013. Cutbacks have mainly affected projects in the planning stage. Projects already under construction are proceeding, although some slowdowns are reported. The reduction in investment has raised concerns within the IEA that spare oil capacity may eventually be squeezed given the long investment lead times. However, OPEC spare capacity has doubled in the last year and it could take years to tighten the oil market.
Impacts on Canadian Trade and Currency
Canada’s dollar is often viewed as a petrocurrency because its movements often track oil prices. In February 2008, the price of WTI crude oil closed for the first time at over $100 U.S. per barrel and the Canadian dollar was trading around parity with the U.S dollar. When the price of crude oil collapsed, the Canadian dollar fell to about $0.82 U.S. by November 2008. In late 2009, as oil prices recovered, the Canadian dollar approached parity with the U.S. dollar.
The global economic downturn and the drop in commodity prices led to a weakening of Canada’s trade position. In 2008, Canada’s oil and natural gas exports were valued at $125.6 billion30, or 26% of Canada’s total merchandise trade exports ($483.6 billion).
In December 2008 and January 2009, due to a decline in commodity prices, led by crude oil, Canada recorded its first monthly merchandise trade deficits since March 1976. In 2009, Canada recorded its first annual trade deficit since 1975 due to a decline in commodity prices.
WTI and Canadian Crude Oil
West Texas intermediate (WTI) crude is the benchmark crude oil for the North American market and Edmonton Par is the benchmark for the Canadian market. Both Edmonton Par and WTI are high-quality low sulphur crude oils with API gravity levels of around 40 degrees. These light crude oils sell at prices in close proximity to each other. Canada also sells a variety of heavy crude oil types such as Lloyd and Bow River blends and bitumen. Light crude oil sells at a premium to heavy crude oil because it easier for refineries to process the crude oil into refined petroleum products. US oil refineries have made significant investments in technology to handle heavy crude blends such as oil sands which has increased the demand, and prices have increased.
The differential between light and heavy crude oil has narrowed which has reduced the incentive to upgrade light crude oil in Canada. To encourage upgrading within Canada, the Province of Alberta is considering its right to take bitumen in-kind in lieu of cash royalties. The province’s share would then be used to supply upgraders and refineries in Alberta31.
Canadian Producer Investment
With the recession, upstream and downstream oil investment in Canada was scaled back due to lower oil prices, lower cash flow and some difficulties obtaining credit.
With respect to oil sands projects, most of which were upgraders, approximately $150 billion in oil sands projects representing 1.7 Mb/d of upgrading and production capacity was suspended32. For 2009, oil sands capital spending is estimated at $10 billion by the Canadian Association of Petroleum Producers – a reduction from $18 billion spent in 2008.
Oil and gas drilling was hard hit by the reduction of crude oil prices. For the first nine months of 2009, industry drilled 5,719 new wells; off 53% from the nine month period in 2008 (12,053 oil and gas wells were drilled in the first nine months of 200833). The peak was in 2006 when 17,747 wells were drilled at the three quarter mark.
The provinces have responded to the drop in drilling rates by offering incentives for new oil and gas production. To support new drilling of oil and gas wells, Alberta and British Columbia have reduced royalty rates. In March 2009, to support the energy industry during the global economic slowdown, the Alberta announced a new $200-per-metre-drilled royalty credit for new conventional oil and gas wells. Alberta's new well incentive program offers a maximum five-percent royalty rate for the first year of production from new oil and gas wells34.
In August 2009, British Columbia announced reductions in its royalty rates to attract more exploration and development by the province's natural gas and oil drilling industry.
North America’s refining sector has been significantly affected by the recession and current gasoline demand forecasts. Weak margins and surplus capacity has affected proposals for new refineries. In July 2009, Irving Oil and British Petroleum halted the proposed $8 billion Eider Rock refinery in St John, New Brunswick which was to supply 300,000 barrels per day of refined products to the U.S. northeast.
Regulatory Reforms Affecting Institutional Investment
According to some analysts, speculation was excessive in 2007 and 2008, resulting in magnified price fluctuations, and confusion between real investment in developing oil supply and investment in oil futures. Several governments (India and the U.S.) and OPEC have called for restrictions on speculative investment. Canada, the United Kingdom, France, the European Union and the International Energy Forum have called for measures to increase the transparency of commodity markets.
In the United States, on July 21, 2010 the Obama Administration passed the “Dodd-Frank Wall Street Reform and Consumer Protection Act”. This Act has been lauded as the most sweeping financial reform since the Great Depression. According to analysts, the "Dodd-Frank Act" could help reduce excessive speculation in commodities markets, by:
- Regulating, for the first time, the $450 trillion over-the-counter derivatives market.
- Closing the so-called “Enron Loophole” in the futures market,35
- Increasing the margin and capital requirements on derivatives such as oil futures.
- Limiting banks interest in hedge funds to just 3% of total ownership.
- Requiring centralized clearing and exchange trading of derivatives.
- Giving the Commodities Futures Trading Commission (CFTC) and the Securities Exchange Commission (SEC) the authority to set federal position limits in energy contracts and securities in exchanges and Swaps held by dealers (the intention is to prevent any individual company or fund from gaining a dominant position in the trading of a particular energy commodity).
- Federally insured deposit institutions such as banks must spin off their derivatives activities into separate affiliates.
Participation in the energy futures markets is a legitimate tool for oil producers to hedge future revenues, and for refiners to hedge future costs. Note that position limits will not apply to commercial interests who are “bona fide hedgers”36. Bona fide hedgers – producers, industrial energy consumers, refiners – hedge oil prices to stabilize revenues from oil sales or to stabilize their costs of oil feedstock. They do not hedge purely to profit from oil price movements. Speculation in itself adds liquidity to the market and is healthy as long as it not excessive. Both commercial and non-commercial players (including speculators) are needed for well functioning futures markets. In order to facilitate trades in the futures market there must be a willing counterparty in a liquid market. Speculators serve this purpose by acting not only as a willing counterparty to trades from commercial interests, but also as a market participant who trades frequently, and adds liquidity to the market and has benefits in terms of market transparency and price discovery. But recently, there have been questions about how large the market presence of speculators should be to facilitate the efficient operations of futures markets. There are suggestions that the market presence of speculators could be excessive which may have contributed to the increased volatility of energy prices. U.S. regulatory authorities have made proposals to prevent the manipulation of energy prices by limiting the volume of investment by speculators in the futures market.
The “Dodd-Frank Act” reintroduces some of the protections to the market that were in place under the U.S. Glass-Steagall Act (1934). According to many, increased flows of money into commodity markets led by commercial interests (banks, hedge funds, insurance companies, etc.) could have contributed to increased volatility in oil prices (particularly in the 2007 to 2008 period). Since the repeal of the U.S. Glass-Steagall Act in 1999, non-commercial interests greatly increased their investments in commodity markets. The changes in banking regulations under the “Dodd- Frank Act” could help limit future oil price swings by reducing the flows of money into the commodity market by non-commercial interests.
Much of the scope and impact of the “Dodd- Frank Act” will depend on regulations the CFTC and SEC are directed to create. At this time, it is unclear what impact these regulatory changes could have on crude oil prices as the proposed regulatory changes have not yet been written into regulations or enacted.