How Oil Prices are Affecting the US and Canadian Energy Sectors

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1 January March Follow on head on Master page A March 2018 How Oil Prices are Affecting the US and Canadian Energy Sectors Written by Stephen Morea, Nathaniel Leach and Ediz Ozelkan Edited by Rebecca Simon Designed by Anam Baig Canadian oil companies relocating their rigs to the United States could negatively affect downstream industries. The regulatory environment for new pipeline construction projects has become more stringent in recent years. Even with the difficulty of transporting oil rigs, Canadian companies are moving their rigs south because the benefits outweigh the sizable expense and headache. Canadian oil prices are trailing US prices, making it less profitable to drill domestically. A restrictive regulatory environment is curtailing prospects for oil transport, producing a domestic glut, while a favourable tax and energy production environment in the United States is encouraging rig migration. Many of these rigs may never return to domestic oilfields. Overall, these conditions could constrain demand for oil field construction activity and transportation services despite an improving domestic economy. Oil prices and oil production The stagnation in Western Canada Select (WCS) crude oil prices has been driven by several near-term factors, such as pipeline closures, limited export capacity, increasing costs for extractors and concerns about the future of large-scale pipeline development projects following the cancellation of some planned pipelines in recent years. Alberta s heavy, bitumen-blended WCS crude oil sells at a discount to the West Texas Intermediate (WTI) crude, reflecting its lower quality as compared with light oil as well as the extra transportation costs needed to bring it to refineries. However, in December 2017, the spread between WCS crude and WTI crude prices hit a fouryear high. Currently (as of March 2, 2018), Canada s oil trades at more than $30.00 a barrel below its US counterpart, or a 39.6% differential. According to Baker Hughes, the average Canadian oil rig count totalled 279 at its recent peak in This count fell dramatically down to an average of 109 rigs in While rig counts have been on the rise in 2017 and 2018, the level of activity and potential profit domestically are outweighed by those in the United States. As a result, despite the costs involved in moving rigs down to the United States, some companies have chosen to redirect their assets south of the border, placing pressure on pipeline construction companies while presenting an opportunity for transportation businesses to capitalize on this movement. Far-reaching consequences Within the Oil Drilling and Gas Extraction industry (IBISWorld Report 21111CA), exports account for more than 83.0% of industry revenue in 2018, 98.0% of which are destined for the info@ibisworld.com

2 March United States alone. Unfortunately, Western Canada s oil sand reserves are largely landlocked with limited options for transport. Oil from Alberta is primarily exported via pipelines to transport terminals in the Gulf Coast or coastal Canada. However, rising oil production, unplanned closures and overloaded pipeline capacity have resulted in a glut of crude oil with no means of transport. These patterns exacerbated the negative effects of tanking oil prices and contributed to decreasing revenue for the Oil Drilling and Gas Extraction industry at an annualized rate of 5.7% over the five years to Traditionally, Canadian oil that is not transported via pipeline is shipped by rail. IBISWorld estimates that revenue for the Railroad Transportation industry (48211CA) is projected to grow at an annualized rate of 3.0% over the five years to 2018 and this forecast can be complicated by these implications. Despite increasing demand for oil transportation, oil and gas pipeline construction in Canada (23712CA) is expected to increase at a slower rate when compared with the United States. According to IBISWorld estimates, the Oil and Gas Pipeline Construction industry in Canada is expected to increase at an annualized rate of 1.8% over the five years to 2023; this includes 3.9% projected growth in 2018 alone. Correspondingly, oil and gas pipeline construction in the United States (23712) is expected to increase an annualized 2.4% during the same period, with 4.2% projected growth in These differing forecasts are driving this rare rig migration. With domestic oil prices continuing to suffer, oil production growth and domestic pipeline construction are expected to continue to be constrained and the efficacy of future pipeline construction projects may be called into % change US vs. CA Revenue Year US Oil & Gas Extraction 23 CA Oil & Gas Extraction SOURCE: question, alongside the more meticulous scrutiny of government regulatory bodies, which will work to suppress pipeline construction. Further, these difficulties will manifest themselves throughout the oil and gas supply chain. For example, constrained oil supply could reduce demand for logistics industries that offer specialized freight services (48423CA) for oil fields. Upstream industries are also affected. The Mining, Oil and Gas Machinery Manufacturing industry in Canada (33313CA) is forecast to exhibit a profound decline over the five years to 2018 at an annualized rate of 12.9%. While oil prices reached their nadir in 2016 and have since risen, along with industry revenue, because of the complications in Canadian oil markets, the industry also experiences uncertain demand from downstream customers. The potential impact of new pipeline projects The regulatory environment for new pipeline construction projects has become more stringent in recent years. In February 2018, the Canadian government introduced a bill to repeal and replace the Canadian Environmental Assessment Act with the Impact Assessment Act (IAA). The IAA calls for a broader assessment of

3 March the environmental, health and social impacts of future projects. Local Canadian governments, such as Ottawa, have drafted similar types of legislation, calling for project assessments to provide for better measures for a project s impact on First Nations communities. These policies will work to curtail pipeline construction in a period of rising demand for its services, contributing to further southbound rig migration. The Canadian government has approved several major pipeline projects, such as TransCanada s Keystone XL, Enbridge s Line 3 and Kinder Morgan s Trans Mountain Expansion, which will alleviate oil transport problems. However, these projects continue to endure delays and regulatory setbacks. For example, Enbridge s Line 3 expansion project will increase incremental capacity by replacing the existing pipeline with a wider-diameter pipe. While the anticipated in-service date for Line 3 is 2019, the project is still awaiting approval from regulators in Minnesota. Additionally, the in-service date for Kinder Morgan s Trans Mountain Expansion, designed to transport oil from Alberta to the coast of British Columbia has been pushed back to September 2020, as the company has cited difficulty in obtaining local permits. At the same time, while approvals of these pipelines are positive harbingers for the energy sector, notable cancellations, such as the TransCanada Energy East Pipeline Project in late 2017, are countervailing forces working against oil production in the region. All in all, the political and economic climate that catalyzed the relocation of Canadian oil rigs across the southern border is expected to persist over the next few years, exacerbating current trends. While the construction of new pipelines is essential to easing the competitive tensions outlined here, 21111CA Oil & Drilling Gas Extraction in Canada: Exports (2017) 2.0% Other 98.0% United States

4 March About IBISWorld Inc. Recognized as the nation s most trusted independent source of industry and market research, IBISWorld offers a comprehensive database of unique information and analysis on every US industry. With an extensive online portfolio, valued for its depth and scope, the company equips clients with the insight necessary to make better business decisions. Headquartered in Los Angeles, IBISWorld serves a range of business, professional service and government organizations through more than 10 locations worldwide. For more information, visit or call unforeseen circumstances may inhibit their completion. Still, even with these pipelines in place, the price differential between WCS and WTI crude oil is expected to continue to shape the bilateral energy economy. Importantly, according to the International Energy Agency, the United States could potentially become the largest producer of oil in the world, given its recent activity. Therefore, the promising prognosis for the United States is encouraging domestic producers to reconsider their business plans, which has consequences all along the supply chain. Ultimately, the aforementioned difficulties will constrain the growth prospects of the domestic oil industry as compared with the United States, and these complications may prompt companies to focus their activities south of the border as opposed to investing more heavily in the domestic market given the current energy ecosystem. Contact: Media Relations media@ibisworld.com IBISWorld Sales & Subscriptions Phone:

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