December 5, 2018 / 3:07 PM / 10 days ago

EXPLAINER-Why is Canada's Alberta forcing oil production cuts?

Dec 5 (Reuters) - The Western Canadian province of Alberta this week announced mandated temporary oil production cuts, a rare move aimed at bolstering sagging crude prices caused by rising production that has outstripped pipeline capacity and led to a glut in storage.

WHY MANDATE PRODUCTION CUTS?

Alberta Premier Rachel Notley said the mandated 8.7 percent cuts, some 325,000 barrels per day (bpd), are needed to draw down near-record volumes of crude in storage in Western Canada and bring relief to sagging Canadian crude prices. Once storage volumes return to more normal levels, the forced cuts will be reduced to 95,000 bpd. The cuts will be spread among companies producing at least 10,000 bpd, based on average production.

Crude production in Alberta’s oil sands is expanding faster than pipeline capacity, creating a bottleneck and a buildup of product in storage. More crude is now moving across the border by rail and by truck, but it is not enough to clear the glut. Adding to the woes, refinery maintenance has taken some buyers temporarily offline.

The steep discount has stripped billions of dollars from the Canadian economy by some estimates, and at one point Canadian oil was selling for more than $50 less than U.S. oil traded on futures markets.

Canada produces some 4.6 million bpd and exports about 3.3 million bpd to the United States, about 99 percent of Canada’s total crude exports.

HOW UNUSUAL IS THIS?

Very. This is a rare move for a market economy like Canada, but it is not the first time an Alberta government has mandated cuts. In 1980, then-Premier Peter Lougheed forced cuts to protest a national energy program that he said would have harmed the province’s oil industry.

DO THE OIL COMPANIES SUPPORT THIS MEASURE?

The controversial cuts are supported by many Canadian producers, but not all of them. Companies like Cenovus Energy Inc and Canadian Natural Resources Ltd are vocal supporters of the move, with Cenovus saying the move will help it maintain capital spending to prepare it to move more oil when more pipelines are available in 2020.

Executives from Canada’s Suncor Energy Inc, Husky Energy Inc and Imperial Oil Ltd, integrated producers with domestic refinery and upgrading capacity, expressed disappointment, however, saying they prefer market solutions to the problem.

HOW LONG WILL IT LAST?

The larger 8.7 percent cuts are expected to last three or four months into the first half of 2019, according to a number of analysts, at which point much of excess storage will be drawn down. After that, the smaller, 95,000-bpd cuts will remain in place until year-end, to ensure that storage levels do not get too high again. Alberta said it will monitor the market closely and reductions will be adjusted accordingly as storage is drawn down or new transport capacity comes online.

HOW WILL INDIVIDUAL PRODUCER CUTS BE DETERMINED?

Producers will be allowed to choose where they cut production, allowing them to shut in their least lucrative barrels to make up their cut quota, instead of having to cut across the board, Alberta said. The baseline for each company will calculated based on the best six months of the year. Each operator will have their first 10,000 barrels per day exempted, so small producers are not affected.

WHAT IS THE DIFFERENTIAL?

Western Canada Select (WCS) heavy blend crude typically trades at a discount to the West Texas Intermediate (WTI) benchmark, with the lower price reflecting the cost of transport and the quality of the product. The discount has typically been around $15, but has widened in recent months, hitting a record at $52.50 below WTI in October, according to data from Shorcan.

WHAT’S HAPPENING WITH PIPELINES?

Alberta and oil producers prefer to add more pipelines, but projects face fierce opposition from environmentalists and some Aboriginal groups. Construction is underway on Enbridge Inc’s Line 3 pipeline replacement from Alberta to the United States, with the project expected to be in service by the end of 2019.

TransCanada Corp’s Keystone XL pipeline, from Alberta to the United States, is facing a supplementary environmental assessment after a federal judge in Montana halted construction last month. The impact on timing remains unclear.

The third project is the Trans Mountain pipeline, which is now owned by the Canadian government. Plans to triple the capacity of that line, which runs from Alberta to a port in the Vancouver area, are undergoing a new regulatory review. It is unclear when construction will begin.

WHAT ABOUT CRUDE BY RAIL?

Crude by rail has ramped up sharply this year, hitting nearly 270,000 bpd in September. Alberta said last week that it would buy locomotives and rail cars to add an additional 120,000 bpd of crude by rail capacity. It expects the first trains to be running by December 2019, with all online by August 2020. Crude by rail will narrow the differential, but not as much as pipelines.

WHAT ARE THE POLITICS AT PLAY?

Dealing with the low crude prices is essential for Notley, who faces an election no later than the end of May 2019. Her party faces a tough challenge from the United Conservative Party, led by Jason Kenney, a former Cabinet Minister with the federal Conservatives. (Reporting by Julie Gordon in Vancouver; Editing by Jonathan Oatis)

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