Havoc in the Strait of Hormuz hands Canada’s oil sector a windfall. Will pipelines follow?

WASHINGTON, D.C. — Placing mines in the world’s top oil chokepoint , the Strait of Hormuz, and threatening to hit any ships that cross it are the latest moves by the Iranian regime in Tehran amid a growing energy crisis that has seen global oil prices rise and fall dramatically. 

Normally, 20 million barrels of oil flow through the waterway each day, so experts say there is already a shortage of over 200 million barrels in the global trading system as Gulf nations halt shipping through the strait amid the fighting.

“Twenty million barrels a day was the peak of COVID demand destruction,” said Rory Johnston, an oil market analyst and CEO of Commodity Context, an independent oil market research platform. “That is the level of activity change we’re talking about, and that was when we were in our houses during lockdown … and there wasn’t a plane in the sky.” 

As a result, Brent, the benchmark price for two-thirds of the world’s crude oil, reached a whopping US$119.50 a barrel over the weekend. U.S. President Donald Trump tried to reassure markets that the war is winding down, which has helped lower prices to just over US$90, but that is still far north of the US$65-68 range from before the United States and Israel began attacking Iran. 

Inflated oil prices are obviously bad news for gas and energy consumers around the globe, and Trump certainly doesn’t want gasoline sticker shock ahead of the summer drive season — or this autumn’s midterms. While the disruptions have rattled markets, they’ve also had an upside north of the border.

Canadian oil is banking surging profits, Alberta royalties are up, and Ottawa is gaining a tax windfall thanks to the spike, but the Trans Mountain Pipeline is already operating at 91 per cent capacity, which means there is no real opportunity to boost Canadian oil exports. Consumers in the eastern part of the country, meanwhile, are facing the pain of higher gas prices. So could this boost in oil prices lead to greater pipeline investment, or will it simply line shareholders’ pockets?

The windfall

Western Canadian Select, the benchmark for Canadian heavy oil, is priced relative to WTI, the U.S. light crude benchmark, which is currently unusually close to Brent; Brent normally trades between US$5 and US$15 above WTI. 

Higher prices help Canadian producers both through stronger global benchmarks, which keep the baseline price high, and by tightening the light-heavy crude differential that had been weakened by Venezuela’s re-entry into the global market following Trump’s moves against Nicolas Maduro.

“It was at US$60, and now it’s 25 per cent more. That’s pure profit,” said Normand Mousseau, scientific director at the Trottier Energy Institute, Polytechnique Montréal. 

Joseph Calnan, VP of energy for the Canadian Global Affairs Institute, agreed, noting that “Canadian producers are making more money on every barrel right now.”

The degree of profitability, however, depends on how much producers have hedged on their production, according to Philip Petursson, chief investment strategist at IG Wealth Management in Toronto. 

Some producers, he said, protect their profitability by selling forward their productions at a fixed rate. “So even though oil prices are higher, they’ve already committed to delivering at US$65 (for example). So they don’t get the benefit of higher oil prices.”

But, for now, the higher prices are great for many producers and a net positive for the Canadian economy, meaning the benefits outweigh consumer pains. When oil prices rise, it’s good for Canadian GDP, and especially the Alberta economy and energy sector overall. This helps increase the value of the Canadian dollar, said Calnan, and offset some of the problems Canada has had with the balance of trade since the start of Trump’s trade war.

The tipping point, said Petursson, is usually when oil prices double on a year-over-year basis, which would be about US$140 a barrel.

So, can the sector’s profits be turned into longer-term capacity, allowing Canadian producers to help fill gaps in global supply at a moment’s notice?

Production investment

This is unlikely, experts say.

“Before a company would commit to new projects because the price was high, I think the price would need to be sustained for a couple of months,” said Petursson, noting the need for sustained prices above US$80 a barrel.

Instead, Calnan said, the Canadian oil industry is in the “wait and see mode,” and he doesn’t think any investment decisions have been made based on the recent high prices, which he and the markets seem to think is a temporary blip.

“I don’t think that this sort of shock can last for that long,” he said. “It’s just too disruptive. There will be some sort of political solution out of this.” 

As if on cue, on Wednesday, the International Energy Agency announced that it would release 400 million barrels of oil from its emergency oil reserves, according to news reports.

Even the broader market has been signalling that the oil price surge is temporary. 

“When you look at a number of other kinds of market indicators,” said Petursson, “it doesn’t seem like there’s strong belief that oil prices are going to remain even at these levels … You’re not seeing the response in the energy producers commensurate to the gains in the price of oil.”

So if private companies aren’t using their new profits to invest in production capacity for future exports and crises, does it mean that Canada’s oil export expansion strategy remains in the slow lane?

Yes, at least for now. Markets suggest the price rise is temporary, so producers are enjoying the temporary blip but not making investment decisions based on it. The real question is whether Ottawa will leverage the moment to argue for pragmatic energy security and infrastructure development — to weather crises and seize opportunities.

National Post

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