Analyst touts Alberta royalty holiday as temporary Canadian crude price crutch

Steep oil price discounts costing Alberta producers and the provincial government millions of dollars each day in lost revenue could be eased if the industry is given a temporary royalty holiday in return for producing less, according to a bank analyst.

In a report Monday, Royal Bank analyst Greg Pardy said Alberta oil is selling for multi-year discounts to U.S. benchmark prices for two reasons: there's not enough export pipeline space and barrels can't go into storage in Alberta because there's no room left.

The traditional solution is to put the stranded oil in railroad cars, but that capacity is also full and growing too slowly to make a difference, he said.

• Canadian crude-by-rail exports rise to new record of 229,544 bpd in August

"In the context of an estimated net supply imbalance of 160,000 to 185,000 barrels per day, we estimate that a five per cent royalty holiday on Alberta's 3.8 million barrels per day (current estimate) of oil production could take about 190,000 bpd of oil ... temporarily off the market," he said in the report.

"Over the course of 3.5 months, this game plan could drain Western Canada storage levels by approximately 4.8 million to 7.4 million barrels, or 16 to 25 per cent of estimated operable storage, opening the door to spread normalization."

Record rail exports

The National Energy Board reported exports by rail rose to a record 229,544 bpd in August, up more than 11 per cent from 206,624 bpd in July and 91 per cent from just under 120,000 bpd in August 2017. RBC estimates fourth-quarter rail exports will be about 250,000 bpd.

Last week, Alberta Premier Rachel Notley called on Ottawa to work to increase capacity for oil on rail as a "short- to medium-term" solution to improve market access, arguing the low prices are hurting governments as well as producers.

But Pardy argued Alberta has the power on its own to improve crude oil prices, noting that the benefit of intervening in the market to drain storage from its capacity of about 30 million barrels would be paid back when prices recover and its royalties are restored.

"While we applaud Alberta Premier Rachel Notley's efforts to accelerate crude-by-rail, there may also be a near-term bridge," he said.

"As a temporary measure, the royalty holiday could be called upon, as needed, until other solutions fall into place, namely incremental crude-by-rail loadings, and Enbridge's 375,000 bpd Line 3 replacement (pipeline expected to start up in late 2019)."

In its Aug. 31 budget update, Alberta estimated it would have oil royalties of $3.6 billion this year giving them up for three months would cost about $900 million.

The provincial government did not immediately respond to a request for comment.

Reluctant to add rail capacity

Canada's railroads have been reluctant to add locomotives and crews to move oil cars unless producers sign long-term contracts because they fear those customers will disappear as soon as pipeline capacity, considered to be cheaper, is available.

Oilsands producer Cenovus Energy Inc. announced recently it had signed long-term deals to move 100,000 bpd of its own heavy crude oil on Canadian railways to the U.S. Gulf Coast to be refined.

The widening differentials between Canadian oil prices and U.S. benchmark West Texas Intermediate have also been linked to a reduction in demand as maintenance shutdowns take some refineries off line in the U.S. Midwest (also called PADD II), but observers have lately been discounting that factor.

In a note Monday, analysts with Tudor Pickering Holt & Co. said it doesn't appear that the shutdowns have had much effect on Canadian oil shipments.

"Digging into the data suggests that crude flows into PADD II increased over the month of October as offline refineries opted to take the cheap barrels and jam them into storage," the report said.

In his report, Pardy points out that oilsands producers actually pay their Alberta royalties based on a WTI price framework, despite a discount that means many are receiving less for their oil than what it cost to produce it.

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