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Is That OPEC Cutting the Oil Supply? No, It’s Canada

The government of the western Canada province of Alberta is imposing a 325,000 barrel-a-day cut on oil producers, an extraordinary intervention in one of North America’s biggest energy markets. The measure wasn’t entirely unprecedented: Alberta’s government ordered production cuts in the 1980s to protest federal energy policies. But the production quotas that are a hallmark of the Organization of Petroleum Exporting Countries are a strange fit in a free-market economy.

1. What prompted Alberta’s action?
Premier Rachel Notley said the production cuts, which take effect in January and are to be reevaluated monthly, are necessary to address a glut of stored Alberta oil that has sent its price, relative to West Texas Intermediate futures, to its lowest level in at least a decade. She blamed the oversupply on a shortage of pipeline capacity. The province is working to buy rail cars as an alternative transport method; longer term, the Canadian oil industry is counting on a trio of pipeline projects to help get more of its oil to market: Enbridge Inc.’s Line 3 increase, TransCanada Corp.’s Keystone XL and an expansion of the Trans Mountain pipeline from Alberta to the British Columbia Coast. The government of Prime Minister Justin Trudeau purchased the Trans Mountain project last spring for $3.5 billion, saying government ownership would increase the odds of it being built.

2. How do production cuts fit in with a free-market economy?
Somewhat uneasily, to tell from initial reactions. Randy Ollenberger, an analyst at Bank of Montreal, said investors “will definitely worry that this is a slippery slope, and that the government can curtail production or interfere in business to pick winners and losers.” Producers who will benefit more from higher Canadian prices applauded the decision. Devon Energy Corp. said that short-term intervention was necessary in an oil market as distorted as Alberta’s. But the move was opposed by Suncor Energy Inc. and Imperial Oil Ltd., two companies with large refining operations that benefited from the cheaper oil.

3. Has this been done in other parts of North America?
Yes. Mexico is one of eleven oil-producing countries including Russia and Oman that joined with OPEC to cut production last year to support prices. In the U.S., no existing law would give the U.S. federal government authority to order production cuts, according to Josiah Neeley, energy policy director at R Street, a Washington-based public policy research organization. Several states “in theory” have such authority but chances that would be exercised are “basically nil.” Throughout the 1930s, 1940s and 1950s, the Texas Railroad Commission played the role that OPEC plays today by mandating production curtailments to prevent oversupply. The agency eventually became a model for OPEC.

4. How will Alberta enforce the cuts?
That’s still being spelled out. In January, the cuts amount to 8.7 percent of output and the amount will be evaluated each month thereafter. So far, the provincial government has said cuts for each operator will be based on its highest six months of production over the past year. The order will automatically expire at the end of 2019. Mike McKinnon, the cabinet spokesman, said that the government’s regulations enable administrative penalties to be applied if companies fail to comply with rules and orders. The Alberta Energy Regulator, which overseas oil and gas activity in the province, can use its power under the Oil and Gas Conservation Act and Oil Sands Conservation Act to shut a well or facility when a company isn’t in compliance with rules, he said. Still, there’s more work to do on this matter before January.
Source: Bloomberg

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