December 3 – Weekly Oil and Gas Market Update

The Alberta Production Cuts

On Sunday night Rachel Notley announced a mandated production cut in Alberta, for crude oil and bitumen, of 325,000 bbls/d (representing ~8.7% of production). This short-term course of action was also supported by Jason Kenney and the UCP. At Validere, we always appreciate people tackling complex problems, and the government attempting to decrease price differentials with this production cut is no exception. We also believe that our success is dependant on the types of questions we ask, and this recent decision has given us a lot to think about it. We will outline the details of the cut below and some of the critical unanswered questions going forward.

The reduction will start at 325,000 bbls/d and then drop to an estimated average of 95,000 bbls/d until Dec. 31, 2019. Current surplus production (above takeaway) is calculated at 190,000 bbls/d, which means the goal of the cut is to draw down excess storage. The cuts will be applied at the producer level, and the curtailment for each producer will be based on that producer’s six months of highest production over the past year. The first 10,000 bbls/d for each producer is exempt from the cut (designed not to penalize small producers with higher fixed costs). The cut will be born primarily by the oil sands and heavy oil producers given that the smaller producers exempt under the cut produce a larger proportion of light oil. This is expected to have the short term consequence of slightly reduced condensate and gas demand (given their role in producing and getting heavier Alberta barrels to market).

Questions/Thoughts:

How will banks that have loans secured by oil reserves respond? The cut will preserve the PDP value of the reserves, by not allowing production at a loss. However, at the same time revenue related covenants could be triggered due to the cuts.

How will cuts work for large projects, especially integrated ones, where reduced operations are less viable?

Will there be an exchangeable market for “cuts” so that producers that are unable to cut due to contracted offtake solutions are able to purchase the equivalent “cut” in the public market? Without this type of system, we may observe market friction where infrastructure in proximity to these types of producers is unutilized. For example, will a producer that is delivering to a connected pipeline now find that some of their capacity needs to go unused if area producers can’t access that specific pipeline due to their own contracted offtake?

Quality Driver:

The definition of “oil” production based on product quality will be critical for certain producers that fluctuate between oil and condensate. Their ability to grow in 2019 may be highly dependent on how their crude is classified. A clear definition of product qualities governed by the cuts will be helpful for companies to plan their 2019 budgets.

Mark Le Dain

Mark Le Dain

Mark Le Dain currently runs strategy for Validere and previously worked as an energy investment banker. Mark has significant experience advising energy and infrastructure companies, successfully completing over $18 billion of M&A transactions and $5 billion of capital markets transactions.
Mark Le Dain