The profit motive and the oil industry’s gift for adaptation shine to Canada’s benefit

Already it is hard to remember the concern that gripped some pundits and even governments just six months ago about the state of Canada’s oil industry. The discount for oil sands crude reached a record high of $40 a barrel last winter. The Alberta government blamed this “bitumen bubble” for its falling revenues and rising deficits, emphasizing the importance of building more upgrader capacity in Alberta and pipelines to new markets. The Canadian Centre for Policy Alternatives cried for the need to rein in oil sands production and to process more crude oil here in Canada, the result of the “unplanned and largely unregulated strategy for developing this resource.” The implication clearly was that the petroleum sector could not be trusted to manage itself responsibly in the best interests of Canada’s economy.

How quickly things have changed. The discount for oil sands bitumen returned to normal levels over the summer, shrinking to $10 in July, reflecting the end of temporary factors that aggravated it and of more fundamental shifts in the market place. It turns out that the solution lay in more transportation and not more processing in Canada. The short-term fix in transportation originated in the completely unanticipated agility of rail and barge transport, not the building of pipelines requiring regulatory approval from an indecisive White House (pipelines will be important to the long-term solution, since they remain the most efficient and safer mode of transport).

The unearthing of innovative strategies for transporting oil confounded the predictions of Monday Morning Quarterbacks with little expertise but lots of self-interest in either discouraging resource development or finding a scapegoat for budgetary bumbling. The ability to find creative and unforeseen solutions to what appear to be intractable problems is a hallmark of market-based economies, something its critics will never understand no matter how many times it happens when an interesting sum of money is at stake.

There is so much money to be made from petroleum in Canada that all sectors involved in its production and distribution are growing and investing at or near record rates, as shown in my just-published report for the Macdonald-Laurier Institute. By far the most investment and growth is directed to the extraction and transportation of petroleum, driven by the development of the oil sands. This is where profitability is the highest. Canada exports more crude than refined oil because that is where the most value is to be found.

All the other petroleum-related sectors are expanding, from refining to wholesaling and even retailing — Canada is only major developed country where gasoline consumption has risen since the recession. However, growth is not uniform within all of these industries. For example, the refining industry increasingly is divided between plants that can process the growing domestic supply of crude (including bitumen) and those that refine imported crude, which usually is more costly. This reflects that even with the surge of crude oil output and better transportation, more refining in Canada will not follow automatically. The determinants of refining increasingly are driven by global, not local, forces.

This uneven growth within refining partly reflects that the industry is undergoing an intense phase of globalization. In the 1990s, there was little international trade in refined petroleum products, unlike crude oil which has long been an integrated global market. Today, trade has risen several fold. Europe has converted much of its light vehicle fleet to diesel fuel, allowing it to export a surplus of gasoline to the U.S. in return for diesel. Canada exports large amounts of gasoline to the U.S., but nevertheless last year Canada imported more refined petroleum products than it exported for the first time ever. Some of this reflects how some refineries in Eastern Canada are losing competitiveness because of their reliance on high-priced imports, a disadvantage compared with refineries that can use lower-priced crude from North America as their main feedstock. Meanwhile, large refineries are being built in Asia to compete in world markets (one in India has the capacity of over half of all Canada’s refining industry).

One proposed solution to the competitive disadvantage of some refineries in Eastern Canada is to supply them with more bitumen from the oil sands. This is unlikely to work, as converting these refineries to process bitumen would cost billions at a time when North America already has a surplus of refining capacity, especially for heavy oil. Another proposal is to upgrade the bitumen to the synthetic crude oil that these refineries can process, but rising construction costs have rendered building new upgraders uneconomic in Alberta. However it is accomplished, the goal should be to extract the maximum value from out petroleum resources.

Philip Cross is a Senior Fellow with the Macdonald-Laurier Institute which just released “Extracting the most value from Canada’s petroleum.”