Pump rage

North America may be an emerging oil superpower, but gas prices are only going up

Pump Rage

Photograph by Simon Hayter

Rising gas prices have long been a rite of spring. We drive more as the weather improves and prices go up. But this year, there is a little extra frustration in the air.

As gas prices topped $1.40 a litre last week—reaching records not seen since 2008—a gas station in Oromocto, N.B., decided to drop its prices to 92.3 cents a litre as part of a promotion with a local radio station. It took minutes for anxious motorists to flock to the station, which went through 3,000 litres of gas before ending the sale after just 30 minutes. In Miami Beach, Fla., an impatient driver tried to beat one gas station’s traffic snarl and ended up slamming her SUV into the pump, setting it on fire. High prices have sparked an angry backlash among motorists. Police in Ontario have reported an increase in gas-and-dash thievery, while several campaigns on Facebook and across social media platforms are calling for nationwide gas boycotts.

The frenzy over fuel prices isn’t just a North American phenomenon, either. Fears of fuel shortages and price spikes in recent weeks have sparked riots in Indonesia and protests in the streets of Britain and Pakistan.

It’s only expected to get worse. BMO Capital Markets senior economist Sal Guatieri warned last week that the risk of prices heading to $1.60 a litre in Canada was “not insignificant.” (That would put the cost of filling up one SUV-sized gas tank at $120. Double that for two-car households, and those are punishing prices.)

Canadians, more than anyone, deserve to feel particularly angry these days about the rising cost of gas. We have, after all, emerged in recent years as one of the world’s oil superpowers. Canadian oil production rose to 1.6 million barrels a day last year, up more than 13 per cent from the year before. The Canadian Energy Research Institute predicts oil sands production could more than double that to nearly four million barrels a day by 2020 and to 6.2 million barrels a day by 2045. Combine that with Mexican oil production and new U.S. shale oil and gas discoveries and North America could add a staggering 11 million barrels a day to its production within the decade. “North America is becoming the new Middle East,” Ed Morse, managing director and head of global commodities research at Citigroup, wrote in a report last month.

So if Canada is awash in oil, why are prices at the pumps still reaching record highs? And why, if we are the next energy superpower with reserves that reportedly rival Saudi Arabia’s, are experts warning that the days of cheap gas are likely gone for good?

For one, the global face of oil supply and demand is undergoing its most profound change since the Second World War, as demand shifts from North America and Europe to the rapidly growing economies of China, India and Russia. Meanwhile, analysts believe that global spare production capacity—oil production that can be brought online quickly in emergencies in order to calm markets—is dwindling and won’t be replaced by production of so-called “unconventional” oil from sources like the Canadian oil sands.

“Crude prices are set in global markets,” says petroleum industry consultant Michael Ervin. “So although we’re a great producer of crude oil, both conventional as well as unconventional such as the oil sands, those raw materials are priced according to market forces. All of that means we don’t get a break at the pumps as a result of the resources that we have here.”

Canada may be better positioned to withstand high fuel prices thanks to the bounty it provides to places like Alberta, says Peter Buchanan, senior economist with CIBC World Markets. Between 2011 and 2045, more than $1.2 trillion in royalties are expected to have come from the oil sands, a figure nearly as large as the country’s GDP. It’s good money, though royalties disproportionately benefit Albertans over other Canadians.

Even so, when fuel prices remain high for longer than six months to a year, these initial benefits can start to erode, especially because they wreak havoc on our largest trading partner. According to the International Monetary Fund, a 10 per cent jump in oil prices reduces U.S. economic growth by 0.2 per cent in the first year. That translates to about US$29.2 billion in lost GDP and puts the Canadian economy at risk of being dragged into recession. “The longer the prices are high, then in some sense the more negative the effect becomes,” says Buchanan.

High fuel prices hit at the heart of household spending, driving up inflation and raising the cost of everything from food to home heating. Even when prices plunge as quickly as they rise, it can hurt consumers since that kind of uncertainty keeps fuel-reliant businesses, like transportation and manufacturing, from making new investments or creating jobs.

But we’d better get used to that uncertainty. We live in a world where fuel prices have become increasingly volatile and price shocks ripple through the system with unprecedented speed and unpredictability, leaving consumers, businesses and entire national economies hanging in the balance.

For more than half a century, the price of oil was dominated by Middle Eastern production and U.S. consumption. When U.S. demand rose, or supply from the Organization of Petroleum Exporting Countries fell, prices rose.

That’s still partly true today. With nearly half the world’s oil supply, Middle Eastern producers still hold considerable sway over global prices and fears over U.S. sanctions against Iran have contributed to the market’s uncertainty. But U.S. demand for oil imports has started to slow and is expected to fall below pre-1990s levels over the next 20 years, thanks in part to lacklustre economic growth and vast supplies of shale oil and gas that are now turning the U.S. into a net exporter of petroleum products. Yet even as demand for U.S. oil imports continues to slide, demand in emerging markets continues to grow, led by the booming populations in India and China. The global fleet of vehicles is expected to rise 60 per cent by 2030, mostly because of China’s rising middle class.

India and China combined still consume less oil than the U.S., but that could change in as little as a decade. Even Brazil and Russia, both energy exporters, are facing increasing domestic demand.

The International Energy Agency predicts China will contribute to more than half of global oil demand over the next 20 years, while the U.S. Energy Information Administration predicts demand from outside the OECD will push crude oil to $230 a barrel by 2035. That’s the equivalent of $145 in today’s dollars, up from the current price of around $100 a barrel. (The last time oil prices were that high, in 2008, pump prices topped $1.50 a litre in some places. Many economists say those high energy costs helped tipped the North American economy into recession.)

“Today, the thing that is driving a lot of price rises is the belief that oil companies and the oil producing system will barely be able to meet projected global demand, if they’re lucky,” says David Detomasi, an assistant professor of international business and an oil industry analyst at Queen’s University. That’s despite investing billions in non-traditional oil sources like Alberta’s oil sands and shale gas in the United States.

Last spring’s civil war in Libya, which took one million barrels of oil a day offline, exposed just how little spare oil production capacity is left in the world. In response, Saudi Arabia, now the world’s second-largest oil producer after Russia, took nearly five months to ramp up production by 600,000 barrels a day, a sign the country may not have the three million barrels a day of spare capacity that markets expected, oil industry analyst Gregor Macdonald warned in a report last month. Meanwhile, OECD countries released oil from their official inventories, another red flag that the cushion of spare oil was eroding.

Couple with that the shift to the “new oil” producers of Canada, the U.S. and Brazil, whose deposits are more expensive and difficult to produce because they’re locked deep in the ground in layers of sand and salt and shale rock, and that leaves the market continually guessing at the right price for oil. “As the older oil fields of the world decline, the price of oil must reflect the economics of this new tranche of oil resources,” MacDonald wrote. “There are no vast, new supplies of oil that will come online in 2013, 2014, and 2015 at the scale to negate existing global declines.”

That finite supply of oil is increasingly exposing gasoline prices at the pumps in Edmonton and Montreal to political upheaval in places as geographically remote from Canada as the oil fields of South Sudan. In January, the government of that country, home to some of Africa’s richest oil deposits, abruptly shuttered production. After months of hostilities with its neighbours to the north over which country controlled the South Sudanese oil flowing north through Sudan’s pipeline, the country capped its gushers, pulling some 350,000 barrels of crude oil per day off the global market.

The last 18 months have not been kind to many of the world’s oil-producing regions. Revolution in Libya, turmoil in Yemen and civil war in Syria have all cut into the global oil flow, choking off supply in a marketplace where demand continues to climb. Add in Iran, which has threatened to shut off access to the Straight of Hormuz, putting one-fifth of global oil supply at risk—along with U.S. and planned European Union sanctions against that country—and the state of the oil producing world is in as much flux today as at any time since the first Gulf War.

Prices eased somewhat last week with the news that Iran may restart talks on its nuclear program. But in the long run, few expect them to go down too much, even if peace, at long last, were to be found in the Middle East.

That’s not to say oil prices are going to go up in a straight line. “It’s incredibly hard for me or anyone else to predict exactly what’s going to happen,” says James Hamilton, an economist at the University of California at San Diego. In fact, the only thing that seems certain when it comes to fuel prices now is volatility. Queen’s University’s Detomasi cites a U.S. Energy Department report from this year that could only forecast with 95 per cent confidence that crude oil prices would average somewhere between $45 and $180 a barrel 18 months from now. That kind of pricing yo-yo brings its own risks, especially to the oil-dependent economies in western Canada. “Uncertainty is kind of neat if you’re a trader, if you can be one step ahead, but sooner or later it goes the other way,” Detomasi says.

It also leaves the market more vulnerable to crisis. In a flush market, one with lots of spare supply, a dip from one source can usually be made up by increasing production from another. But that slack just doesn’t exist anymore. “If we don’t have excess capacity, any little disturbance has to be equilibrated by movement in the price,” says Hamilton. In other words, the kind of mini-disaster that in the past might have at most nudged oil prices could today knock them significantly up. A gas leak at Total SA’s Elgin oilfield off the coast of Scotland in March, for example, played a major role in keeping prices up even as fears over the situation in Iran eased somewhat in early April.

Global politics doesn’t explain everything about the sharply rising price at the pumps, especially when crude prices sit at $100 a barrel, well below their $150 spike in 2008. For that, Canadians need to blame the benchmark used to price crude oil and its increasingly disconnected relationship to the price of wholesale gasoline sold by refineries.

Canadian oil sands bitumen is priced on the basis of the value of a barrel of West Texas Intermediate, or WTI, a specific grade of oil that is used as a benchmark for landlocked North American crude that moves to refineries by pipeline. Its price is set by the inventories at Cushing, Okla., the largest oil hub in North America. Oil that arrives at North American refineries by tanker uses the Brent benchmark, which reflects the price of oil produced in the North Sea.

Traditionally, the price differences between Brent and WTI were small. But the gap between the two benchmarks has been growing since 2008. With crude inventories building up at Cushing thanks to such things as new oil from the oil sands and a lack of pipeline capacity to refineries on the Gulf Coast, WTI prices have been falling. Meanwhile, declining production in the North Sea, where oil giants Total and Shell were forced to shut down production because of the Elgin gas leak, has driven up the cost of Brent.

Brent now trades at a $20 premium over WTI and some analysts expect that price difference to double in the future. Increasingly, oil markets have used Brent—which can move anywhere in the world by tanker and is therefore considered to be a more accurate reflection of oil prices—to price as much as 70 per cent of the global oil supply.

Technically, that should mean gas prices in western Canada fall, since most western fuel comes from refineries that use cheaper WTI crude oil, while eastern Canada primarily gets its fuel from waterborne sources whose prices are based on more expensive Brent. But data from MJ Ervin and Associates shows that refineries in the Canadian and U.S. Midwest have simply been pocketing the difference.

All that means prices at the pumps are largely out of the control of oil sands producers and governments. Not to mention motorists, whose increasing desperation for cheap gas hasn’t gone unnoticed. Last week, an online travel agency sponsored a Toronto gas station to drop its prices to 50 cents a litre and declared the two-hour lineups that ensued to be a resounding public relations success. (Those waiting in line included a diabetic woman who told a television news crew she had skipped breakfast to make sure she didn’t miss the cheap gas.) Canadian drivers had better get used to such stunts. The only safe bet for the future of gas is more price spikes, more lineups and more headaches at the pumps.

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