The American oil boom and its impact on Canada

Sherry Cooper: What has been a boon for the U.S. oil-producing companies and regions is a negative for Canadian oil companies, which carry the burden of oil sands projects that have some of the highest costs per barrel in the world

Julia Schmalz/Bloomberg

By Dr. Sherry Cooper

Ironically, while many are focussing on the negative impact of high gasoline prices on the U.S. economy, oil production in the U.S. is surging, providing the largest stimulus to growth and job creation since the recession began in 2007. The fastest growing states are those with the highest exposure to energy, as exploration and drilling activity is fuelling a surge in growth. This new energy boom is the result of technological developments that have made the release of oil from shale rock not only feasible, but very profitable at oil prices around $100 or more a barrel.

Shale gas has been big energy news for several years as hydraulic fracturing has unlocked huge reserves of natural gas believed to be unreachable as recently as five years ago. This surge in natural gas supply is the primary reason for the plunge in gas prices.

Two years ago it was believed that oil molecules were too large to extract from shale. But now, new fracking technologies and horizontal drilling has led to the biggest oil boom in many years. After Russia, the U.S. has now become the largest non-OPEC crude oil producer in the world, followed by Canada.

But the infrastructure has not kept up with supply as there is a shortage of pipeline and refining capacity. Crude oil must be refined to produce gasoline and diesel. Getting the oil to the refineries is a problem and currently, refineries in the U.S. do not have the capacity to handle all of this oil. So gasoline prices remained tied to North Sea Brent crude prices, which have been pushed up by fears of Iranian oil disruption and geopolitical risk in the Middle East.

The surge in U.S. (and Canadian) production has held down the price of benchmark U.S. crude oil, West Texas intermediate (WTI), and forced Canadian producers to accept steeper than usual discounts on WTI prices. In response, at least one Canadian oil company temporarily shut down some production. What has been a boon for the U.S. oil-producing companies and regions is a negative for Canadian oil companies, which carry the burden of oil sands projects that have some of the highest costs per barrel in the world. This could also reduce price-based royalties so important to the budgets of Alberta and Saskatchewan.

To alleviate some of the infrastructure problems, an increasing volume of crude oil is now transported by railway and tanker trucks, boosting employment and activity in these industries, but the costs are far higher than pipeline transport.

Pipeline bottlenecks remain even as companies drive ahead with plans like TransCanada Corp.’s Keystone XL—at least temporarily delayed for political and environmental reasons—and Enbridge Inc.’s Northern Gateway project, which would deliver Alberta oil sands bitumen to the Pacific Rim market. The Northern Gateway has been in the planning stages for many years, fraught with environmental and political roadblocks. Clearly, with the U.S. becoming less dependent on Canadian oil, Canada has to broaden its customer base to include China, the second largest and fastest-growing consumer of oil.

Enbridge is also racing to expand its pipeline capacity in North Dakota, part of the Bakken oil region. Enbridge already has pipeline and rail loading facilities capable of moving 275,000 barrels per day from the region and says it’s looking to add even more pipeline space after 2013, amid forecasts that the Bakken alone will grow to more than one million barrels a day. It’s now at just over 500,000.

Broad-Based Economic Impact

The beneficiaries of this shale oil and gas boom are many and diversified both by region and by sector. With an estimated 3,000 new wells slated to be drilled in the next year, it is positive for job creation. Already, the depressed housing industry is stepping up production to house the growing number of oil workers and their families in states from Texas straight up to North Dakota, including Louisiana, West Virginia, Colorado, Montana and Wyoming.

Combined with the increasing availability and low price of natural gas, rising domestic oil production is providing a boon to U.S. construction and industrial production. The price of land in these regions has skyrocketed and many small landowners have pocketed huge leasing windfalls, even in places that were formerly considered waste land. Demand for sand, used in the fracking process, has also surged, boosting activity in regions like Nebraska and Wisconsin where sand mines are multiplying rapidly. Boom towns are sprouting up across these states and municipalities are struggling to create the infrastructure necessary to support their new households. Retailers, as well, benefit, as do bankers. Private-equity firms completed $24.8 billion of energy deals of all types last year, up from $8.5 billion in 2010, according to data tracker Preqin.

Manufacturing plants are returning to the U.S. to take advantage of cheap natural gas and relatively low unit labour costs, spurring major investments in petrochemical and steel production in the Gulf Coast, Midwest, and Northeast. Households are also benefiting from lower bills for heating and electricity because of cheap natural gas and more and more homes and businesses are switching from expensive heating oil to cheap natural gas. There is a growing demand for gas-powered electricity, and companies like Siemens are opening facilities in the U.S. to build turbines to generate electricity from natural gas. The U.S. trade balance is also supported by these developments.

End of Peak Oil Worries

This unexpected boom in oil supply puts to rest the so-called “Peak Oil” debate, where adherents to this theory argued that the supply of oil is fixed and dwindling, as traditional oil wells dry up. They argue that this would lead to much higher oil prices and reduced travel and transport. Some even suggested it would spell the end to globalization.

Not All Rosy

With this boom, there are a growing number of concerns. The environmental impacts, though uncertain, are troubling. Potential pollutants entering the air and water supply are of great concern. Drilling is disrupting communities, damaging roads, and increasing costs to local governments. Some are worried about the effect of drilling on earthquakes. Risk of a boom-bust phenomenon, so evident in many oil regions, is also real. Very low prices have already reduced drilling for natural gas, causing job losses and disruption to communities; but mostly, companies have shifted their resources from dry gas drilling to liquids-rich gas and oil drilling. In some regions, like parts of Texas, there are already water shortages exacerbated by the huge volumes of water needed for hydraulic fracking.

Bottom Line: The boom in shale oil drilling is just what the struggling U.S. economy needed. This, along with cheap shale gas, is providing enormous stimulus to many sectors and regions. The Canadian oil and gas industry must export oil to China and the rest of Asia to offset the negative impact of reduced U.S. oil demand going forward. Canadian pipeline companies and oil service companies will continue to benefit from the U.S. boom, and so will other Canadian exporters to the U.S. market. This energy boom is creating jobs and boosting income, assuring the U.S. economy continues to recover.

Dr. Sherry Cooper is Executive Vice President and Chief Economist, BMO Financial Group