The Fuse

Canadian Wildfires Knock Off 1 mbd of Supply, Fail to Ignite Oil Prices

by Nick Cunningham | May 10, 2016

Horrific wildfires spread across Alberta, Canada last week, burning neighborhoods and sending thick black plumes of smoke into sky. The disaster, which is still unfolding, forced the evacuation of the entire population of Fort McMurray, a city with 80,000 residents that is situated near many of Canada’s largest oil sands projects.

The evacuation meant that the entire oil industry’s workforce in the region also had to flee, forcing several major oil sands producers to throttle back production. A handful of oil companies shut down almost a dozen major sources of production, causing global oil markets to suddenly lose about 1 million barrels per day (mbd) of production. Oil supply outages of that size have historically led to a strong reaction from the markets, with price spikes of several dollars per barrel typically seen immediately. WTI and Brent did gain ground as the fires broke out, but have retraced their gains as the disruptions are expected to be temporary and the realities of market fundamentals sunk in.

Fires lead to huge supply disruptions

The Canadian wildfires engulfed parts of Fort McMurray, which is the largest city near the vast oil sands operations in northern Canada. The city is so characterized by the oil industry and the high salaries bestowed on its legions of oil workers that it has earned the nickname “Fort McMoney.” But with those workers forced to flee the city in the first week of May, oil sands companies had no choice but to shut down facilities.

By May 6, the Alberta government said that there was “high potential” that the wildfires could double in size to 2,000 square kilometers. “There is no amount of resources we are going to be able to put on this fire that can hold it,” Chad Morrison, a senior wildfire manager for the Alberta government, said at a press conference. The financial losses from damage and lost oil production could reach CAD$9.4 billion (USD$7.3 billion). It could also reduce Canada’s GDP by 0.5 percent in May, according to RBC Economics Research.

The combined outages have reached about 1 mbd, which represents about one third of Canada’s entire output.

Suncor Energy announced on May 4 that it was reducing production at all of its oil sands facilities in the surrounding area. The Canadian company accounts for the largest losses, shutting in more than .5 mbd of output. But it was not alone. Royal Dutch Shell’s Canadian unit shut down its Albian Sands operations, which consists of two mines that produce about 255,000 barrels per day. Syncrude said that it shut down production at both its Aurora and Mildred Lake sites, affecting roughly 350,000 barrels per day. Husky Energy saw 60,000 barrels per day disrupted and Nexen Energy shut down 25,000 barrels per day at its Long Lake facility. Maclean’s has a nice rundown of all the outages in the region.

The combined outages have reached about 1 mbd, which represents about one third of Canada’s entire output. “When we’re talking about a potential shutdown of up to a million barrels per day, that’s very serious business for the global oil market if it persists,” the chief economist of BMO Capital Markets, Douglas Porter, said on March 6, according to The Financial Post.

However, few expect the supply outages to persist. Goldman Sachs said that so far the only damage to mines or oil-producing sites occurred at Nexen Energy’s Long Lake facility, which suffered only minor damage. Oil companies have taken such a large volume of supply offline out of precaution, as well as because of the need to evacuate personnel, but not because fires have damaged their assets.

The lack of material damage to oil facilities themselves should allow for the quick return of supply to the market. The fall in production is likely to be temporary, but “uncertainty on when the fires will have dissipated enough and on the required time to bring production to ramp up remains high,” Goldman Sachs wrote in a May 9 research note.

There could also be a delay in returning oil workers to the job once they are given access. Based on the interruptions from wildfires at sites operated by Canadian Natural Resources and Cenovus in 2015, it could take at around 10 days to restore output. Goldman Sachs says that if this is the case, Canada’s oil industry may lose 14 million barrels of production in total, assuming an outage of 645,000 barrels per day on average for three weeks. “While significant, such a disruption would have an only limited impact on overall North American crude inventories, as U.S. stocks of 543 million barrels are near record highs and 60 mb above last year’s level,” Goldman Sachs concluded. Also, the weather has improved in recent days, with rain and cooler temperatures reducing fears of the fire continuing to spread at a rapid rate.

Still, the wildfires in Alberta have not been extinguished and if “the fires intensify or migrate towards the producing/pipeline/tank capacities, the length of the disruption could end up significantly larger than we assumed,” Goldman cautioned.

Global overproduction continues

Combined with the ongoing outages in Nigeria, Iraq, Libya, and Colombia in recent weeks and months—a total that Goldman says average between .5 and 1.0 mbd since mid-March—the oil supply overhang has all but vanished

The International Energy Agency estimated in its April Oil Market Report that global crude oil production would remain oversupplied in the first half of 2016 by about 1.5 mbd. In that context, the Canadian wildfire erased two-thirds of that surplus in an instant. Combined with the ongoing outages in Nigeria, Iraq, Libya, and Colombia in recent weeks and months—a total that Goldman says average between .5 and 1.0 mbd since mid-March—the oil supply overhang has all but vanished. It unusual, although far from unprecedented, that oil markets are hit with sudden supply disruptions of this magnitude.

But, of course, nobody expects these outages to be long-lasting. Canada, which represents the largest loss of production on that list, is the most likely to restore output in the short-term. As a result, while the disruption from the wildfires has taken some supply off the market, a stronger effect on prices will come from the gradual but more durable losses taking place around the world because of a drop off in drilling.

Recognizing this reality, oil prices lost ground on May 9 after early gains. WTI fell by $1.22 to $43.44 per barrel, or a 2.73 percent decline, and Brent fell by 4.21 percent to $43.46. Oil traders looked passed the fires and took other issues into consideration—crude oil inventories sit at record levels, oil speculators have pushed up prices by quite a lot already in recent weeks, and supply continues to outstrip demand. Canada’s wildfires probably won’t have a huge impact on these fundamentals.