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Market Watch: Petroleum

Tejas Amale
|Aug 5|magazine6 min read

Over the last year, perspectives on Canada's petroleum markets have shifted from uncontrolled exuberance to decidedly cautious but positive.

There are two big pieces of good news for Canadian petroleum: Production is rising and will continue to rise – perhaps rapidly – for the foreseeable future.

1. The Bakken Formation now appears to hold much larger reserves than previously anticipated, and advances in fracking technology make a larger portion of those recoverable than had been imaginable five years ago.

2. Continued development of tar sands deposits promises radical market expansion as well. Overall, Canadian oil production is expected to more than double by 2030.

At first, all that extra production looked like a black gold rush. Investors sobered up, however, as they watched global oil prices tank over the last year. In late 2014, the price of oil plunged below $50 per barrel for the first time since 2004. All that extra production from Canada, the United States and Russia functionally flooded the market just as demand growth started cooling off in China.

The current prices are artificially low, according to most experts. Many analysts expect oil to climb back over $70 a barrel by the end of 2015. Provided the price stabilizes, Canadian producers will be able to count on a healthy profit. If prices were to plummet again, however, some of the smaller producers could face serious cash flow problems. Future production growth would also decline if prices stay low.

Another factor counseling caution in the Canadian petroleum market are environmental objections. The tar sands projects remain controversial because the process of extracting and refining tar sand oil is much more polluting than conventional drilling. The industry has largely overcome domestic protests to tar sand extraction, but the environmental lobby successfully persuaded President Obama to veto construction of the Keystone XL pipeline. The pipeline isn't essential for Canadian petroleum's growth, but it's a worry sign. If the environmental movement gains more steam, it might pose a real challenge to profits.

Finally, Canadian oil will also have to compete with growing production from the United States. Most of the Bakken Formation is in North Dakota and available to U.S. petroleum countries. The U.S. has also expanded offshore drilling and, if the next president is a Republican, will likely increase drilling in Alaska, too. Since Middle Eastern production looks to be on the rise as well, it's possible demand will fall well short of supply and drive prices down further.

Overall, however, a few ugly splotches on the canvas shouldn't overwhelm the oil industry's rosy picture. Canada's natural oil wealth is larger than ever, and extraction efforts already in progress all but assure profitability.