An Excerpt from the Quarterly Report of Petroleum Pricing in Canada, Quarter 1 2020:
A Canadian Perspective on Petroleum Markets amid COVID-19
Canadian petroleum prices experienced an unprecedented decline in the first quarter of 2020. Canadian average wholesale gasoline and diesel prices decreased 55.9 percent and 36.2 percent, respectively, from the end of the previous quarter. Based on an average of select American cities bordering Canada, U.S. wholesale gasoline and diesel prices show a similar decrease during the first quarter of 2020, declining 64.3 percent and 38.4 percent, respectively. Figure 4 illustrates that wholesale prices between Canada and the U.S. closely followed each other as borders between Canada and the U.S remain open for trade during the pandemic.
By the end of the first quarter, the Canada average gasoline pump price reached a low of 77.7 per litre, down 41.2 cents from the end of the previous quarter. Most of the decrease was attributable to lower refining margins for gasoline (down 7.6 cents per litre) and lower crude prices (down 31.7 cents per litre). Refining margins for diesel fuel were marginally higher by the end of the quarter, however, up 0.2 cents per litre. The majority of the decline in diesel prices over the quarter (down 29.9 cents per litre) was, therefore, attributable to declining crude prices.
Figure 5 shows that crude oil benchmark prices dropped significantly over the last quarter, with a sharp decline in March. Both West Texas intermediate (WTI), a U.S. crude benchmark for conventional light oil, and Western Canadian Select (WCS), a heavy crude blend produced in Canada, reached lows in March never experienced in the last twenty years. In late March, Brent crude dropped to its lowest price since September 2003. Brent is a global crude oil benchmark, and is used significantly in eastern Canadian refineries.
In 2019, Canada exported nearly 218 million cubic metres of crude and refined petroleum, valued at approximately 90.3 billion Canadian dollars (Canadian International Merchandise Trade Database). 91.5 percent of those exports went to the U.S. There has been a negative impact on Canada’s balance of trade with the U.S. with the sharp drop in the price of these exports, and a consequent decline in the dollar’s value against the U.S. dollar. The weak dollar will likely remain so until Canadian crude and refined product prices recover.
As Figure 4 shows, Canadian petroleum prices follow American prices when adjusted for exchange rates: when not adjusted, Canadian wholesale petroleum prices have not fallen as much as U.S. prices. In March, the value of the Canadian dollar has fallen from 74.9 to 70.5 Canadian cents per the U.S. dollar. Without the devaluation of the Canadian dollar in March, wholesale gasoline prices would have been approximately nearly 3 cents per litre lower, and diesel would have been just over four cents lower.
Is COVID-19 to blame for the significant drop in crude prices experienced around the world? The answer is partially yes. A substantial decrease in the demand for petroleum products has led to a significant increase in crude oil inventories. Refiners have reacted by reducing crude runs and shifting yields to favour diesel production, whose demand has not fallen as sharply as gasoline and jet fuel. Lower refining activity leads to greater crude inventories. Canada is no exception: Canadian crude runs fell to 69.9 percent of refinery capacity by the end of March, down from nearly 90 percent near the beginning of the month (Canadian Energy Regulator). As well, the North Atlantic refinery in Newfoundland was the first North American refinery to close upon lower demand as a result of COVID-19. There will likely be further production cuts while demand remains low, not only in Canada but around the world.
Drastically reduced demand from COVID-19 was only one reason why crude prices have decreased: increased supply of crude into global markets further added to a surge in inventories. As COVID-19 was first discovered and spread in January and February, crude prices decreased. But crude prices began a sharper decrease in early March following a meeting by the Organization of the Petroleum Exporting Countries (OPEC) and a group of 11 non-OPEC countries (led by the Russian Federation) who failed to agree to further crude production cuts in response to COVID-19. The group, referred to as OPEC+, had been collaborating since December 2016 to set crude production limits following a crude price collapse in 2015. That downturn was related to a crude supply glut resulting from increased U.S. crude shale production.
Without an agreement reached in March, April crude production was expected to increase by as much as four million barrels per day. Refer to Figure 6 for total crude production share by select countries in 2019 when total world crude oil production was 82.3 million barrels per day. With crude prices falling to multi-year lows, OPEC+ met again on April 12th, and this time agreed to crude production limits. Production limits are set to begin in May at 9.7 million barrels a day, much more than the 1.5 million barrel a day cut proposed in the initial meeting in March.
Is it enough to balance crude oil markets? According to the U.S. Energy Information Administration’s (EIA’s) latest Short Term Energy Outlook (STEO) in April, total world petroleum consumption in March was over 12 million barrels a day less than it was at the end of 2019 and could fall a further 6 million barrels a day in April, see Figure 7. In all likelihood, crude oil markets will remain unbalanced for the remainder of the year.
So what does this mean for Canadian petroleum prices? If crude prices remain depressed, Canadian and U.S. oil production will likely decline upon lower investment. This will aid with OPEC+ crude oil production cuts, set to remain in place until the spring of 2022 (although at lower levels) in rebalancing the market. It is unclear how long the COVID-19 virus will keep economies shut down and with that, the demand for petroleum products to remain low. As long as crude prices and demand remain lower, Canadian finished petroleum prices will also remain low. We are living in unprecedented times, and many lessons can be learned from this pandemic to avoid future extreme market imbalances and a price collapse such as that experienced this past quarter.
© 2020 Kent Group Ltd
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