Any oil executive in Calgary will tell you that predicting the price of oil is a mug's game. Not only is it difficult to do, it’s also beyond the scope of dozens of factors way beyond anyone’s control. The common maxim — because we’re not part of cartel — is that we’re ‘price takers, not price makers.’ .As an oil company — or government — the only thing you can really control are costs and hope the revenues are sufficient both to cover them and provide enough to reinvest in your main assets. It all falls under a broad umbrella of what C-suite execs call ‘risk management’ and due diligence. Which is all the more important when you’re playing with investors’ money. .The same can be said for the Government of Alberta, which is the de facto largest oil company in the country..For far too many years, successive governments have paid too little attention to the revenue side of the ledger, either highballing — or alternatively lowballing — oil price estimates for political purposes to justify either wasteful spending or massive spending cuts. The dangers of overestimating are obvious, but underestimating can be harmful as well, leading to real opportunity costs when the next bust inevitably comes around. As much as I loved former Premier Ralph Klein, “Ralph Bucks” were an unmitigated disaster. The worst part was that we all knew better, even then. Hindsight isn’t always 20/20. Successive governments have been playing catchup ever since..That’s why I was somewhat impressed (and relieved) to see some realistic resource estimates in finance minister Travis Toews‘ 2023 budget. My impression is that they strike a right balance of optimism and caution that allows the UCP government to move ahead with targeted spending, debt repayment and Heritage Fund contributions while preserving some upside in the event of another windfall boom. .Frankly, I didn’t feel the same way last year and though it’s crass to say it, Toews has Vladimir Putin to thank for his latest bout of good fortune. In business parlance, that’s called a Black Swan event..The province is expecting resource revenue to decline $9.2 billion this year — essentially the entire surplus for 2022 — which may or may not pan out depending on all those geopolitical factors beyond our control. .At this point we’re a bit in the red. The province is forecasting West Texas Intermediate to average $79US this year — WTI was trading a bit north of $76 this morning — and each dollar up or down is worth about $230 million to the treasury. Which means we’re down almost $700 million only a day in. That’s why oil is risky business..My gut instinct tells me that the province’s longer term estimates may also prove to be somewhat on the low side but after checking the futures curves, WTI is in fairly steep backwardation over the next year so Toews is in line with Wall Street..Keep in mind that 70% of the province’s oil revenues come from raw bitumen sales — not light oil — which trades at a discount to WTI. It’s counterintuitive, but this arbitrage or Western Canadian Select ‘differential’ has more of an impact on how much the government receives in royalties than the actual benchmark WTI price. Last year it was about $20US a barrel, which is par for the course. It speaks to a lack of pipeline takeaway capacity to our largest export market, the US. In 2024 and 2025 the province is forecasting the differential to narrow to about $16.80 and $16.40, respectively, which seems a tad optimistic. It’s usually about 25-30% of WTI and have been as high as 50%. I’ve rarely seen it less than $20 in absolute terms no matter what US oil trades for..And given that Canadian oil is priced in US greenbacks but sold in Canadian dollarettes, currency exchange fluctuations also play an outsized role. A lower Canadian dollar in fact increases price realizations, offsetting the differential. The province is expecting the Canadian dollar to average about 80 cents US by 2025 which also accounts for some of those lower revenue projections..One thing I was looking for — but couldn’t seem to dig up (yet) — is the contributions of the oil sands mines, which are collectively churning out nearly 1 million barrels per day (bpd). As you may or may not recall, operators were granted a 1% royalty before payout after deducting capital costs for new construction under a joint deal between former Prime Minister Jean Chrétien and Ralph Klein. .That was subsequently increased to 10% under former Premier Rachel Notley’s royalty review but it’s still not clear if and when the mines will move to the higher 30% rate. Given that synthetic crude actually trades at a premium to WTI — and the fact that there won’t be any future expansion given looming emissions caps — those lower estimates after 2025 may prove to be low..That said, it’s better to err on the side of caution, especially with so many moving parts in such a volatile industry. As Albertans, we are after all the owners of this fabulous resource and it’s a collective responsibility to manage it wisely. Or as Toews alluded in his budget address Tuesday, not — to use the less than parliamentary term — whizz it all away this time.
