Global commodity prices have increased in recent months. Oil prices have risen sharply. Interest rates in Canada and across the globe have risen. Commodity supply disruptions have affected shippers in the Western Hemisphere.
Supply disruptions and tightness in supply are likely to continue into 2019, especially in the oil markets. And a rise in interest rates in Canada, the United States and around the world are likely to impact returns for speculative investors holding energy commodity futures contracts, adding to supply disruptions and rising prices.
We now have a market for petroleum and bitumen in the United States with the Gulf Coast market being the primary destination. In the Western Hemisphere, the major buyer is the Canadian government, and its international pricing agency, the Canadian National Energy Board (CNBE).
Western Canadian Select (WCS) delivered to Alberta, Canada, trades at a discount of about $11 per barrel to the West Texas Intermediate (WTI) price that is often referenced as the U.S. crude price. WCS is a heavy, sour crude produced by a small amount of Western Canadian producers in the oil sands of Alberta. A significant portion of the market for WCS is in the United States.
Limited water-borne access to refineries in Alberta has resulted in a long refining process of WCS barrels. Very high sulfur content and maintenance issues have limited the amount of light sweet crude that can be added to WTI to produce a similar U.S. light sweet crude.
After crude oil is refined, it is separated into streams (varying thicknesses) and valued according to quality. WTI is a light, sweet crude that is more valuable than WCS to midstream oil companies.
Harvey-related disruptions have negatively impacted crude supplies. The increase in interest rates by the U.S. Federal Reserve this month (up four times in four months) also likely has negatively impacted the price of Canadian crude. All of these factors are likely to result in WCS increasing to reflect U.S. pricing, and a narrowing of spreads with WTI.
Other factors are also driving up the price of energy commodities. There is a shortage of labor in the world’s oil and gas industry, especially in the U.S. and Canada. This could impact the ability to meet ever-increasing demand.
Curtailments are a concern because they eliminate stable supply in the short term. These shortages generally result in a buildup of crude oil in storage tanks. When these large supplies are removed, prices should rise.
Despite these supply constraints, crude oil demand should continue to rise around the world. Moreover, the impact of rising interest rates could be negative for energy commodity prices.
A meaningful rise in interest rates could disincentivize future speculative investors from holding oil futures contracts. The change in potential yield on these contracts could also make them less attractive to investors.
So, is the Bank of Canada concerned? The bank takes these issues into account when considering its monetary policy decisions.
A rise in interest rates is a strong tightening of monetary policy, and the Bank of Canada sets interest rates to keep inflation consistent with a 2 percent target over the longer term. A strong inflation rate is not sustainable over the longer term if short-term interest rates are too low.
We anticipate that in coming months, with record-high prices for interest-bearing assets, a modest easing of monetary policy in Canada will be announced. Monetary policy interest rates in Canada will not rise as high as those in the United States or elsewhere in the world. Even the increases could prove modest. We therefore expect a further increase in the benchmark Bank of Canada interest rate of about 25 basis points, to a range of 1.75 percent to 2 percent.
Peter Hodson, CFA, is CEO of 5i Research Inc., an independent research network providing conflict-free advice to individual investors (www.5iresearch.ca).