Economic insights provided by Alberta Central Chief Economist Charles St-Arnaud.
Key takeaways:
- The expanded TransMountain Pipeline (TMX) is already showing significant benefits to the oil sector, six months after its completion.
- The increase in market access has been significant, with non-US oil exports more than doubling in the second half of 2024 and greater deliveries to the US West Coast.
- As a result, the price differential between Western Canada Select (WCS) and West Texas Intermediate (WTI) narrowed significantly in late 2024, by about $US8 per barrel – much lower than historical gaps.
- We estimate that this narrower oil spread increased oil revenues in 2024 by about US$7bn since the opening of TMX; this is about $10bn Canadian or adding a thirteenth month of production to the year.
- However, US import tariffs may reverse this trend, as they are likely to lead to a widening in the oil spread. This means US consumers are unlikely to see the full extent of the tariffs reflected in higher prices at the pump, and that Canadian producers will absorb part of the tariffs.
- Nevertheless, the impact in the US will be more acutely felt in regions where the reliance on Canadian oil is higher (Midwest) and much less in regions where it is lower (Gulf Coast).
- With oil having a smaller economic multiplier in recent years (see), the impact on Alberta’s economy is unlikely to lead to a bust in the oil sector. The impact will likely result primarily from lower revenues for oil producers rather than lower production. However, lower oil revenues will lead to weaker oil and gas royalties for the Government of Alberta and could push the province into a deficit.
- Premier Smith has voiced her opposition to using oil exports to retaliate against the US, likely partly because of the fiscal impact of such a move, with the Government of Alberta benefiting more directly from exports to the US than to other provinces.
- We believe that an export tax on oil with revenues returned to the province could mitigate some of the impact of retaliation and would be less negative for Alberta than export curtailment.
- Nevertheless, other aspects must be considered when deciding whether to retaliate against US tariffs, such as negotiation tactics, impact on the national economy, etc.
A valuable TMX expansion
After years of delays, the expanded TransMountain pipeline (TMX) finally started operations in May 2024. With a new capacity of about 890,000 barrels per day, almost three times its original capacity, the expanded TMX will significantly increase Canada’s oil export capacity and allow Canadian oil production to continue to grow.
Another benefit of the TMX expansion is increased market access to new destinations for oil exports, reducing Canada’s reliance on the US as its main market. Since the start of operations on the expanded TMX, we have seen a sharp increase in non-US oil exports, rising from about 2.5% of total exports to about 6.5% (Fig 1) — a significant shift.
This increase in diversification both internationally and within the US has led to an important benefit for Canada: a narrowing of the spread between Western Canada Select (WCS) and West Texas Intermediate (WTI) and a lack of seasonal widening.
WCS normally trades at a discount against the WTI because of a difference in the type of oil (heavy and sour vs light sweet) and the associated higher refining costs. The expected spread should be between $10 and $15 a barrel. However, over the past 15 years, the spread between WCS and WTI has often been much wider than justified by the difference in the type of oil. The main reason for the historically wider spread is a lack of infrastructure allowing oil to flow where it is needed, leading to oversupply situations.
WCS normally trades at a discount against the WTI because of a difference in the type of oil (heavy and sour vs light sweet) and the associated higher refining costs. The expected spread should be between $10 and $15 a barrel. However, over the past 15 years, the spread between WCS and WTI has often been much wider than justified by the difference in the type of oil. The main reason for the historically wider spread is a lack of infrastructure allowing oil to flow where it is needed, meaning that it often gets oversupplied.
The best illustration of this has been the seasonal widening of the spread in the fall, before narrowing toward more “normal” levels as the new year starts. This phenomenon is due to a seasonal reduction in demand by US refineries due to changes in gasoline grade and maintenance, while oil production in Alberta remains elevated. This lower demand while supply remains strong pushes WCS lower relative to WTI.
Since 2010, the average WCS-WTI spread has been about US$17 a barrel. However, the range of the differential has been wide, from as low as US$3 during the pandemic to as wide as US$43 in October 2018, just before the Alberta government announced an oil production curtailment to narrow the spread.
Looking at 2024, the WCS-WTI differential has been about US$14.5 on average, only slightly lower than its historical average. However, as a clear sign that TMX is already delivering its expected impact, the oil price spread did not experience its usual seasonal widening last fall; instead, it narrowed slightly due to the increased oil flow to Canada’s West Coast.
Since the opening of the expanded TMX pipeline in May 2024, the WCS-WTI spread has been about US$8 narrower than it was in 2022 and 2023, with a peak of about US$15.5 in October.
Assuming oil production in Alberta increased in line with its historical average in November and December 2024, we estimate that the reduction in the oil discount led to greater TMX oil revenues by about US$7bn. If we include the depreciation of the Canadian dollar in the second half of 2024, the extra revenues, thanks to TMX, reached about C$10bn. This estimate does not consider greater oil production enabled by the greater export capacity that TMX provides. As a reference, we estimate that the total value of oil produced in 2024 reached about US$90bn or about C$123bn.
The threat of tariffs and oil
President-elect Donald Trump will take office on Monday, January 20th. Many observers wonder whether he will immediately impose 25% tariffs on imports from Canada, whether these tariffs will be gradually phased in, and whether energy imports will be exempted.
The impact of import tariffs would be significant on both sides of the border. There are many factors that need to be considered with respect to the impact of tariffs. One such consideration is whether there are potential substitutions; how easy would it be for the US to source its oil elsewhere or for Canada to ship its oil to another country? Here are some important statistics that are worth considering:
- About 45% of the oil used by refineries in the US is imported, which is the lowest share since the mid-1980s. Nevertheless, oil imports from Canada represent about 25% of refined oil in the US, the highest proportion on record.
- Regionally, imports from Canada represent about 12% of refined oil in the US East Coast (PADD1), 68% in the Midwest (PADD2), 7% on the Gulf Coast (PADD3), 42% in the Rocky Mountain region (PADD4), and 17% on the West Coast (PADD5).
- Canada exports about 90% of its oil production, with approximately 83% of Canada’s output exported to the US. While the TMX expansion helped to diversify Canada’s oil exports, the reliance on the US remains elevated.
In the case of the US, at least in the short term, it would be challenging to source its current oil consumption from Canada (about 25% of its consumption) from local production or import from another country. Moreover, some regions of the US could face significant oil shortages, especially the Midwest, where Canadian oil feeds almost 70% of refinery needs; this would likely lead to a scarcity in gasoline and other refined products. However, other regions could continue to operate, especially the Gulf Coast, with only marginal disruption. The question is whether refineries in less affected areas could increase refining and compensate for lost refining output in other regions. There is also a concern that the US could seek new sources of oil, such as Venezuela, an alternate producer of heavy crude.
In the case of Canada, with about 80% of its production flowing to the US, there are few alternatives to the US market due to a lack of infrastructure; consequently, it would take years to develop such infrastructures. This means that any reduction in US oil imports will pressure Canadian producers to reduce output.
An oft-forgotten topic regarding the economic impact of tariffs is who will ultimately bear its costs. Due to thin profit margins for manufacturing goods, importers usually pass the extra costs onto consumers. However, for Canadian oil exporters, Canada has more to lose from import tariffs on oil than the US. As a result, Canadian oil producers have a strong incentive to absorb some of the costs from import tariffs by lowering their selling price, leading to a widening of the WCS-WTI spread.
Ultimately, tariffs would be negative on both sides of the border. Nevertheless, the increase in gasoline prices in the US is likely to be less consequential than the actual tariffs because of the lower WCS price and the widening of the oil price spread. Hence, US consumers are unlikely to fully pay for the tariffs via higher gasoline prices, as some suggest.
In Canada, the impact will be mostly felt through a decline in oil revenues and lower profitability for oil producers. However, as we have seen during the pandemic, the economics of the oil sands sector, with its steep upfront costs, means that Canadian oil producers remain profitable even at low oil prices. Moreover, as we have shown in the past (see), the economic multiplier from the oil sector in Alberta has been much smaller over the past decade than in the early 2010s. As such, the lack of boom in recent years when oil reached more than $100 a barrel means that a negative shock to the oil industry is unlikely to generate a bust that would plunge the Alberta economy into a recession.
Nevertheless, a drop in the province’s oil value would significantly reduce fiscal revenues. Royalties on oil and gas production, at about $20bn, represent about 25% of government spending. A reduction in royalties would push the province into deficit. Additionally, a weaker exchange rate would provide further support to oil revenues once USD revenues are converted into CAD, providing some buffer against the negative impact of the tariffs.
Export curtailment vs export tariffs and Premier Smith’s opposition
After the First Minister’s meeting, Premier Smith made it clear that she opposes the use of oil exports to retaliate against the US imposing tariffs on imports from Canada. Her opposition is understandable given the impact any reduction in oil exports would have on Alberta’s economy and public finances, likely pushing the province into a potentially large deficit, as mentioned previously.
The situation in Alberta is much different than in Ontario because the province benefits directly from greater export revenues. In contrast, Ontario’s benefits are more indirect and linked to the jobs in the sector and taxes related to this income. Alberta’s situation is more similar to Quebec’s, where the province benefits directly from Hydro-Quebec’s electricity exports. It is estimated that about 22% of Hydro-Quebec’s net income comes from electricity sold to the US. A quick estimate suggests that electricity exports to the US generated about $0.5bn in fiscal revenue for the province. Nevertheless, it is a small proportion of $150bn of fiscal revenues.
Similarly, the oil sector is a greater share of the Alberta economy, at about 20% of GDP, compared with the manufacturing sector in Ontario, at 11% of GDP, and electricity generation in Québec at slightly less than 3% of GDP.
However, some retaliatory options could potentially soften the blow to Alberta. A curtailment of oil exports to the US would have the biggest negative impact on Alberta. This is because the reduction in export volume would likely lead to a sizeable reduction in production. A narrowing in the WCS-WTI would unlikely compensate for the economic impact of a lower production spread that would likely result from lower oil supply.
We believe that imposing an export tax on oil would be a less harmful retaliatory option. However, there is a twist. The revenues of such tax should be returned to Alberta to compensate for the loss in fiscal revenues due to weaker royalties. Doing so could ensure that US consumers pay a greater share of the US import tariffs at the pump while minimizing the impact of a reduction in revenues on the province.
Of course, any retaliation could push the US to look for cheaper alternatives to oil from Canada and could have long-term negative impacts on the Canadian energy sector.
Nevertheless, other aspects must be considered when deciding whether to retaliate against US tariffs, such as negotiation tactics, impact on the national economy, etc. The decision should be based on the best response for the country, not individual provinces.
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Independent Opinion
The views and opinions expressed in this publication are solely and independently those of the author and do not necessarily reflect the views and opinions of any organization or person in any way affiliated with the author including, without limitation, any current or past employers of the author. While reasonable effort was taken to ensure the information and analysis in this publication is accurate, it has been prepared solely for general informational purposes. There are no warranties or representations being provided with respect to the accuracy and completeness of the content in this publication. Nothing in this publication should be construed as providing professional advice on the matters discussed. The author does not assume any liability arising from any form of reliance on this publication.