How Canadian Markets Work

Canada is a participant in the global oil market in which buyers and sellers trade volumes, mostly on the basis of short-term contracts. It is this interaction that sets the world price of oil. Crude oil can be transported relatively easily by tanker, pipeline and truck to most major locations in the world. If prices rise in Asia, for example, sellers will divert crude oil from North America to the Asian market. As this happens, the supply available in North America would fall and prices would tend to rise. Although Canada is the eighth largest producer in the world, it produces only three percent of total daily production, according to 2006 statistics, so it does not influence the world price of oil. Therefore, Canada is a price taker, rather than a price setter.

The price of crude oil is most commonly quoted in $US per barrel since the U.S. is the world's largest market for crude oil. Traditionally, the U.S. has been Canada's main export market and, usually, Canadian crude oil is priced relative to the crude oil benchmark West Texas Intermediate (WTI), at Cushing, Oklahoma. Figure 1 shows that WTI crude oil prices have been extremely volatile in recent years. In 1998, oil prices fell sharply as the world was experiencing a glut of crude oil. Prices fell to levels not seen since 1986. In response, the Organization of Petroleum Exporting Countries (OPEC), comprised of nations that are responsible for about 40 percent of global daily oil production, reduced production drastically in early 1999, forcing inventories down sharply. As a result, prices were much higher by late 1999. Beginning in 2002, a huge increase in worldwide demand, particularly in China, combined with a series of geopolitical events that had an effect on global oil supplies, contributed to a rapid rise in crude oil prices.

Notably, in March 2003, the U.S. invaded Iraq, the country with the world's fourth largest crude oil reserves. In a global oil market, disruption to supplies in one region will be reflected in crude oil prices worldwide. In September 2004, Hurricane Ivan struck the U.S. Gulf Coast and resulted in a substantial loss of crude oil production in the U.S. During August and September 2005, Hurricanes Katrina and Rita also wreaked havoc on the U.S. crude oil industry.

WTI reached a record high of US$147.27 per barrel on 11 July 2008.

On 18 November 2007, Equador officially joined OPEC, increasing the membership to 12 oil producing nations. OPEC will always have significant influence in the world markets but Canada has also gained some world recognition in recent years due to its oil sands resources. As rapid development of the oil sands resources continues, Canada will play a larger role in influencing world crude oil market dynamics.

Figure 1 - West Texas Intermediate Crude Oil Market Timeline

Source: NEB

Figure 2 shows the price for Canada's two major benchmark crude oils: Western Canada Select (WCS, heavy) and Edmonton Par (light, similar in quality to WTI). The prices for these crude oils are primarily based in the U.S. upper Midwest market, adjusted for quality and transportation costs from one of the two major Alberta hubs, Hardisty or Edmonton. The Midwest is the largest U.S. market for Canadian crude oil.

Figure 2 - Canadian Benchmark Crude Oil Prices

Source: NEB
Note: Effective June 2005, WCS replaced Bow-River at Hardisty.

All crude oil is not valued equally. Light oil that is low in sulphur (sweet) is more valuable to refiners than heavy oil with higher sulphur content (sour). Canadian producers market a wide range of crude oils, ranging from heavy sour bitumen blends from Alberta's oil sands to pentanes plus (C5+) primarily obtained from natural gas. The difference in value between light and heavy oil (the differential) is primarily determined in the market for each type. In general, a widening of the differential leads to poorer profitability for Canadian heavy oil producers.