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Varcoe: Canadian producers lock in higher oil prices but keep spending plans unchanged amid Iran conflict

'These are very volatile events right now, shaping the price. So we're just locking it in — and if it goes higher, I'll lock in some more'

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Oil prices jumped Tuesday as the war in the Middle East disrupted shipping in the pivotal Strait of Hormuz, pushing crude prices above US$74 a barrel.

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Canadian oil producers, however, aren’t suddenly rushing out with plans to spend additional revenue.

But they’re not sitting on their hands, either.

“About a month-and-a-half ago, with $55 (oil), we were like ‘batten the hatches, tighten the belts,’ all that stuff. And now, with $77 that it hit this morning, (at) Surge, we’re hedging,” Paul Colborne, CEO of Calgary-based producer Surge Energy, said Tuesday.

“We put on some nice hedge positions to lock in our 2026 cash flows . . . These are very volatile events right now, shaping the price. So we’re just locking it in — and if it goes higher, I’ll lock in some more.”

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Since the U.S. and Israel launched air strikes on Iran on Saturday — and Tehran responded by attacked neighbouring Gulf states and energy infrastructure in the region — oil markets have moved higher, up sharply from markets that were below $58 a barrel to start the year.

West Texas Intermediate (WTI) crude closed Tuesday at US$74.56 a barrel, up $3.33 on the day — and topping $77 at one point — as attacks in the region escalated.

Iranian officials declared the strategic Strait of Hormuz, which touches Iran to the north and Oman to the south, is closed, insisting any ships that move through the waterway would be targeted and burned.

Bloomberg reported that Iraq has begun shutting in oil production at its largest fields because of the closure.

It’s estimated more than 20 million barrels of oil and products is transported through the waterway each day. That represents almost 30 per cent of the international seaborne crude trade, making it “the most critical oil choke point in the world” with limited options to bypass it, according to consultancy Rystad Energy.

“The loss of supply because of the closure of Strait of Hormuz is substantial, but the duration is still unknown, so we don’t know if this is going to have lingering market impacts,” Rystad senior vice-president Susan Bell said Tuesday in an interview.

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“The immediate impact is the markets are pricing in a sort of near-term supply shortage . . . Once the Strait of Hormuz is secured, that oil will start flowing. It will be costlier because of insurance premiums, and that’s going to linger.”

In Canada, the world’s fourth-largest oil producer, higher crude prices mean increased cash flow for petroleum producers. Many companies — along with analysts and the provincial government — were expecting oil prices to average around US$60 a barrel this year, due to global production exceeding demand, leading to rising inventory levels.

It’s too soon for companies to start changing their capital expenditure plans, but some are securing higher prices during this period through their hedging programs, said Brian Schmidt, CEO of Tamarack Valley Energy, a mid-sized oil producer in Western Canada.

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Hedging can involve selling oil at a fixed future price, which limits upside but reduces the risk for producers from fluctuating prices, while ensuring sufficient cash flow is in place for capital spending, debt and dividend payments.

“You put in hedges just to take out some of the volatility in the market, so you become a little bit more predictable,” said Schmidt, whose company hedged some production this week.

“Everyone in town is probably trying to figure out if they should lock in. I mean, it can go the other way, too. I’ve seen some reports saying oil is going to $90 or $100, so you’ve got to be careful.”

In last week’s budget, the province forecast oil prices will average $60.50 a barrel for the fiscal year starting in April. It expects oil and gas capital spending in Alberta will increase by four per cent to $33.5 billion.

Tamarack plans to spend about $400 million in capital expenditures this year, and was budgeting for WTI crude to average $60 a barrel.

Schmidt said higher oil prices will help the bottom line of companies, and some might allocate capital to projects that start production sooner, but he noted it often take months to secure rigs or get approvals for new developments — and stronger prices could have subsided by then.

“There are minor tweaks you can do, but nothing that’s going to be major,” he said.

Similarly, Colborne doesn’t anticipate bumping up his capital spending to bolster production in 2026. And he doesn’t expect oil prices will soar above $100 a barrel, noting some countries have built up strategic petroleum reserves to act as a buffer to short-term tightness in global markets.

“I don’t think you’re going to see a ramp-up in drilling . . . because what if it drops right back down?” he added.

“I don’t think anyone’s going to jump out and take risky steps.”

Economists say if strong prices persist, it will lead to higher pump prices for consumers and rising inflation.

ATB Financial chief economist Mark Parsons said Alberta will see “more gain than pain” from rising oil and gas prices, given the large effect the sector has on the province’s broader economy.

As for industry spending, Parsons noted similar price spikes have not translated into meaningful investment increases by Canadian producers in recent years, such as when oil surged above $100 a barrel following Russia’s invasion of Ukraine.

“Producer cash flows are going to improve, royalties are going to increase. The question is, does that money get spent into more drilling activity? And I think it does, but this will have to be more sustained,” Parsons said.

“For now, I think it’s more of a wait and see.”

Chris Varcoe is a Calgary Herald columnist.

cvarcoe@postmedia.com

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