The Sky is Falling—Again
Oil Price: Biggest Factor Affecting the Industry
The slumping oil price is the talk of the industry. From field hands and technical teams getting laid off to slowing down of projects until 2016 or later, the oil price is affecting many in the industry. The Way Ahead Forum section editors sat down with stakeholders from different sections of the industry to get a better picture of what the recent oil price changes mean to business.
What would you define as “low” in oil prices?
Euan Mearns (EM): This is a good question. The best answer I can suggest is that the price is low when it falls below the level where companies can make a profit. The corollary would be that the price is high when companies make large windfall profits. Since different companies and states have different operating costs and these operating costs vary with time, there is no unique definition. But I believe at USD 50/bbl few, if any, companies are making a profit, hence we may safely assume that USD 50/bbl is low.
Jared Wynveen (JW): Generally speaking, I think a low oil price is one in which we can no longer sustain continued development and expansion of our resources. Depending on the play, low pricing might be anywhere from USD 40/bbl (WTI) to USD 80/bbl, but ultimately it all depends on the specifics of the operator, the reservoir, and the product quality.
James Fann (JF): Energy prices have always historically moved in cycles. Instead of thinking of a low oil price as an absolute number, for Canadian energy producers, I would suggest a low oil price would be one such as to slow down and potentially stop the development of new projects or expansions that would increase the oil supply. This price would cause supply to either decrease or remain flat.
Have you seen ups and downs in price in the past? How has it affected your business?
EM: In 1998, the oil price fell below USD 10/bbl. I was running a small geochemistry company at the time and it was incredibly hard. I had to lay off 10% of my staff and cut costs to the bone. We survived, but for a number of years found it hard to make a profit. One thing the industry should anticipate is a delay between the price going back up and increased activity that may lag price by a year or 2.
JW: Although I have only been in the industry since 2006, McDaniel has been around since 1955 and has been through many commodity cycles. We are happy to say that after all those cycles we are still here, but similar to any other service company in town, downturns in commodity pricing have a big impact on the success of our business. To that end, even though we do not produce oil or gas, we are nevertheless inextricably connected to the broader market cycles.
JF: The oil and gas business typically moves in cycles and does change its level of investment in future projects depending on a company’s long-term outlook on prices, and its financial position. This is reflective of past trends and certainly current trends.
What do you think will be the local, national, and global effect of low oil prices?
EM: In Aberdeen, where I live, companies are already laying off thousands of workers. This applies equally to the operating companies and service industries. As the economic impact of this on the local economy is felt, local businesses will experience a downturn and the price of property will likely fall.
The North Sea is now a very mature offshore province and the record high investment levels of recent years will dry up. It is to be expected that future production will be lower than it might have been. The UK will inevitably become more reliant on imported oil and gas. Elsewhere in the UK, consumers will celebrate lower energy prices for a while, and the overall impact on the UK economy will likely be positive.
At the global level, those countries that are net importers of oil and gas will benefit from lower prices but the exporting countries, many of which are heavily dependent on revenues from oil and gas, will experience extreme economic hardship. This can have a destabilizing effect in certain countries like Russia, Iran, Algeria, Nigeria, and Venezuela. It is a bad thing for international security to have these countries destabilized.
JF: Low oil prices translate into lower-cost transportation fuels, which have typically led to a benefit for other parts of the Canadian and global economies. However, the energy industry is a huge part of Canada’s economy, creating thousands of jobs and providing billions of dollars in economic stimulus, as well as taxes and royalties to support government spending. When oil prices are low for an extended period of time, it has a negative impact on the economy.
What are your views on oil prices in 2015?
EM: The oil price is low for three reasons. Weak demand stemming from a slowing of growth in the world economy, oversupply of expensive oil coming mainly from the US and Canada, and the fact that Saudi Arabia has relinquished its role as a global swing producer. The low price will stimulate demand and will result in global production capacity falling and these two processes combined may be expected to result in a strong price recovery at some point in the future. Calling the timing of this recovery is incredibly difficult. The oversupply issue has momentum and it is not going to rectify itself quickly. Hence, I believe 2015 will be a difficult year and the oil price may stay below USD 60/bbl till the end of the year. I believe we will see a strong recovery toward USD 100/bbl in 2016.
JF: Lower oil prices result in lower cash flow, which places pressure on capital spending. However, lower prices also create opportunities to execute our current capital programs with better efficiencies and reduce some of the inflationary pressures we have seen in a higher-priced environment.
This industry is very resilient and innovates when prices are low, so I would expect that in the long term, a lower-price environment could lead to a fundamental shift in technology in the higher-cost plays.
Do you feel that the low prices will be sustained?
EM: The marginal barrels of oil that the world is dependent upon are expensive to produce compared with the easy oil from supergiant fields that are becoming a thing of the past. The world will have to either adjust to having sufficient oil to meet its needs and pay this higher price or it will have to adapt to lesser amounts of oil. My hunch is that we would rather pay the higher price and I do not, therefore, believe the low price will be sustained.
JW: Long term, I don’t think lower prices will be sustained. I think over time, the market will find a new balance as high-cost producers drop off capacity and consumers pick up demand. There is no better cure for low oil prices like low oil prices.
JF: In various industry reports, the marginal break-even price of oil including a return on capital has been estimated to be in the USD 60/bbl to USD 75/bbl range.
Prices below that level would slow down production growth, impacting the supply side of the supply/demand balance, which should cause prices to rise again. Oil prices move cyclically, so pricing in general will not likely stay constant at any level over longer periods of time.
What can make the oil prices go back up?
EM: On the economic front, supply must fall and demand must rise. Supply has become inelastic and price is therefore very sensitive to small movements in either supply or demand. As a simple rule of thumb, a 2-million B/D swing in supply/demand translates to a USD 40/bbl swing in price. Without market intervention, volatility will rule.
However, I believe this issue may be settled by events. For example, the Organization of the Petroleum Exporting Countries may decide to reverse the current policy in its June meeting. Or conflict in the Gulf countries may lead to supply disruption.
JF: Oil and gas prices are a function of supply and demand. For prices to change direction from going down to up, either supply has to be reduced, or demand needs to increase.
How resilient is your business to lower oil and gas prices? What is the break-even oil price for your company?
JW: Given that many oil and gas companies require external reserves evaluations for corporate filing purposes, a certain percentage of our business is less affected by oil price volatility than many other service companies in Calgary. That being said, advisory work, reservoir studies, and other nonessential evaluations are heavily impacted when commodity prices are distressed.
JF: Cenovus is in a relatively strong position compared to our peers as we continue to focus on reducing our cost structures. We have a strong balance sheet and a good commodity hedging position, which will help us during this low cycle in oil prices and allow us to potentially take advantage of opportunities during this time.
The break-even price for oil varies depending on the asset. We use a WTI supply cost to describe the oil price required to earn a cost of capital return on our projects. The supply costs for our operating oil sands assets Foster Creek and Christina Lake projects are in the range of USD 40/bbl to USD 45/bbl WTI, including a 9% return on investment.
Is your business more affected by lower oil price or lower natural gas price?
JF: In 2015, we have a good hedging position which helps mitigate some of the impacts of lower pricing. If you are referring to the current lower price environment, our business is impacted more by lower oil prices as our largest capital investments take place in our oil properties. Although the business is impacted negatively by a reduction in the cash flow, it is influenced positively by better labor availability and potential reductions in costs of suppliers as companies reduce their capital spending.
Are companies in your sector reactive or proactive regarding oil prices, staffing, and capital budgets?
JF: In late 2014, and early 2015 we have seen adjustments [reductions] to the budgets of many Canadian oil and gas producers. It really depends on the company and their financial position as well as the types of assets that they possess. For Cenovus, we manage a portfolio of assets and understand which areas can speed up or slow down depending on the pricing environment.
Reactively, if there is a market event outside of expected price trends, companies will respond by adjusting budgets and pace of development. Proactively, companies use hedging and manage their financial position to be prepared for changes in expected prices. Our oil sands assets will produce for decades, so it is important for us to recognize how we can execute our longer-term strategy by understanding how our development is affected by near-term pricing.
Do you have any advice to young professionals preparing to enter the job market at this time of lower prices?
EM: This is a bad time for young professionals to be entering the job market in the oil and gas industry. A year ago the industry was crying out for young engineers. Today, the industry is shedding staff as fast as they can. My advice would be more for the employers. Have faith in the oil price making a strong recovery in 2016 and maintain graduate recruitment programs since this is essential to the future viability of the industry.
JW: Do not be picky and do not be afraid to take a job out in the field if the opportunity exists. Experience in any facet of oil and gas, even if it is not in your field of study, is better than no experience at all.
JF: I don’t think I would give different advice to young professionals entering during a time of high or low oil prices. I joined this company (via the legacy company of Alberta Energy Co.) when WTI was trading at USD 20/bbl and steam-assisted gravity drainage development was viewed as the marginal barrel. I spent my early years learning from experienced technical staff how to solve problems to unlock our future resources.
Whether prices are high or low, I think young professionals should have the patience to learn technical skills from experienced staff, and particularly in a lower-price environment, work on solving problems to reduce costs or increase the realized pricing of the commodity which they are producing.
|Euan Mearns is the editor for the Energy Matters blog at euanmearns.com and an honorary research fellow at the University of Aberdeen. His mission is to understand the various components of how the Earth energy system works and to educate politicians, policy makers, and the public on energy matters so that better choices can be made. He was a founder and managing director for Isotopic Analytical Services, and an editor at TheOilDrum.com. Mearns earned a BS in geology and a PhD in isotope geochemistry from the University of Aberdeen.|
|Jared Wynveen is an associate with McDaniel & Associates Consultants since 2006. Wynveen has been responsible for evaluating numerous heavy oil and bitumen projects at various stages of development. His primary focus over the last 7 years has been the preparation of economic evaluations of oil sands assets for the purposes of annual securities reporting, joint venture agreements, and debt and equity financing. He also provides technical and financial advisory services to foreign oil and gas companies and financial institutions that are interested in oil sands projects, both in Canada and worldwide. He holds a BS degree in mechanical engineering from Queen’s University.|
|James Fann is the principal for integration of markets, products, and transportation at Cenovus Energy, a Canadian oil company. Fann started working with Alberta Energy Co. in 2001 and was a part of its transformation to Encana in 2002, and subsequently to Cenovus Energy in 2009. He has worked in both upstream and downstream, including in investor relations and oil sands operations. Fann is a professional engineer and holds a BSc in chemical engineering from the University of Waterloo and an executive MBA from the University of Calgary’s Haskayne School of Business.|
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