OPEC is desperately attempting to halt the slump in prices
Has oil hit bottom?
OPEC is desperately attempting to halt the slump in prices
In the corridors of Calgary’s tinted-glass skyscrapers, in coffee-shops and along the slushy, snowbound downtown streets, one could almost hear the collective sigh of relief last week as oil prices moved upward, at last. Alberta’s oil capital had watched with creeping trepidation as the price of benchmark West Texas Intermediate crude tumbled from more than $22 (U.S.) last fall, to a nine-year-low of $13.21 (U.S.) in mid-March, before recovering last week to bob around $16 (U.S.). The bounce came on news that two giants of the Organization of Petroleum Exporting Countries, Saudi Arabia and Venezuela, along with nonOPEC Mexico, had secretly brokered a multinational deal to cut oil production by at least 1.1 million barrels a day beginning on April 1. After the initial uptick in oil prices, however, some analysts began to question whether OPEC’s cuts would be deep—or durable—enough to stabilize the market. ‘There is a significant risk that this agreement will not hold,” said Teresa Courchene, senior economist with the Toronto Dominion Bank. “That means there will be a fair amount of volatility in oil prices.”
That will hurt some sectors of the oilpatch more than others. Most susceptible are producers of heavy oil, several of which have already scaled back exploration or delayed development plans. So far, though, the effects have largely bypassed Alberta’s economy and its provincial treasury. Nor do Atlantic Canada’s mega-dollar offshore oil projects appear threatened. Still, $16 (U.S.) oil is well below the $20.60 (U.S.) average price oil companies were earning last year. And it is lower than the $17.50 (U.S.) that Alberta treasury officials were counting on in February when they forecast a surplus for the 19981999 budget. As a result, they, as well as the energy industry, will have their attention focused closely on Vienna this week, where OPEC’s oil ministers are expected to meet to confirm their planned cut.
What has pulled down prices is an underlying trade imbalance. Demand has been depressed by the Asian economic crisis and by a warm winter in northern climates, while OPEC members have increased output. In an attempt to reverse the imbalance, various producers were negotiating feverishly last week, trying to increase the proposed production cut to 2 million barrels a day—2.8 per cent of the world’s estimated daily crude supply. Producers, however, have had difficulty curtailing production in the past. “OPEC typically exceeds
its quota,” observes Judith Dwarkin, vice-president of the independent Calgary-based Canadian Energy Research Institute. “It remains to be seen whether or not they will make the cuts.”
If they do not, it will exacerbate an already difficult situation for Canada’s producers of heavy oil. The thick, tar-like oil fetches a lower price than standard crude at the best of times. Prices have lately fallen even further, because of growing competition among producers. Now, falling light crude prices are putting additional downward pressure on the price of heavy oil. Although the economics of individual projects vary, Dwarkin’s institute says heavy-oil prices are now generally below what is needed to cover operating costs, let alone the cost of capital.
While a few companies have begun shutting down production at some of their wells, others are scaling back development plans. Imperial Oil Limited of Toronto announced on March 17 that it was suspending new drilling and construction at its heavy-oil operations at Cold Lake in northern Alberta, leaving in the ground oil that was
CRUDE OIL'S LONG FALL
Over the past year, benchmark light crude oil prices dropped 50 per cent, before they ticked back up last week
supposed to come into production in 1999 or later. “Right now, heavyoil returns are meagre,” explained spokesman Hart Searle. Although Imperial said it was not laying off any of its own staff, about 250 people working for contractors on the Cold Lake project will be looking for work as a result.
PanCanadian Petroleum Ltd. of Calgary, meanwhile, announced in February a gradual cutback in its heavy-oil production, along with 200 layoffs across all divisions—more than 10 per cent of its workforce. And spokesman Alan Boras said that OPEC’s action would not reverse either decision. “Certainly, we’re encouraged,” said Boras. “But until these things are proven to be sustained, you have to just continue to watch.”
For the most part though, the oilpatch was some way from entering panic mode. For one thing, every veteran of the boom-and-bust 1980s in Alberta knows the energy industry is a cyclical one. Natural gas is still showing healthy returns, and some investment will shift to that from oil. And a few firms continue to plan for robust growth, despite the current climate. Suncor Energy Inc. of Calgary has confirmed plans to spend $4 billion over the next four years, most of it to double its oilsands production, which Suncor upgrades and sells as light crude oil.
In fact, Alberta’s economy is still expected to lead the country, with 3.8-per-cent growth in its gross domestic product this year, according to a Scotiabank report released last week. “Obviously, the oil price is important to Alberta,” says the Royal Bank’s chief economist, John McCallum. “But I think Alberta is less a boom-andbust economy today than it was 10 years ago.” McCallum noted that energy companies have tended to keep costs low and finance recent expansions more through
equity than debt. “Alberta has been on top of the world with an absolutely booming economy,” he adds. If oil stays around $16 (U.S.), “Alberta will still be a booming economy—just not quite as much of a boom as if it were $20 (U.S.).”
Atlantic-Canadian oil hopes also remain high, despite a brush with $12.95 (U.S.) crude—the minimum price the $5.8-billion Hibernia project off Newfoundland needs to break even. “We’ve been concerned, needless to say,” said Harvey Smith, president of the Hibernia Management and Development Co. Ltd in St. John’s, Nfld. “But there’s not a lot we can do except ramp up to production as soon as possible. Once we get to peak, our operating costs will be extremely competitive.”
Analysts add that offshore megaprojects such as Hibernia and Terra Nova (due to come onstream in 2000) are simply too large to respond to run-of-the-mill price fluctuations. ‘You are talking about huge capital investments with long, long lead times before they start pumping oil,” says Wade Locke, an economist at Memorial University in St. John’s. Once companies have sunk capital into a project of that magnitude, he said, “the price would have to drop quite a bit for them to say, We just don’t want to pump any more oil.’ ” Prices would have to drop a lot further still to knock the Alberta budget off track. Prices were high enough in the early part of the 1997-1998 fiscal year, which ends on March 31, to offset recent declines. As well, other revenues, particularly from natural gas and corporate income taxes, were higher than expected. As a result, Treasurer Stockwell Day was able in mid-March to announce a $2.3-billion surplus for the current fiscal year, more than $2 billion higher than first projected.
Alberta’s government has hinted it might put additional money into health care in the months ahead. But that is one area where falling oil prices may begin to pinch. Provincial law forbids Day from running a budget deficit, and some Albertans fear that any drop in revenue will force the government to make further spending cuts. “My concern,” said Liberal treasury critic Gene Zwozdesky, “is that if oil prices remain low, they are boxing themselves into a corner that can only mean more cuts to important programs.” There is, however, a forecast $165-million surplus plus a $420-million contingency built into Day’s 19981999 budget. That cushMarch 27, ion, according to trea1998 sury calculations, would $16.76 (U.S.) allow the province to ride out an average oil price as low as $16 (U.S.)— even if natural gas prices also dip.
Optimistic sentiments and government calculations all come with one rider, however: that oil prices do not go off the deep end, and stay there. As the Royal Bank’s McCallum puts it: “At $16, things are pretty much OK At $12, things are pretty bad.” Although the betting is on the upper end of that range, one thing seems clear: after several years of relatively strong and stable oil prices, uncertainty and volatility have returned to the market. Which means even the most optimistic Calgarians are likely to keep their eye trained on whatever turn the market takes next.
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