BUSINESS

The oil price puzzle

Energy companies fear that the bubble will burst

JOHN DALY October 15 1990
BUSINESS

The oil price puzzle

Energy companies fear that the bubble will burst

JOHN DALY October 15 1990

The oil price puzzle

Energy companies fear that the bubble will burst

BUSINESS

Brian Krausert says that it is too early to celebrate. Since Iraqi President Saddam Hussein's tanks rolled into Kuwait

on Aug. 2, the price of oil on world markets has almost doubled, but as Krausert sat in his 11th-floor office in downtown Calgary last week, the robust, bespectacled, 40-year-old president of Beaver Drilling Ltd. was far from euphoric. Despite the higher prices, three of Beaver’s nine $500,000 drilling rigs were idle. Like other executives in Alberta’s oilfields, Krausert says that North American oil exploration companies are reluctant to commit themselves to costly new projects for fear that prices may plummet as quickly as they have climbed. Said Krausert: “This industry is not a light switch. Maybe by the new year, with cheques in their pockets, oilmen will start believing that the price will stay above $30 a barrel for a while.” For now, however, the turmoil in international oil markets is confounding petroleum executives. Last week, the price of a barrel of West Texas Intermediate Crude—the industry benchmark—jumped up and down wildly before closing at $37.47 (U.S.) a barrel on the New York Mercantile Exchange. Analysts say that future prices depend almost entirely on events in the Persian Gulf. A peaceful settlement of the conflict could see oil fall to below $20 a barrel in early 1991—but if war breaks out, it could jump to $65 or more. In the long

run, higher oil prices could create big profits for drillers like Krausert. But consumers would clearly suffer. Already, gasoline prices have risen to their highest levels in five years, airlines have raised ticket prices, and Third World countries that depend on imported oil have appealed for help from Western nations.

Meanwhile, Canada’s large oil companies are still pumping about the same amount of oil from their producing wells as they were before the Iraqi invasion. As well, the companies are waiting for oil prices to stabilize before exploring and developing new oilfields. Many are still recovering from the collapse in prices in the mid-1980s and are reluctant to invest more money now in case the current price surge is short-lived. Says Kathryn Lundy, a spokesman for the Calgary-based Canadian Association of Oilwell Drilling Contractors: “Increased oil prices improve cash flow, but companies are using the cash to pay off debts. As long as interest rates are high, investment in drilling will not rise all that much.”

Indeed, several major Canadian firms are in the process of cutting their payrolls. Before the Iraqi invasion, Imperial Oil Ltd. of Toronto, for one, planned to reduce its 15,250-strong workforce by an unspecified total through attrition and by offering early retirement. That decision remains unchanged. “Two months of volatility are not enough to convince us that higher

prices are here to stay,” said Hart Searle, a spokesman for Esso Resources Canada Ltd., an Imperial subsidiary. He added, “The experts claim that peace talks could bring the price of crude crashing down, lower than even before the crisis.”

The current instability on world oil markets may also affect Ottawa’s plans to sell off Petro-Canada. Last week, Privatization Minister John McDermid tabled legislation in the Commons that would authorize the sale of the first 15 per cent of the company to private shareholders. When plans for the sell-off were announced in the federal budget in February, analysts said that the company could expect to raise $500 million from the initial share offering. If the international oil market stabilizes and prices remain high, that figure could rise to as much as $750 million, says Denis Mote, an oil analyst with Montreal-based brokerage firm Maison Placements Canada Inc.

But because the privatization legislation still must be debated and ap-

proved by Parliament, and because bringing such a large share issue to the market is technically complicated, analysts say that the government likely will not be able to sell the shares until next year at the earliest. McDermid himself would say only that the sale would take place “when market conditions are favorable.”

The cautious approach of Canada’s oil companies contrasts sharply with the increase in activity in many of the world’s major exporting countries. Large producing nations, such as Saudi Arabia and Venezuela, have raised their production levels to compensate for the United Nations ban on exports from Iraq and Kuwait, which used to ship a combined 4.6 million barrels a day. Because of that, Canada and other Western countries are continuing to receive adequate oil supplies.

Consumers have been among the first to feel the pinch of higher oil prices. In most European countries, gasoline sold for 80 cents a litre or more before the Iraqi invasion, but since then, prices at the pump have risen by at least nine cents a litre. In Canada, the average price had increased to 61 cents a litre by late last week, from an average of 57 cents a litre in July. In several jurisdictions, politicians vowed to crack down on oil companies that take advantage of the Gulf crisis to gouge consumers. Declared Ontario Premier Robert Rae, whose New Democratic Party government took office last week: “If we find any price increases that are totally unjustified, we have the constitutional power to deal with that.”

At the same time, many experts say that Canada and the United States must share the responsibility for the fact that their economies are vulnerable to oil price explosions. After the 1973 and 1979 Arab oil embargoes, Western European countries and Japan imposed higher taxes on fuel to encourage conservation. By

contrast, before prices began climbing in August, North American gasoline prices, after adjusting for inflation, were about the same as those that prevailed before the 1973 embargo. As a result, André Plourde of the University of Ottawa says, over the past five years “there has been an increase in demand, particularly for transportation fuels.”

If oil prices remain high, most analysts predict that North American automakers will be among the big losers. Over the past five years, General Motors Corp., Ford Motor Co. and Chrysler Corp. have reduced the number of four-cylinder engines in their product ranges and replaced them with more powerful, but less fuel-efficient, six-cylinder engines. And this fall,

Detroit is launching several large new family cars, including the eight-cylinder Buick Roadmaster. In September, however, the first month when gasoline prices began to climb as a result of the Gulf crisis, the Big Three’s combined car and truck sales fell by 26 per cent compared with September, 1989. Meanwhile, foreign-owned manufacturers’ sales rose by one per cent.

The impact of the steep climb in oil prices on airlines, many of which were struggling to earn a profit before the Gulf crisis, has been even more dramatic. Since August, jet-fuel prices have more than doubled, increasing far more quickly than other fuel prices because the Saudi and Iranian oil that replaced Iraqi and Kuwaiti oil on world markets requires more refining to

PUMPED UP Average gasoline prices per litre

turn it into airplane fuel.

Higher fuel prices, in turn, have led Air Canada to increase its domestic fares by six per cent since Aug. 2, while Canadian Airlines International Ltd. has raised its domestic fares

by five per cent. As well, both airlines will raise international fares this month.

Charter carriers, who have to set and collect their fares long before their flights take off, have been hit even harder by the sudden jump in fuel costs. Late last month, Imperial Oil Ltd. cut off heavily indebted Worldways Canada Ltd.’s credit line for buying fuel. In order to keep the airline flying, a group of independent tour operators stepped in last week and paid off the airline’s $l-million fuel bill. As well, the province’s Ontario Development Corp. granted a temporary $6-million loan to Worldways, which is Canada’s largest charter airline.

In contrast to the continuing panic on world oil markets and in heavily oil-dependent industries, the calm that still prevails within Canada’s oil industry is striking. In order to boost their output and sales, Canadian oil companies would have to commit themselves to expensive new drilling projects and invest in costly new production equipment and pipelines. But while high-cost frontier megaprojects such as the $5.2-billion Hibernia development off Newfoundland, the proposed OSLO heavy-oil extraction plant in northern Alberta and production wells in the high Arctic would be profitable at current oil prices, they would take several years to gear up for production. That means that Brian Krausert and thousands of others in Canada's oilfields may never share in the grim windfall created by Saddam Hussein.

JOHN DALY

with

PETER LEWIS

in Brussels,

PHILLIP DAY

in Ottawa and

JOHN HOWSE

in Calgary