The Oil Outlook

Rising petroleum prices and tight supplies could still whack the economy

Patricia Chisholm October 30 2000

The Oil Outlook

Rising petroleum prices and tight supplies could still whack the economy

Patricia Chisholm October 30 2000
In this year of living dangerously, many investors have been badly burned as they jumped from sector to sector, trying to match the huge returns of recent years. First one industry, then another, has soared and crashed: technology, chemicals, transportation and, lately, consumer products. Yet at least one Bay Street watcher has done well by diving into a business usually considered fraught with risk: oil and gas. Jeffrey Rubin, chief economist at CIBC World Markets, shifted most of his personal portfolio out of indexed equity funds last February and socked it into oil and gas stocks. Since then, the sector has gained about 40 per cent in value, as oil prices continued their steady rise of the past two years, hovering at $33.75 (U.S.) a barrel last week, up from about $12 at the end of 1998. “My advice, if you are feeling poor filling up the tank,” says Rubin, “is put some of your money into that company’s stock.”

Oil. It’s a simple little word that conjures up a messy mix of associations, from cheap, plentiful energy to greed, politics and fear. Most of all, though, it is synonymous with uncertainty. Ever since the first, and most devastating, oil shock of the early 1970s, the fortunes of developed nations have been buffeted by prices for a barrel of the black sticky stuff. Oil price spikes in 1973, 1979-1980 and 1990 were followed in every case by punishing recessions. Now, with stock markets gyrating wildly, economic activity in the United States slowing, winter approaching, and the Middle East teetering on the brink of war, oil-importing countries are finally waking up to the reality that once again, high oil prices could trigger inflationary pressures and push their economies into a tailspin. “An oil-price spillover into core inflation—non-energy inflation—in Canada and the U.S. is the biggest risk to our soft-landing scenario,” says George Samu, an economist at the Royal Bank of Canada in Toronto.

This time, though, it’s not OPEC-engineered limits on supply that are causing most of the problem. With the world sucking up about 75 million barrels a day—the most ever—oil producers have only about two million barrels a day of spare capacity. “The world has grown complacent about having a consistent supply of cheap oil,” says Matthew Janisch, head of energy research for BMO Nesbitt Burns in Calgary. “In the near term, things are very precarious. If Iraq shuts down, we'd be in serious trouble.”

Years of booming global demand are part of the reason that the balance between oil supply and demand, never easy, is resting on a knife edge. At the same time, lack-lustre prices in the mid-1990s reduced the incentive to look for new, more expensive sources of crude, creating a greater reliance on conventional stocks. As a result, oil inventories are extremely low, leading U.S. President Bill Clinton to order the release of 30 million barrels from the U.S. Strategic Petroleum Reserve to alleviate shortages of home-heating oil this winter. “There are always new sources of oil to be found,” notes Wilf Gobert, an energy analyst at Peters & Co. Ltd. in Calgary. “But it’s how much is available in a defined time frame. It’s getting harder to find oil that you can bring on stream in a short period of time.”

It’s still difficult to predict how an oil-price spike will play out. While excess capacity may be far lower than it was in the past, so, too, is the world’s dependence on petroleum. Due to greater efficiency and use of alternatives, the world uses about one third less oil than it did 20 years ago to produce each dollar of global economic output. Then, there is the coming slide in demand. Many experts, including Nesbitt’s Janisch, believe that slowing world economies will take pressure off prices, allowing a barrel of crude to settle within OPEC’s target range of $22 to $28 (U.S.) in the second half of 2001. And while Middle East tensions are a clear threat to that goal, they are counterbalanced by the cartel’s growing appreciation for economic stability among its customers. When prices spiral upward, demand can drop precipitously, sending oil markets into free fall.

And, of course, sharp price hikes tend to provoke a frenzy of new exploration and extraction activity in regions where there are huge, so-called unconventional oil deposits—deep under the ocean floor or trapped in vast sand pits. Geologists have conservatively estimated that Alberta’s tar sands alone hold more oil than all of Saudi Arabia’s proven reserves. Even more of a threat for OPEC nations is the snowballing drive towards alternative energy sources, such as cars powered by electricity or hydrogen fuel cells. The Gulf states, analysts say, would much prefer to sell off their massive reserves at good prices before the world market for oil goes flat.

Yet there is a small group of experts who warn that oil-importing countries could run smack into a supply wall—the point where demand is greater than production—as early as two years from now, long before alternative oil sources and new technologies kick in to feed the planets energy habit. The CIBC’s Rubin predicts that oil prices will have to hit $50 (U.S.) by the end of 2002 to put a brake on demand big enough to avoid hitting that wall in the middle of this decade. That figure may not be high by historical standards, he notes, since prices in 1980 reached almost $90 when calculated in today's dollars. But it would likely be enough to curb usage and, hopefully, spur conservation efforts. “The resale value of [gas guzzling] sport utility vehicles is already dropping,” Rubin says. Still, he adds, this is the scenario for a rational world. “In an irrational world,” he warns, “you can get price spikes much higher.”

More common, however, is the view that demand will slow and new reserves will be found well before tight supplies send prices skyrocketing. Judith Dwarkin, a vice-president of the Canadian Energy Research Institute in Calgary, says other factors, such as growing concerns about climate change, mean that the age of petroleum-powered transportation is in its last gasp. The next two decades will also see the beginnings of an eventual “tectonic” shift to alternative energy sources, she predicts. The biggest oil companies, like Shell and BP Amoco PLC, are already investing millions to explore new alternatives: BP, for one, has designated the endeavor as one of its core businesses. Shell has solar-power projects in South Africa and Germany. “We may be getting close to supply peaks, but so what?” says Dwarkin. “The demand side is much more interesting and dynamic.” It’s an attractive vision: a world where the price of a barrel of slimy black goo has no bearing on prosperity, pollution or politics.

The trouble with the 10th month

No doubt about it: it’s October. This is the month that many investors dread—especially those who hate roller-coasters. The major North American markets last week careered down to lows not seen in months, then roared back in a two-day rally. What makes October such a tough month, dating to the Great Crash of 1929 and Black Monday in 1987, is often the appearance of poor results from what is typically a slower quarter. This year, a host of tech companies—such as Apple Computer, JDS Uniphase and Dell Computer—have delivered disappointing numbers.

Last week, it was IBM’s turn, and again the markets took a hammering. Both the Dow Jones industrial average and the Toronto Stock Exchange 300 composite index—hugely influenced by tech darling Nortel Networks Inc.—slipped below the psychologically important 10,000 level. Part of the panic was due to fear that slowing sales and rising oil prices could lead to what many brokers called “the R word”—recession. But then, Microsoft, America Online and Nokia announced sunnier results and the bulls rushed back— some no doubt deciding that October would be over soon.

Coming soon: the return of Eatons

Sears Canada Inc. is gearing up to relaunch seven upmarket (and apostrophe-free) Eatons stores across Canada during November, with a grand opening set for Nov. 25. The date was put off two weeks due to delays in renovations, leading some analysts to predict that Sears would lose crucial Christmas-period sales in a year when its results are already disappointing. But Sears, which will stagger openings of the stores it bought after T. Eaton Co. Ltd. went bankrupt last year, said it expects curious customers to flock in to see the fashion-centered new look.

Financial Outlook

Factories are running flat out across Canada. In August, they shipped $45.4 billion worth of goods, up two per cent from the previous month. That is double economists’ estimates. The electrical and electronic products industry accounted for half of the increase. Those firms shipped $4.5 billion worth of products, up nearly 11 per cent from July. Three years ago, the sector was the fifth-largest source of manufactured goods; soon, it is expected to surpass food to take the No. 2 spot.

Though analysts are expecting further manufacturing gains for the rest of the year, forecasters still believe overall economic growth will slow to about 3.4 per cent in 2001 from this year’s 4.8 per cent.

Diamonds aren’t forever

Dia Met Minerals Ltd., Canada’s only diamond producer, said it was for sale after two key shareholders said they would unload their stock. One was Marlene Fipke, who gained her 26-per-cent stake in a high-profile divorce settlement with company founder Charles Fipke. The other was director Dave Mackenzie, who owns 12 per cent. The most likely potential bidder appeared to be Australian resources giant BHP Ltd., after South Africa’s De Beers Consolidated Mines Ltd. said it was not interested.


Trouble @Home

Thousands of users of the Rogers@Home high-speed Internet cable service are having trouble logging on to the service and using e-mail. RogersCable Inc. said the problem was due in part to tight system capacity, which it is expanding, and to hardware problems suffered by its partner, Redwood, Calif.-based At Home Corp. Rogers is fighting a high-profile ad war with Bell Sympatico’s telephone-based high-speed service.


Merging gas pumps

Chevron Corp., the No. 2 U.S. oil company, said it would buy third-ranked Texaco Inc. for $51 billion in stock to create the world’s fourth-largest energy company. The proposed Chevron Texaco Corp. deal will face up to a year of review by regulators.


Bre-X no-show

Everyone showed up except the defendant as the trial began of John Felderhof, chief geologist of defunct Bre-X Minerals Ltd. Felderhof moved to a luxurious spread in the Cayman Islands after Bre-X’s claims of a major gold find in Indonesian Borneo were revealed to be a massive hoax. In Toronto, his lawyers challenged the Ontario Securities Commission charges on constitutional grounds.


Nutrition labels coming

Ottawa proposed new rules requiring clearer, American-style lists of nutritional components—calories, fat, etc.—on food-product labels. The changes would take effect next year.

When the pumps run dry

How long can the world’s oil last? This table lists a conservative industry view of proven reserves among the 10 top nations and Canada, and calculates when those reserves would run out at current production rates. But industry analysts note that new sources and techniques are constantly expanding supply (reserves in billions of barrels, 1999).

Saudi Arabia

Reserves: 263.5

Global Share: 25.5%

Years left: 88


Reserves: 112.5

Global share: 10.9

Years left: 100+

United Arab Emirates

Reserves: 97.8

Global Share: 9.4

Years left: 100+


Reserves: 96.5

Global Share: 9.3

Years left: 100+


Reserves: 89.7

Global Share: 8.7

Years left: 70


Reserves: 72.6

Global Share: 7

Years left: 65


Reserves: 48.6

Global Share: 4.7

Years left: 22


Reserves: 29.5

Global Share: 2.9

Years left: 57

United States

Reserves: 28.6

Global Share: 2.8

Years left: 10


Reserves: 28.4

Global Share: 2.7

Years left: 25



Reserves: 6.8

Global Share: 0.7

Years left: 9.3

Rest of world

Reserves: 159.3

Global Share: 15.4

Years left: --

Total world

Reserves: 1,033.8

Global Share: 100

Years left: 41