All one hears is talk of low prices, slashed budgets and depressing economic tidings across the globe.
Robert Curran, Contributing Editor, Canada
The year that was 2008 started amid uncertainty, reached dizzying heights, then crashed back to earth in a fall so precipitous that it shook world markets and threatened national economies. The year ahead promises more stability, but in all the wrong ways. Depressed commodity prices, slumping demand, decreased spending, lower exploration and drilling activity, topped off with massive layoffs, do not provide the type of stability anyone in the oil and gas industry wants to see.
In fact, there doesn’t appear to be a single positive blip on industry’s radar screen for the year ahead, with the possible exception of a weaker Canadian dollar. But amid all the negative market factors, there may be even greater apprehension about the full-court press applied by environmentalists-particularly over the development of Alberta’s massive oil sands deposits-and the possibility that politicians may succumb to the siren call of political gain, potentially sacrificing development of the country’s key energy source to further their political agendas.
POLITICS AND TAXES
The combination of a well-rehearsed and relentless anti-oil sands public relations campaign by environmentalists and the Canadian industry’s woefully inadequate response has left Canadians questioning whether developing the massive oil reserves is being handled correctly. This is despite the fact that Alberta’s oil sands industry is heavily regulated and scrutinized throughout the federal and provincial application processes, that this scrutiny is maintained after the projects initiate production, and that it continues throughout the productive life of each one, right through to remediation and reclamation.
Further complicating matters in Alberta is the new oil and gas royalty regime, which went into effect this January. Producers were highly critical of the new system when it was announced in late 2007, claiming that it failed to accurately consider the inherent costs of exploring for and producing oil and gas in the province. But as the economic climate worsened throughout the latter half of 2008, Alberta Premier Ed Stelmach relented, announcing changes to the new structure that were designed to reflect the new and unexpected market troubles.
The changes, called “transitional” by the Alberta government, offer relief for wells with depths greater than 1,000 m and less than 3,500 m. Industry welcomed the changes, but many still say it’s too little, too late, having already reduced spending plans or shifted capital to other areas. Given the dramatic shift in expenditures on land acquisition in Western Canada-Alberta land-sale revenues dropped dramatically, while Saskatchewan and British Columbia set new revenue records-it appears that the talk was not just rhetoric.
Of course, no reasonable royalty structure can offset the basic market conditions that have prompted so many producers to hunker down and try and weather the storm in early 2009. With oil struggling to stay above the US$40/bbl mark and natural gas hovering around $5/Mcf, it’s unlikely any changes could make a substantial difference.
Plea for tax relief. One of the most remarkable developments of the downturn is a plea made by the Canadian Association of Petroleum Producers (CAPP) to the federal government, urging Prime Minister Stephen Harper to stimulate Canada’s financial and banking industries through reductions in corporate income tax and other taxes on business. CAPP believes these measures may act as a catalyst for the financial and banking sector to invest more capital in the beleaguered oil and gas industry.
Given the petroleum industry’s well-chronicled opposition to any intervention by governments in the free market, their support of such measures speaks volumes of the level of concern that exists in the Canadian oil patch.
Lower loonie. The one positive factor for producers is the current level of the Canadian dollar vs. the American greenback. In late 2007, the Canadian dollar reached levels not seen since the 1950s. A year ago, the two currencies were virtually equal. For those exporting oil or natural gas, a weaker Canadian dollar creates a premium on any contracts signed in American dollars. In early January 2009, the Canadian dollar fell below US$0.80, effectively creating a 25% margin on any exports to the United States. The downside to the weaker dollar is the natural vulnerability it creates for Canadian firms that may become takeover targets for companies that report earnings in US dollars.
Company profits. Not surprisingly, stock markets were hit hard in 2008. Overall, the value of stocks on the Toronto Stock Exchange, Canada’s bellwether exchange, fell some 35% over the course of the year, the biggest annual decline recorded since the darkest days of the Great Depression.
SPENDING
Many observers are predicting dismal fourth-quarter earnings for most Canadian producers. The first major company to announce its four-quarter results, Suncor Energy Inc., reported a C$215 million loss for the fourth quarter, compared with profits of C$1.04 billion in the last quarter of 2007. For 2008, profits slipped to C$2.14 billion, down 28.4% from 2007 year-end earnings.
Suncor recently announced a secondary reduction in spending to C$3 billion, down 60% from its original budget of $7.5 billion, and down 50% from its revised budget, announced in October. The bulk of the cuts come from the company’s oil sands operations, particularly construction of the Voyageur upgrader and Phases 3 through 6 of the Firebag expansion.
Given the market conditions that underscore current industry activity plans, spending cuts are the norm. Most companies have announced substantial reductions to their 2009 capital expenditures. A report by Barclays Capital indicates that Canadian producers will slash spending by about 23% in 2009. Meanwhile, CAPP predicted the industry would spend a total of C$43 billion across Canada in 2009, down 14% from the estimated C$50 billion spent in 2008.
Among the notables is EnCana, which announced plans to spend US$6.1 billion this year, down 18% from its originally planned budget of $7 billion. The company says it also has built some flexibility into its program such that it could adjust spending upward or downward by a further US$500 million. A continued weak commodity price environment will likely result in further reduction, but more success in the company’s shale oil plays in British Columbia (Horn River) or Texas (Haynesville) could result in increased spending.
Talisman Energy Inc. recently announced plans to spend C$4 billion in 2009, a 27% decrease from the previously announced level of $5.5 billion. Of the total budget, $1.2 billion is allocated to North America, of which some $1 billion is ticketed for the company’s Marcellus (Pennsylvania) and Montney (Alberta/British Columbia) shale gas deposits. This also means Talisman has decided to withdraw from the once-promising Bakken tight oil play in southeast Saskatchewan, and has announced that the property will be put up for sale.
Petro-Canada also announced substantial cuts to its budget. The company set spending at C$3.96 billion, a decrease of 36% from the $6.15 billion it had previously established. Most of the cuts are targeting new growth projects. The company had previously announced that it was putting its Fort Hills upgrader on hold. Petro-Canada also says it has built considerable flexibility into the budget to ensure it can respond to further changes in the market.
Nexen Inc. also announced lowered spending, at C$2.56 billion, about 14.7% down from 2008 expenditures, amid continued rumors that France’s Total may be looking at a takeover bid for the Calgary-based producer. Most of Nexen’s spending is allocated to international projects in offshore West Africa (Usan), the British North Sea (Ettrick-Blackbird) and the Gulf of Mexico (Longhorn). In Canada, C$100 million has been ticketed for Phase 1 development of the Long Lake oil sands project.
Husky Energy Inc. has said it will spend C$2.6 billion this year, a decrease of 30% from 2008 expenditures of $3.7 billion. Western Canadian spending will fall dramatically in 2009, to $725 million, down 57% from the $1.67 billion it spent in the same area in 2008. Oil sands expenditures will also fall precipitously in 2009, to C$65 million, vs. $300 million last year.
MERGERS AND ACQUISITIONS
The extreme volatility of 2008 actually led to a much lower value of mergers and acquisitions when compared with 2007, falling 50% to US$131.5 billion, according to an analysis conducted by KPMG Corporate Finance, based on data supplied by Thomson Financial. There were 1,972 deals in 2008, down slightly from 2,098 in 2007, but a dramatic decrease in total value from the US$269 billion recorded in 2007. Metals, mining and oil and gas sectors dominated activity, accounting for about 55% of the 2008 deal value for Canadian companies.
KPMG said tight credit markets and the downturn in global equity values in the latter part of the year had a significant adverse impact on the M&A market. The lack of available debt capital-a major catalyst in previous M&A cycles-has also made acquisitions far more equity intensive from a financing point of view.
According to Sayer Securities, oil and gas activity was C$17.5 billion for 2008, well off the C$50 billion worth of activity recorded in 2007, and the lowest total since 2004. Sayer is predicting that M&A activity will remain low until the current credit crisis is over and commodity prices recover well beyond current levels.
Some notable second-half deals included:
• In August, Calgary’s Precision Drilling Trust announced plans to acquire Houston-based Grey Wolf Inc. in a cash-and-paper deal worth about US$2 billion. In late December, the deal was consummated when Grey Wolf shareholders approved it. Precision struggled to find financing for the acquisition as credit markets tightened, saying that it planned to reduce debt, cut payouts to investors and pay a higher interest rate than expected to fund the deal.
• Also in August, New York-based Riverstone Holdings LLC announced plans to take over Calgary’s Gibson Energy Holdings Inc. for C$1.1 billion cash. The deal closed in December.
• Another December deal was announced by Nexen and Long Lake oil sands project joint-venture partner OPTI Canada Ltd., in which Nexen paid C$735 million to pick up a further 15% interest in the Long Lake project. The deal, effective Dec. 31, also makes Nexen the operator of the project’s upgrader. Nexen how holds a 65% stake in the project.
DRILLING
The Canadian drilling industry was hit hard by 2008’s second-half downturn. Daily Oil Bulletin records indicate that drilling fell to 16,895 wells in 2008, down almost 9% from the 18,530 wells drilled in 2007. It was also the lowest annual drilling total since 2002. Saskatchewan was the only western province to record an increase in drilling, up 17% to 3,987, compared with 3,396 in 2007. Alberta drilling totals fell to 11,762 wells, down 15% from 2007’s 13,872. In British Columbia, there were 843 wells drilled, vs. 869 a year earlier.
The only bright spot for drillers was that a record number of horizontal wells were drilled last year (3,120), up 25% from 2007. Drilling contractors also took more days on average to drill a well, so rigs were working longer, if not more frequently.
But those within the Canadian industry are a pessimistic bunch these days. The Canadian Association of Oilwell Drilling Contractors is once again fairly pessimistic in its outlook, predicting a total of 14,325 wells to be drilled in 2009. CAODC based its forecast on an average WTI price of C$99/bbl and an average Nymex spot natural gas price of C$7.30/Mcf. CAODC is also predicting that rig utilization will average 39% in 2009 compared with 42% in 2008. A utilization rate of 50% is normally required for the drilling industry to remain profitable.
CAPP is slightly more optimistic than CAODC, forecasting drilling totals to hit 14,700 in 2009. CAPP’s forecast is based on an average crude oil price of $75 (WTI) per barrel, and a gas price between $7.50 and $8 per Mcf, while the Canadian dollar is forecast to remain near the US$0.85 mark.
The Petroleum Services Association of Canada (PSAC) is the most bearish of the lot in its forecast. It calls for 2009 to have only 13,500 wells drilled across Canada. PSAC is basing its 2009 forecast on crude oil prices of US$50/bbl for West Texas Intermediate and natural gas prices of C$5.50/Mcf (AECO).
Perhaps no sector of the Canadian industry reflects the current state better than Alberta’s oil sands. In the short term, the negative news has been almost overwhelming: Numerous projects have been shelved or cancelled, spending has been slashed, assets have been sold, and one major player, BA Energy Inc., filed for bankruptcy protection in December.
In December, CAPP cut its oil sands production forecast to 1.44 million bpd in 2009, after projecting last summer that output would reach 1.53 million bpd. And yet it remains clear that the massive reserves of the oil sands still hold the key to Canada’s energy future, and much of the work has simply been delayed until market conditions improve.
Some of the announced delays and/or cancellations include the withdrawal of Royal Dutch Shell’s Carmon Creek thermal project application and delaying the decision on a second expansion of its Athabasca project; Nexen and OPTI delaying the second phase of Long Lake; Suncor delaying work on the upgrader for its Voyageur expansion; Total withdrawing its application for the Northern Lights mine; and both Statoil and Value Creation Group scrapping their own upgrader plans.
One of the few positive signs has been Imperial Oil Ltd.’s plans to move forward with work on its Kearl oil sands mine. The 100,000-bpd project is scheduled to begin production in 2012, although the company will be assessing its project schedule this year, once it has completed the site preparation.
If there’s a silver lining to the generally miserable conditions experienced in 2008, it’s in land sale revenues. Despite the dropoff in Alberta revenues, Canada’s traditional leader in that category, overall revenues, actually increased last year, to just over C$5 billion, well ahead of the record set in 2006 and 88% higher than the $2.66 billion collected in 2007. Land sale numbers are generally indicative of future activity.
Of note is that for the first time, British Columbia collected more land sale bonus revenue than Alberta, pulling in an astonishing $2.66 billion, about 150% higher than 2007’s total of $1.05 billion. Alberta collected $1.23 billion, down 9.6% from its 2007 total of $1.36 billion. Saskatchewan also enjoyed a record year, pulling in $1.12 billion, almost quadrupling the previous high-water mark of $250 million, which was set in 2007.
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