Written by: Reynold Tetzlaff, National Energy Leader, PwC Canada
Prices for Canadian oil and gas are continuing to trend lower and have recently taken us into areas of negative returns, as seen in some of our natural gas and heavy oil plays earlier this year. While the energy industry recognizes that some of the reasons for this are beyond its immediate control, there are several challenges affecting Canada’s global competitiveness:
- slow progress on pipeline developments
- a volatile Western Canadian Select (WCS) to West Texas Intermediate (WTI) differential
- uncertain investment outlooks
- lack of market access
- a complex and unpredictable regulatory process
The sector has focused its efforts on addressing factors within its control, such as capital spending and operating costs, but it takes a stronger, more collaborative approach, to tackle the many external influences.
From impact on GDP, tax contributions, employment and foreign investment, the effects of our industry’s current state aren’t siloed to one province or isolated to the industry alone, but are felt by all of Canada. Here I explore the ripple effect of our oil and gas sector, the challenges facing the industry and a possible way forward.
The ripple effect
The industry’s current state has a large impact on the rest of the country, as declining energy revenues force reduced spending, investment, employment and payments to government.
Impact on gross domestic product
In 2017, we exported CA$97 billion worth of oil and gas, and as of Q2 2018, the sector accounted for 15% of Canada’s merchandise exports. The energy sector as a whole accounts for almost 11% of gross domestic product (GDP), with 6.25% of GDP provided by the oil and gas sector.
Impact on payments to government
Upstream oil and gas averaged CA$12 billion tax contributions to government revenues over the past five years. This represents more than 11% of all operating revenues earned by the Canadian government. The normal levels of total industry revenue for producers and the various levels of government are around CA$100 billion annually. As a result of declining commodity prices, and to a lesser extent decreased natural gas exports, the amount of taxes paid by oil and gas companies has fallen by 38% over the past 10 years.
Although 80% of Canada’s oil and gas production comes from Alberta, other major producers include British Columbia, Saskatchewan, Manitoba and Newfoundland. A vibrant oil gas industry not only benefits Alberta and other producing provinces, but Canada as a whole in the form of tax contributions and transfer payments.
Impact on employment
More than 3,400 companies outside of Alberta supply goods or services to the oil sands sector alone, with more than 1,500 from Ontario. Direct and indirect employment across the country in the oil and gas sector is now 533,000, down from 644,000 in 2015.
Impact on foreign investment
The recent plight of the Canadian oil and gas sector has had repercussions on investment in the country. Capital spending in the oil and gas sector in the United States rose 38% to US$120 billion last year. Investment in the same sector in Canada was CA$45 billion, down from CA$81 billion two years earlier. The level of investment in oil and gas extraction dropped by 7.4% to CA$162.2 billion, as direct investors from abroad sold some of their assets back to Canadian investors, mainly in the oil sands. The S&P/TSX Energy Index has dropped 7.8% this year so far, compared to a gain of 1.3% for the comparable US index. Energy deals in Canada have dropped by 16% for the first nine months of this year, compared to a surge of 72% in the United States.
To attract investment, the energy industry needs greater certainty. Provincial and federal governments need to work together to define rules, policies, regulations and ensure that they are understood and upheld. By creating a predictable and stable environment, governments will provide an opportunity for all industries to attract local and international investors.
In order to fully realize the benefits from a strong oil and gas sector here in Canada, we need to balance environmental and economic considerations, while understanding and addressing the challenges that are limiting our competitiveness. Globally there are concerns associated with the energy industry’s impact on climate change, however Canada’s environmental policies and standards are best in class, as is our industry’s dedication to reducing environmental impact through technology-enabled solutions. Ultimately, the policies that are implemented to protect our environment shouldn’t hinder the responsible extraction of our resources.
Challenges facing our industry
Access to markets
Canada’s limited access to foreign markets greatly affects our ability to compete not only with the United States but on the world stage. With the cancellation and delay of projects like Keystone XL, Northern Gateway, Trans Mountain and Energy East, the expansion of our pipeline network is uncertain and so is our ability to increase takeaway capacity as well as access markets other than the United States.
To provide perspective, total Canadian production has grown to about 4.2 million barrels per day (MMb/d). Our pipelines have the capacity to carry about 4 MMb/d of that, with the balance being shipped by rail, which is often associated with higher costs and safety risks when compared to pipelines. With one of the world’s largest proven hydrocarbon reserves, Canadian production will continue to grow well past present day figures. However, with no new pipelines constructed, we will continue to experience the same challenges and landlocked resources as we have in the past.
The increasing differential
Historically, the differential between WTI and WCS has been around US$10-$15. While recently that gap has been more volatile and increased to more than US$45 per barrel, with WTI selling at over US$70 a barrel and WCS for approximately US$25.
With 99% of our products being exported to the US at a substantial discount, the annual revenue loss for Canadian industry and governments equates to a wide range of estimates, one of which is approximately CA$29 billion. The primary reasons we accept such losses are due to Canada’s lack of pipeline capacity, the inability to accommodate rising production, stretched rail capacity and the annual closure of North American refineries for maintenance. Although the latter factor will lift towards the end of the year, additional pipeline infrastructure is needed to remedy capacity issues.
Canada is the largest foreign supplier of oil to the United States, accounting for 43% of American oil imports and making up 21% of American refinery intake in the Midwest and on the Gulf Coast. The vast majority of oil and and gas that we produce is exported to our southern neighbours, historically our major trading partner for oil, natural gas and other commodities. With only one major customer, no pipelines to tidewater and restricted access to global markets, we aren’t able to access global prices for our supply.
Our inability to move crude from coast to coast also means that we have to import oil and gas to meet our own demands. Canada imports 0.8 MMb/d of crude oil, costing us US$14 billion. Sixty one percent of it comes from the United States for our own eastern refineries and we also import from other countries such as Saudi Arabia. The US oil is bought by us at world prices, not WCS prices, so the US benefits both from buying our oil at discounted prices and selling us theirs at world prices, resulting in significant economic loss to Canada.
When it comes to natural gas 51% of our production (valued at US$6.7 billion) goes to the United States. Conversely Canada imports enough American gas to cover 20% of its consumption, mainly in central Canada where 77% of the gas used comes from the Eastern United States.
As a country, we’ve put ourselves at a massive financial disadvantage by having only one large customer and no way to access other markets.
When CA$89 billion in pipeline and LNG projects are cancelled, derailed or abandoned, along with CA$27 billion in divestments by major oil companies, all in a period of about 30 months, serious questions must be asked.
The decline in commodity prices may have been the stated factor, but the accompanying regulatory process is also a major contributor. Our regulatory processes have long been hailed as world class and replicated by other nations. But the complexity, time taken, responsibility and sheer volume of work required have increased to a level that has become onerous and expensive. Uncertainty and inefficiency has resulted.
The current federal government’s Bill C-69, which has already been passed through the House of Commons, seeks to redress these concerns, but has received hundreds of amendments from both government and opposition members. Industry has suggested that the Senate pause to consider the full impact and implications of what’s being presented, as inexact legislation could only amplify the challenges that the bill hopes to correct. Aimed at modernizing the National Energy Board and the Canadian Environmental Assessment Agency, the growing concern is that the current version of the bill may make the processes more complicated, legally vulnerable and time consuming for the industry, as well as erode investor confidence.
So what’s next?
It’s important we remember the significance of the contribution that the energy sector plays in our economy, for the betterment of all Canadians. Practicality has to come before politics. While there’s no immediate solution to resolve this complicated problem, it’s evident that new pipelines, access to foreign markets, becoming competitive with the U.S. tax regime, correcting the regulatory process and attracting more investment will help restore Canada’s competitiveness.
Reynold Tetzlaff, National Energy Leader, PwC Canada
Reynold is PwC Canada’s National Energy Leader and Calgary Managing Partner. He has over 20 years of experience, dealing mostly with energy companies his entire career. Reynold has assisted clients through complex transactions like initial public offerings (including the largest IPO in the Canadian energy sector in 2012), debt refinancing and global expansion of their operations. Reynold is a frequent speaker at energy events and provides insights into Canadian oil and gas industry trends.