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By David Yager
May 25, 2020
Now that the Black Swan has replaced the Great Horned Owl as Alberta’s official bird, we are reminded yet again that predicting the future for the volatile oil and gas industry gets more difficult with every passing year.
First there was global warming, later called climate change. For 150 years fossil fuels have prevented Canadians from freezing to death and fueled the country’s essential transportation links by rail, road, and air. Who would have ever imagined so many of our fellow citizens would grow to despise coal and oil and gas when the country in uninhabitable without them?
Then came a global virus pandemic which has collapsed oil demand. Every responsible business in the world does a “worst case” budget scenario. That never includes anticipating your own government ordering you to lay off your staff, shut down your business and not leave home for your own personal safety. Had you put this in the 2020 business plan you’d have been ridiculed, possibly fired.
These two events follow decades of forecasts that have been wrong for a variety of other reasons including technology, geopolitical turmoil and regional Canadian politics.
Forecasting future events has been so fraught with peril it has been ridiculed for years. Nobel Laureate Nils Bohr quipped, “Prediction is very difficult, especially if it’s about the future.” Famed economist Paul Samuelson added, “Wall Street indices predicted nine of the last five recessions.”
And don’t forget the famous line credited to George Bernard Shaw; “If you laid all the economists in the world end to end, they would never reach a conclusion.”
The only accurate and unquestioned forecasts involve climate change. It seems incredible that the hardest thing to predict – the weather – is the sole forecast that rates such a high degree of universal certainty.
Using tree rings, ice cores and lake bottom sediments to simulate historic atmospheric properties dating back thousands of years, the science is settled. It must be true. Why else would our governments intentionally destroy the Canadian economy?
Seriously though, human nature requires that we try to figure out what will happen next. For the oilpatch the worst is over. Following are my fearless prognostications about better times ahead.
Oil Prices
Source: Energy Information Administration, Daily Closing WTI Spot Price
After starting 2020 at US$61, WTI was under gradual pressure through February as it became clear that the growing international travel restrictions were going to have an impact on oil consumption. This caused OPEC+ to hold a pre-emptive meeting in early March to try to adjust supply to falling demand. That ended abruptly on March 6 when Russia declined to participate. Immediately thereafter, petulant Saudi Arabian Prince Mohammed bin Salman warned the world an oil price war was underway.
So began a slide culminating in the lowest price in history April 20, the last trading day of the May NYMEX WTI contract. Although mainly a technical trade, WTI closed at -US$36.98. Concern became fear for oil price watchers all over the world.
Through March and April, predictions on just how awful things would be were endless. As the world locked down due the pandemic, short term oil demand was going to plummet by as much as 30 million b/d, or 30%. Dates by which every oil storage tank in the world would overflow appeared daily.
By April 9 Saudi Arabia and Russia had regained their senses and a 10 million b/d reduction among OPEC+ participants for May 1 was announced. The chart above shows this didn’t help in the short term, but it was certainly a step in the right direction. But 10 million b/d was no where near enough.
Fortunately, markets work. It made no sense for oil companies to produce at a cash loss. So began a series of shut-ins that materially affected the pressure on storage and ultimately the price. It happened so quickly that exact numbers are unknown. America’s Energy Information Administration (EIA) reported that by May 15 US production was down 1.5 million b/d from late March. By mid-April official reports were 365,000 b/d of Canadian oil had been withdrawn from the market. These figures are old and likely low. Total production cuts in the US and Canada are probably well over 3 million b/d.
A sure measure is storage. In its weekly inventory report for the week ended May 15, the EIA indicated that commercial oil inventories were down 5 million barrels from the previous week and were only 10% above the five-year average for this time of year. Storage crisis averted.
Oil markets have responded accordingly. WTI has doubled in the month of May. Western Canada Select, which at one point fetched as little as US$3 a barrel, closed on Friday May 22 at US$24.91.
This is hardly great news. Things are still awful, particularly in the service sector. Oil prices are well below where they need to be. A large portion of what has been gained in price has been lost in volume.
But notwithstanding the appearance of yet another Alberta Black Swan, the worst is over for oil prices.
Oil Demand
That oil consumption would fall off a cliff is now history, not speculation. This has allowed prognosticators to focus their attention on when oil demand will return. How the world will never be the same is the most popular headline. Some portion of demand destruction is said to surely be permanent. Business travel and tourism will be reduced impacting airlines. More people will work from home and spent less on transportation. Consumer discretionary spending will be clobbered by the loss of jobs, income, savings and confidence.
In May the EIA released its oil and liquids demand forecast to the end of next year. It foresees a continuous recovery that is already underway. Consumption peaked at over 100 million b/d in late 2019 and the tall foreheads in Washington DC figure this will back by the end of the next year. Chinese oil consumption has already recovered to 13 million b/d, close to where it was a year ago. India’s government has stated that country will return to historical levels of oil demand in June. And according to this chart, the demand plunge in Q2 was under 20 million b/d.
Of interest is inventory changes as evidenced by the bars at the bottom of the chart. The major stock increases in the first half of 2020 changes direction in Q3 and continues for the next 18 months.
As consumption returns, inventory reductions will be assisted by the OPEC+ agreement and the fact that some of the production shut in may not come back on stream. Natural reservoir declines of 5 to 7% per year and the drastically reduced capital spending on new supplies will also contribute.
City Journal, published by the Manhattan Institute, published at article May 21 titled “The COVID-19 Crisis Will Only Intensify the Dominance of Oil”. It states 97% of global transportation is powered by oil. While on-line meetings like Zoom are popular and convenient, the article reports that, “…innovation, inspiration and commerce happen with close, regular human interaction.” People will demand more individual workspace in buildings and offices which will increase energy consumption for heating and cooling. Vacationers that no longer fly will buy or rent gas-guzzling RVs. As abandoning dense city centres becomes more common, living in and commuting to and from suburbia will increase fuel consumption.
All those electrons being consumed to communicate electronically and conduct commerce remotely also require energy. But the article concludes, “But in an age of cheap fuel, will a recession-riddled world show the same tolerance for subsidizing expensive alternatives like wind and solar?”
Gas Prices
Source: Alberta Natural Gas Reference Price, Government of Alberta
Unnoticed unless you produce it, is that yesterday’s zero is today’s hero. That’s natural gas. Once the economic engine of the entire industry, gas has so far escaped the oil price travesty. With LNG Canada still under construction and drilling down, gas prices are providing those producers that haven’t abandoned this commodity with a hall pass from the crude price collapse.
For the past couple of years the AECO spot price has been under tremendous pressure on a seasonal basis due in part to maintenance activity on the Nova gathering system that takes gas from new production in northwest Alberta to the storage hubs in the southeast. In June of 2018 Alberta’s natural gas reference price was only $0.75. Last June it was $0.55. On a daily basis it has not been uncommon to see the AECO spot price go to zero, even negative.
When the UCP was elected in April of 2019 they committed to fixing this problem until such time that capacity expansions on the Nova system are completed, probably next year. Working with industry and the Canadian Energy Regulator, last fall they helped change the tolling system such that when capacity was reduced on the Nova system the spot gas wasn’t the first to be bumped.
This has greatly improved and stabilized gas prices. On May 21, the AECO spot price was $2.15, up from $1.88 a year ago. As importantly, the AECO front-month for June 2020 was $2.039. Last year it was only $0.91. The 12-month average futures price was $2.331. A year ago it was $1.537.
Natural gas has been paying the rent in a big way in Alberta since the Trans Canada pipeline to central Canada was completed in 1958. In case nobody noticed, it still does and it is likely to get better as the economy recovers and LNG Canada nears completion.
Oil Jobs Will Recovery Quickly
Source: Statistics Canada Labor Force Characteristics By Industry, Monthly
If you’ve lost your job there is little comfort to be gained from knowing others are in the same situation. Misery does not necessarily love company.
However, as governments let people leave their homes and non-essential businesses re-open, the pace at which the recovery will affect employment will not be evenly distributed.
The chart shows the change in employment from January to April of this year. Oil and gas (it is ridiculous that Statistics Canada still bundles it with mining and quarrying 73 years after Leduc) is down 13.3% but that is partially seasonal because of spring break up. What has happened to manufacturing (-16.3%) construction (-19.4%), retail trade (-22.1%) and accommodation and food services (-49.8%) demonstrates that being in hydrocarbon business isn’t that awful by comparison.
Of note is that employment in finance and insurance grew, utilities were flat, and agriculture held fairly steady (-2.1%). Public administration also only shrank slightly. It clearly takes a lot people on public payroll to tell everyone else they can’t go to work, dispense advice, and supervise proper social distancing.
But looking ahead, compared to many other sectors oil is essential and therefore will recover with the economy. It is more capital than labor intensive and can be executed safely without large numbers of people working in confined spaces. You may not need a new car but you still need gasoline. People can live without a lot of things but not fuel, petrochemicals and plastics.
Last week Hertz, the venerable car rental company, announced it was seeking bankruptcy protection. When people quit travelling, car rentals plummet. As a former CEO quipped in a news story, “No business is built for zero revenue.” There’s a lot of that going on in the economy in many sectors.
The oil industry will indeed have revenue, and this requires more workers. Conditions will continue to improve in the weeks and months ahead.
There Will Be No Snap Federal Election
Confidence that the federal government will do the right thing for Western Canada and its oil and gas industry is very low. Cynicism if very high. No need to restate why here. Of all the industries that have been clobbered, only one has been singled out as not worthy of taxpayer support because getting rid of fossil fuels will make the world a better place. It is quite natural to be very suspicious of what is going on in Ottawa.
Recent polling reveals that the Prime Minister’s Trudeau’s daily homilies and billions of stimulus money for everyone and everything are popular. There has been speculation in the media that the Liberals will call a snap election and secure a majority government before anyone figures out how much the virus lockdown has cost the country, and how high taxes must to go get the public accounts back in order.
However, calling an election for no reason besides cementing a grip on power has never been popular. Although it seems much longer, it has only been eight months since the October 2019 federal election. The major issue among Canadians is the economy and their economic future. Normally a government falls over a non-confidence motion like a budget. There is no budget is sight and the House of Commons cannot reconvene in full for safety reasons.
Further, what matters to voters is changing fast. While climate change was among the top three issues during the last election, in a recent poll by Abacus Data revealed the number one issue is getting the economy functioning again and Ottawa should borrow and spend whatever is required to accomplish this. There is no evidence the Trudeau administration needs more MPs to do this.
Of interest, of the top seven issues Abacus asked Canadians about, the “transition to a clean, low carbon economy” was last. Political priorities are changing. California recently cut tens of billions in funding commitments for more renewable energy to redirect more funds to getting people back to work. California has historically been a leader on environmental issues.
The Globe and Mail reported May 24 that the Prime Minister will be consulting directly with the heads of Canada’s big six banks to plot economic recovery strategy. Excellent. They won’t recommend an election or more renewable energy.
A key strength to the long-term success of the federal Liberal Party has been figuring out what Canadians want and giving it to them.
Canadians don’t want an election and they don’t want to pay more for anything including energy. What they want is a job so they can buy food, clothing and shelter without a taxable government handout. This is not the time for partisan politics, and the Liberals will figure that out.
David Yager is a Calgary oil service executive, energy policy analyst, writer and author. His 2019 book From Miracle to Menace- Alberta, A Carbon Story is available at www.miracletomenace.ca.
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