Is the Albert oil sector poised for more growth or struggling just to survive?
This is Part 2 of an interview with Ted Morton – notorious Calgary School academic, conservative MLA and cabinet minister in several Alberta PC governments, and now a fellow of the School of Public Policy, from whence he comments on Canadian energy politics. Morton is a pessimist about the current state of the energy industry, but I’m much more optimistic. This is the last of our conversation about pressing issues facing the Alberta oil patch.
Ted: Reform of the National Energy Board has turned into a disaster. The climate change activists and Aboriginal groups have used it to slow things up and block Northern Gateway and then Kinder Morgan. Those people don’t want a better, safer pipeline, they want no pipeline because their real objective is to stop the growth, shut down altogether the oil sands, so they’re using the NEB simply as a means to further that goal.
Now, they have every right to do that. Anybody can use a litigation or administrative obstruction to try to achieve policy goals but from a governing perspective, the system is now very broken.
And they’ve been a number of submissions to the federal government how to correct this. There’s a consensus that you need a two-staged process to deal with the policy issues. Things like balancing energy resource development with climate change goals, meaning fiduciary duties with respect to Aboriginal consultation. Get all those policy issues dealt with in the first stage, say within 12 months and then get a recommendation with the NEB, then a yay or nay from the government,
If it’s nay, if it’s negative, fine, that’s the end, you haven’t wasted a lot of money. We can’t afford anymore scenarios like we had with Enbridge where they spent six years and over $500 million on the Northern Gateway pipeline project simply to be told in the end after NEB approval that they couldn’t do it. That risk has to be removed or nobody is going to run the risk of committing that kind of capital to new pipeline projects if there’s a risk of a repeat of Northern Gateway.
Markham: I assume then that you probably agree with all or most of the expert panel’s recommendations, which advocated that very structure.
Ted: I’d say there’s a fifty-fifty or maybe better than a fifty-fifty chance of that happening, but it has to happen.
Markham: I would argue that there’s a 100% chance of that happening. I interviewed Natural Resources Minister Jim Carr last year and we talked at length about the NEB. He says the NEB is broken and Canadians have lost faith in it.
The reason why it appears to be broken is that the eco-activists who oppose the pipeline deliberately broke it. They found some chinks in the NEB’s armour and they exploited it as a deliberate strategy to discredit the NEB. Their behaviour during the initial Energy East hearings demonstrated very clearly that they were willing to do it again with that pipeline.
I think that the only way the NEB goes forward is by adopting the expert panel recommendations and Jim Carr hinted during our interview that that, in fact, was exactly what they were looking for and it’s something that, long before I interviewed Carr, in fact, I wrote a column in which I said you have to get the politics in the policy out of the– the NEB has to separate them.
Ted: Yeah, you have to separate them. I think we agree on that and you’re 100% certain that’s going to happen, I’m mostly certain that that will happen.
Markham: Okay, fair enough. Next up, issues that make Alberta less competitive.
Ted: You’ve had both corporate and personal tax hikes, at least in Alberta. The corporate tax increase [from 12% to 14%], of course, makes it less profitable to do business here. The personal tax increases make having head offices and important executives here less desirable. You’ve seen the hard cap put on the oil sands emissions and there are still questions about whether that’s going to lead to stranded assets. You have a very aggressive so-called greening the grid electrical transformation here that’s going to lead to more expensive electricity for everybody who uses electricity.
You have new carbon taxes, both federally and provincially, that have to be paid. That’s the risk of carbon leakage and I link that particularly with the fact where the US is obviously under Trump and a Republican Congress. You’re not going to see any federal carbon taxes south of the border at least federally and so you have a real risk of carbon leakage there.
None of those by itself is fatal, but you put it together and again, I think the proof in the pudding for me is the list of international companies that have relocated– that they sold either all or most of their Canadian assets over the last 12 months.
Markham: Let’s talk about that.
Ted: You’ve got Statoil, you’ve got Shell, Marathon, ConocoPhillips, Apache, why are they leaving?
Markham: I interviewed a couple of Texas economists and they made the point that super-majors and the majors shuffle assets all the time – selling some, buying others – especially in a price downturn as they try to rationalize their assets and go back to core assets so that they have the lowest costs possible.
The interpretation from Ed Hirs at the University of Houston was that Conoco was under a lot of pressure to clean up its balance sheet – way too much debt and they’ve been looking to sell some assets for a while. Shell bought BG Group in early 2016 and announced that it would sell $32 billion of assets to pay for the $53 billion acquisition. So the fact that those two companies would sell assets, and they make up the bulk of the oil sands assets that were sold to Cenovus and CNRL, should come as a surprise to nobody.
And out of the $32 billion that was paid for those assets, by my calculations, about $20 billion of it came from Wall Street. So that to me is actually a vote of confidence in Canadian companies. Certainly, it attracted plenty of foreign capital when it was required.
So that’s my take on it.
Ted: I don’t think we see the vote of confidence for Cenovus’ acquisition of ConocoPhillips with what’s happened to Cenovus stock but that may be more unique to Cenovus than the more macro issues I’m talking about.
But, again, I would point out companies like Statoil pulled out of Alberta, but they’re still keeping their investments and even expanding their investments in places like [the Permian Basin in West Texas] which strikes me as a very negative statement in terms of Alberta’s competitiveness.
I would also point out that you have a number of Canadian companies that have reallocated more of their new capital south of the border. In terms of E&P companies, Encana and Crescent Point, for example, have all expanded their US operations and less than what they’re doing in Canada. Service companies have done something similar. Ideal, Total, Phoenix and even some of the pipeline companies, both Trans Canada and Enbridge have made big acquisitions in the US for pipeline expansion. So it’s not just the internationals are leaving Western Canada, even Western Canadian companies are reallocating assets south of the border.
Markham: Right, but the Western Canadian Sedimentary Basin has always been a high-cost basin to do business in and now those Western Canadian companies you mentioned, they’re investing primarily in oil in the Permian Basin, and I mean, everybody’s rushing into the Permian Basin. That “layer cake” rock has got the best geology in North America and keeps proving out the lowest production costs.
So the fact that companies again would reallocate resources to lower-cost basins than Western Canada, I don’t think that surprised anybody. Based on my interviews, it’s not so much a lack of confidence in Alberta as it is capital flowing to places where production costs are likely to be lower during a low-price environment. And here we are sitting at $47-48 today, and now the OPEC deal doesn’t look all that solid and it looks like we might have $50 oil for a couple of years. So you can certainly see why they would want to do that.
It’s a rational management decision and the economists I talk to don’t take the point of view you do. That’s both Canada economists like Kent Fellows and Trevor Tombe at the University of Calgary, Kevin Birn at IHS Markit, or Maria Sanchez at Drilling Info [Houston], or Bernadette Johnson at Ponderosa Advisors [Denver]. They all see this as companies reallocating assets to do the things that they do best and to be in basins where they can keep their costs low because they specialize in that type of production, whether it’s conventional or unconventional or oil sands. So that’s my take on it.
Ted: Well, if that’s true, then the situation is actually worse than I’ve predicted because what I’ve argued is that a lot of the capital flight, the money we see leaving Western Canada, not just by nationals but even by Canadian companies is in part policy-driven. What you’re saying is that it’s all market-driven and there’s nothing we can do about markets. We just have to wait it out, so it seems to me that the argument you just made is actually a more pessimistic scenario than mine.
Markham: In some ways, it is, I would agree with you. On the conventional side in Western Canada, I think that is probably true. But there was a study that came out a three months ago from Dinara Millington and her team at the Canada Energy Research Institute. They demonstrated that on the in situ side of the oil sands, that the Alberta policy goal of the 100 megatonnes emissions cap – which the oil sands producers had a role in drafting – was always to reduce carbon-intensity, not to reduce production. The CERI study laid out six technology pathways to easily meet the emissions objectives of the provincial government and if any of them were implemented, would keep the oil sands total emissions down to about 75-80 megatonnes from its current level at 70.
The study also found that by substituting solvent for steam would also lead to cost reductions of 34-40%. Under that scenario, you’ve got the happy coincidence of both lower carbon-intensity and lower costs.
And you have the marketing advantage that now you have oil sands heavy crude with a carbon-intensity on the California Air Resources Board index of 5-10, competing for against heavy crudes like from Nigeria, Venezuela, Mexico, where their carbon intensity scores are 22, 35, 50, 80. Alberta oil sands crude actually comes a net carbon benefit. No ‘dirty oil’, no more talk about a ‘carbon bomb’, now that’s actually a marketing push.
So I am optimistic. I think over the next decade, as the oil sands innovates and brings in new technology, it actually becomes much more competitive over time and fixes its PR problems around dirty oil. But I see your point with respect to conventional production, that sector could continue to experience some problems in a a low-price environment.
Ted: Fair enough. I guess I have one more trump card that I would’ve liked to have played but it’s just a survey, it’s that Fraser Institute Survey. Best jurisdictions to invest in, Alberta was ranked 43rd and most of the jurisdictions that we compete with for investment are ranked way ahead of it. Oklahoma, Texas, Kansas, Wyoming, North Dakota, Mississippi, Utah, Montana. A year before, Alberta was ranked 18th, so we’ve dropped from 18th to 43rd and the very jurisdictions that we compete with for capital investment are the ones ahead of us. I think you would say that’s because it’s lower cost production and I would say, yeah, that’s part of it but that’s also a lower cost policy as well.
Markham: No, there’s some truth to that argument because if you look at the three big oil basins in the US, the Permian is a very low cost, the Eagleford is a medium cost but the Bakken is actually fairly high cost. So to have the Bakken rank higher than Western Canadian conventional, that’s interesting. I haven’t unpacked that issue enough to have an informed opinion.
But on the issue of competing for capital, Kevin Birn makes the point that the industry has crossed a threshold. Going forward, it’s got its infrastructure in place.It’s built its big plants. It’s got its roads and its camps and all the other things that it needs and it’s gone from needing expansion capital to sustaining capital, which is now a lot less than the Permian and other basins because it doesn’t have the declining rates that those basins do.
So he estimates that going forward, the oil sands capital requirements will probably be about $25 billion every year. It’s just a function of the industry having completed one phase and now gone on to the next phase, which requires less capital. And during that time, let’s say from now until 2030, oil sands production is going to increase by about 1.5 million barrels a day.