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A game of bulls and bears

By Tobias Ma, April 2 2015 —

In early February, oil prices rebounded into the $60 per-barrel range for West Texas Intermediate (WTI).  However, Stephen Schork, a well-known oil stocks analyst, referred to the price jump as a “dead cat bounce.” 

In financial lingo, a dead cat bounce describes a small, brief recovery in the price of a declining stock. The term stems from the notion that a dead cat hitting the ground will still bounce into the air before touching down for good. 

Where analysts like Schork might have tested this notion and why they chose to incorporate it into a financial metaphor is as potentially upsetting as the future of our province’s oil. WTI plummeted to a six-year low on March 16 amidst a slew of cuts from energy companies across Alberta. Schork might seem weird for talking about dead cats on national television, but he was right about the price of oil going back down the tube.

The Organization of Petroleum Exporting Countries (OPEC) is the governing entity of some of the world’s biggest (and most politically unstable) players in the oil industry. 

Historically, OPEC has played a regulatory role in each country’s production. Unchecked production results in oversupply and low oil prices. OPEC has intervened in the past to limit production so that oil-exporting nations don’t drive prices into the dirt by competing with each other. 

Last year, Saudi Arabia, the largest producer in the world and the de facto leader of OPEC, refused to curb production and geared up for a game of chicken with their competitors and political rivals. The resulting low prices have damaged the Saudi treasury, but have also put pressure on Iran, Russia and U.S. shale oil startups. 

Saudi Arabia is well-stocked and well-positioned for a price war. Ibrahim Abdulaziz Al-Assaf, the kingdom’s finance minister, said in February that his country has already “built buffers to help us in sustaining our policies,” meaning that they have saved billions of dollars to prepare for this play.

Saudi Arabia can survive a lower price dip than other countries by virtue of their product. The kingdom possesses an abundance of conventional, easily extractable oil, making their production costs cheaper than all of their competitors. 

Saudi Arabia also possesses the dubious advantage of gross economic stratification. The average salary is around 16,000 SAR (Saudi Arabian Riyals), which equates to $5,000 CND. The International Energy Agency estimates that the cost of extracting one barrel of oil in Saudi Arabia ranges from $1–2 USD. After capital and overhead costs like worker pay, the final cost of producing one barrel hovers at $4–6.

According to the National Energy Board, the extraction costs for a barrel of Canadian crude are around $10–$14 CAD depending on whether the oil is produced via conventional mining techniques or Steam-Assisted Gravity Drainage (SAGD), a method that extracts oil by injecting steam into the ground, causing oil to rise to the surface. With additional costs such as specialized mining equipment, higher wages for labour and the cost of upgrading the tarry bitumen to synthetic crude, it costs around $36 to $40 to produce a barrel of useful Athabascan oil from a new operation. 

This means that in order to gain a 15 per cent profit, an average barrel of Canadian crude requires a global WTI buying price of anywhere between $40 to $60 USD, depending on the company and the project. Aramco, Saudi Arabia’s national petroleum enterprise, could accrue a 20 per cent profit if the price of WTI fell to $8 per barrel.

All of the Ford F-150s appearing in Albertan used car dealerships might make this price drop seem like the end of the world, but take comfort in the fact that others have it worse. 

Low crude prices have hit small American producers spearheading the shale oil revolution hardest. Shale deposits are found in abundant supply throughout the U.S. but were previously considered a niche product due to the energy required for extraction and refining. Advances in technology have dramatically reduced the cost of converting shale into usable crude, which has encouraged American entrepreneurs and investors to explore shale reserve development.

A RAND Corporation study projected that further developing infrastructure for shale oil could reduce the costs per barrel from $70–95 to $30–40 USD. This figure resembles that of Canadian tar sands oil, but shale is still a ways off from that price point.

Much like the warlike spice traders of Frank Herbert’s Dune series, Albertans have built their entire economy around the extraction of a single resource. We are within rights to feel paranoid and oppressed by the crude price drop. However, we should keep in mind that OPEC’s refusal to cut production is a reaction to global oversupply, not a cause of it. 

Saudi Arabia is muscling out shale companies before they turn the U.S. into an energy-independent state, as well as putting political pressure on its oil-churning rivals Iran and Russia. Canada, as usual, is a bystander caught in the crossfire. At the end of the day, we are not a big enough player on the global energy scene for a superpower to try cutting us out. Canada ranks tenth on the list of oil exporters at around 1.5 million barrels per day. Saudi Arabia exports more than five times the amount.

Canadian unconventional oil producers have advantages over their American counterparts because her large energy companies are well-established and acclimatized to dealing with market fluctuations. Shale producers are young, small companies without established cash flow, running prototype operations with inevitably high overhead costs. And for better or worse, corporate income taxes in Alberta come out to 25 per cent compared to 39 per cent in the States.

All of Canada’s advantages can and will be eradicated if the competition down south is given room to grow. America can out-produce and out-construct Canada on every front. If shale gets fat off of sustained high prices, Canadian oil companies could find themselves looking at a more permanent downturn.

So while OPEC’s refusal to curb production might seem like an anti-social business practice, it could benefit Alberta’s economy in the medium term. The number of U.S. rigs has dropped by 60 per cent since October’s crash. I’m not suggesting that we celebrate the loss of livelihoods, but the harsh reality is that only so much market share is up for grabs. By denying part of that share to the U.S., Saudi Arabia has delayed the possibility of Canadian oil’s biggest consumer transforming into a producer.

Another offset to low oil prices is low construction costs. Skilled labour has consistently been Alberta’s most badly-needed resource, and big projects regularly engage in bidding wars to retain tradespeople. Although many projects around Fort McMurray have stalled or seen cancellation, surviving projects can expect a more dependable and affordable supply of able bodies than before, as well as lower fuel costs for their site vehicles.

Oil politics are complicated, which seems a glib point, but even the most well-respected analysts can miss the knock-on effects that decisions have years down the road. One article by Mike Priaro, a consultant writing for the Calgary Herald, suggested that Barack Obama’s decision to veto the much-debated Keystone XL project is actually good for Canada’s economy, since we should focus more on pipelines like TransCanada’s Energy East to promote the use of Canadian refineries.

Had Obama approved Keystone, the increased flow of oil to Texas may have only further contributed to market saturation, which has glutted the U.S. so badly that they no longer have space to store their crude.

Canada has depended on resource extraction to build her fortune. This is a natural consequence of having a small population and a lot to go around. Canada should take advantage of these blessings, but should invest intelligently into her energy future, which means finding out how to diminish her presence in an American market that constantly looks for reasons to get rid of us. 

The cost of labour makes maintaining refineries in Canada difficult, but if we continually send our product down south to be refined and sold back to us, we undermine the benefit of reduced export costs associated with a lower Canadian dollar.

If I had a Magic 8-Ball that told me the future price of crude oil, I would be screaming on a trading floor somewhere with cocaine on my nose, not writing articles for a student newspaper. 

But I can make a cautious prediction based on experts’ opinions, as well as the data they’ve used to suggest business and policy decisions. Albertan oil will survive, although the sting of this price drop will linger. There will be no cataclysmic collapse, despite the doom and gloom prophesizing of gleeful Financial Post commentators from Toronto. 

While optimists say a price recovery of up to $80 per barrel of WTI is possible by the end of 2015, current trends point to a time frame of around 2016 or 2017 before we can hope for a return to high times. 

And those times won’t last forever. Shale technology is here to stay — we can’t exactly burn down Rome in the hope of destroying its knowledge. Once prices are up, American rigs will come back online and Albertan producers will find themselves in competition all over again. Michael Moore, a professor from the University of Calgary’s School of Public Policy was recently quoted in the Herald as saying, “The wildcat image of the oil-sands industry is probably coming to an end. . . Expansion is going to become more focused on existing assets and the business will become more predictable and stable.”

What does this mean for students hoping to enter the industry? Should prospective petroleum engineers take up bong design instead, or prepare to sell their swords to the oil barons of Nigeria? 

It depends on your objectives. Don’t base your decision to study finance or engineering on the expectation of landing a six-figure job at an oil company straight out of convocation. Those jobs exist, but they’re drying up and the string of industry layoffs mean that you’ll be competing against individuals with far more experience than you. 

Alberta’s oil industry does not need uninspired slugs hoping to stumble onto a gravy train that’s already running on fumes. The industry needs critical thinkers who know what it takes to compete on an international scale. Part of this is hard work, yes. 

But consider that East Asian engineering firms regularly make their employees stay past 8 p.m., that the U.S. has over nine times the potential workforce that Canada does, and that the exploitative tactics of Saudi Arabia’s temporary foreign workers program makes our own seem like charity. 

We will not survive on brute force alone. What Canada does have are some of the best universities in the world and a cultural inclination towards research, innovation and stewardship. That’s where you come in.

When he’s not pretending to be a journalist, Tobias Ma works as a cost analyst at an oil and gas corporation.

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