Commentary – Dark Days for Black Gold
Some used to call it Black Gold.
Back in the good ‘ol days of John Wayne, crude oil gushing from a well was a thing of value. These days, neither the black stuff nor gold is worth much. Both commodities have been clobbered in the market; oil down 50% from last year’s average; gold down 20% from 2014 highs. But it doesn’t end there. Other valuable natural resources like iron ore, nickel, and copper, have been thrashed by double-digit price drops too.
None of this is good news for Canada, a country that makes a living selling these raw goods to the world.
You may be surprised to know that energy and mining directly contribute about 14% to the nation’s GDP. But that’s not all. When you consider multiplier effects into other segments – commercial real estate, banking, heavy manufacturing and so on – the contribution is easily over 20%.
Or at least it was. In less than a year, places beyond the far longitudes of the planet – for example Greece, China and Iran – have soured the economic headlines for the sweet resource commodities that Canada sells.
So it’s no wonder there is a lot of talk about the “R word”, or recession, in Canada. We don’t need to get wrapped up in euphemisms and definitions to get the gist of what’s happening in our economy. Bloomberg’s global Commodity Index is at a 13-year low and down by 25% relative to last year – so a fifth of our GDP is no longer going to be a fifth, and the whole of our economy is likely to shrink this year.
Recognizing what’s happening, the Bank of Canada sliced interest rates by 25 basis points closer to the knuckle. As expected, the Loonie took a hit, and is now worth 23% less than the US dollar. That was good news for Canadian resource producers, who sell commodities in high-valued US dollars, and pay expenses with discounted Canadian currency, but the mild bump in Canadian dollar revenues won’t be enough to resuscitate resource industries in 2015, and probably not ’16 either.
Let’s take a look at oil. The $US 50 to $55 per barrel price average expectation for this year hasn’t changed since first quarter, and lingering oversupply in wells, pipes, tank farms and tankers is now likely to extend well into 2016.
Second quarter numbers for producers and service companies are due to start coming out and they are not likely to be good. July, which is the start of the third calendar quarter, is off to a bad start with prices falling $10.00/B under the June average. Board meetings, which are convening over the next few weeks, will be heavy on the coffee and light on the jokes. Budget planning for 2016 has already begun. Next year’s capital expenditures will be decided by the end of September and approved no later than mid-November. The die is already cast for next year, and the winter drilling season is looking to be, at best, a lame re-run of 2015.
It all sounds grim, and over the near term it is. But there is some solace: the depressed low-price situation is not only Canada’s to bear. All natural resource producing nations are in the same predicament with varying degree. Investment is drying up, because there is little cash flow to put back into the ground.
Take for example Mexico, long touted to be the next rising star in the global oil business. Following government reforms, the Latin state tried auctioning off some of their most prospective land blocks about a week ago. Expectations were jolted when only two of fourteen blocks were sold. The remaining dozen didn’t solicit any acceptable bids.
A lack of bids for Mexico’s prospective oil riches should not be a surprise. Risk takers want black gold, not tarnished pewter. About half of the world’s oil supply doesn’t make investment sense at today’s oil prices. And with cash flows down sharply, oil and gas companies don’t have much money to put in the ground, even in places where the rocks might make sense. All of which is to say that today’s oil prices are not sustainable for creating the capacity required to meet long-term consumption growth. And the same is true for other extractive resource industries where commodity prices have been hammered down in the markets.
Unfortunately, the long lead-time between price signals, investment and output in extractive industries means that supply and demand trends are rarely synchronized. The third quarter will be bringing more bankruptcies, forced consolidations and most destructively, more loss of human capital – in other words, layoffs. At the same time, the damage to the supply side will be juxtaposed against growing levels of consumption for cheapened commodities. For oil, the demand side will be at record levels, averaging 94 million barrels per day in 2015.
So the market is working (painfully) to bring oil and gold back into the black again. And that’s why the term Black Gold endures.