Commentary – OPEC Deals Send the Wrong Message: Closing Valves is not Innovation

Commentary – OPEC Deals Send the Wrong Message: Closing Valves is not Innovation

Produced by Peter Tertzakian | by

OPEC and its cartel of friends must be sweating condensates in advance of their May 25th meeting.

The oil price war, triggered almost three years ago, is far from over. Calling a truce with production cuts has been an ineffective strategy. In fact, it’s been a feeble strategy and nobody in the business should rely on its extension to be effective.

Price wars are often triggered by the arrival of a new entrant into an entrenched market clique.

American light tight oil began flowing into petroleum supply chains in 2010. By 2014, output from plays like the Bakken, Eagle Ford and Permian had penetrated 4% of the world’s oil market, antagonizing starched interests in the industry.

There is a standard script for price wars that is played out in many businesses, not just oil. Airlines, pizza parlours and makers of high-tech equipment know the story line well.

Act I is the arrival of an antagonist, a new actor who tries to steal business from the old.

In Act II the leading defenders of market share lower their prices, flooding the market with cheap supply. The intent is to flush out the newcomer. Weak competitors are targets too.

By Act III all participants are overproducing to salvage market share. Prices collapse before intermission.

Tension peaks in Act IV as bankruptcy and distress claims high cost producers. The denouement takes place in Act V when surviving participants capitulate and the market returns to balance. Survival is predicated on financial strength, innovation and reducing costs.

Curtains close on Act VI, by which time long-term pricing returns to the market (often at lower price points than before the price war).

In today’s oil drama the resilience of many actors in Act IV (Bankruptcy and Distress) has been surprising. Producers like China, Mexico and Venezuela have seen their output decline due to underinvestment. But the declines have not been broad based; others have risen. Overall capacity shrinkage has not been fast enough to end the Act.

Act V was supposed to be when everyone capitulated. Surprise: Instead of being flushed out by lower prices, North American producers have been aggressively increasing productivity and driving down their costs.

The 2016 OPEC deal propped up prices, which was a gift to US and Canadian producers to keep going up the learning curve. While hard data is not all available yet, the EIA estimates that US rig productivities in major tight oil plays have increased by over 7% in the past six months, Canada’s operators are making similar gains.

OPEC’s issue—and other actors who are relying on OPEC for reprieve—is that the cartel is not following the correct script for ending a price war. Contrived “supply management” is not effective against a challenger that is bulldozing into the market with relentless innovation.

The appropriate defense against an innovative competitor is to innovate even faster.

In fighting a price war, closing a valve is not high up on the scale of innovation.

Tooling up to use the latest sub-surface processes and applying digital technologies is the future of low cost oil extraction. That’s what leading producers in the US and Canada are doing. And it’s why another OPEC deal is a fruitless strategy that merely extends Act IV: the demise of the inefficient.

Producers who are hiding behind a curtain of OPEC cuts are getting a misguided message. The implied narrative is, “Don’t worry, there is no need to improve your business practices and lower your costs through innovation. Everything will return to the good ol’ days once our supply cuts clear out the excess inventories of oil.”

On May 25th, oil markets are expecting that the OPEC-and-friends cartel will extend their supply quotas. And they likely will. However, the proper script would be to abandon the strategy of output cuts and let the market naturally choke off investment to the inefficient. Act IV can then play out faster, causing the production declines of high-cost defenders to set in faster.

Oil producers that follow the proper script of a price war will stay in business well after the curtains close. Those who don’t will die on stage from the sword of innovation.

Video – Larry Burns Interview – ARC Energy Investment Forum

Video – Larry Burns Interview – ARC Energy Investment Forum

Produced by Jackie Forrest | by

Larry Burns, former Vice President of R&D for GM, and current advisor to Google (now Waymo) on self-driving cars, outlines his views of radical change for human mobility at the ARC Energy Investment Forum.

May 1, 2017 Charts

May 1, 2017 Charts

Produced by wp_user | by

The CAD fell by nearly a cent on the week; The US added 193 MB/d of production in February; The US rig count rose by 9 last week.

Commentary – Changing Investment Behaviour in the WCSB

Commentary – Changing Investment Behaviour in the WCSB

Produced by Peter Tertzakian | by

If dollars were votes the Canadian oil sands is getting an approval rating of about 55% this year. Maybe that sounds like a great number for a politician. But for ongoing oil and gas projects a “re-investment ratio” less than 100% is a vote of non-confidence relative to other hydrocarbon jurisdictions.

Some point to the loss of oil sands investment appeal—amplified by the exit of multinationals like Shell, ConocoPhillips, Marathon, Statoil, Murphy Oil and probably others to follow—as evidence of Canadian uncompetitiveness. But that’s a half-barrel interpretation.

No investor will deny the unattractiveness of cost inflation, increased taxes, regulatory burdens, social activism and dithering on project approvals. But Canada’s oil and gas industry is much more than just a low orbit around Fort McMurray. If anything, the shift of dollars away from the oil sands is validation of a much bigger global mega-trend: The unstoppable suction of investment capital toward light, tight oil, liquids and gas plays in American states like Texas. And the pull is also drawing capital to similar hydrocarbon resources here in Western Canada too.

In fact, this year Canada’s oil and gas industry will invest twice as much in plays outside the oil sands as in.

Like in any business, resource investors like to recycle their cash flow from production into places that make money. The faster the payback the better. They’ll keep reinvesting until their belief in making returns wanes, or until they realize that there is greater and faster money to be made from developing resources elsewhere, like Texas or other parts of Western Canada. The latter explains why capital is moving out of the oil sands. In fact, capital investment is flowing out of many places around the world, not just the bituminous reserves of Northeastern Alberta.

Let’s consider the domestic numbers. The fraction of cash flow generated from producing oil projects that is recycled back into the next set of projects is termed the “re-investment ratio.” A full re-load—or a 100% ratio—is a strong vote of confidence. Sugar coating the next project with some extra equity capital or debt levers the conviction above 100%, amplifying the belief that there is money to be made over and over again.

Figure 1 shows the historical re-investment ratio for the oil sands, which up until 2017 has been close to or above 100% for all years since 2005. Even during the Financial Crisis it was almost double what it is now.

While growth capital for the oil sands region is on hold for the foreseeable future, the investment behaviour in the rest of Western Canada’s oil and gas business validates the appeal of our light oils, liquids and natural gas. Plays like the Montney in West Central Alberta and Northeast BC are showing very well. Capital investment outside the oil sands region is expected to be over $C 29 billion this year, a 40% gain over last. An expected re-investment ratio of 140% is a solid affirmation that the same technologies and processes that are making the plays like the Permian Basin famous are also delivering favourable returns in Canada at $US 50/B.

Some are bothered by the capital pass of the oil sands. But the region’s relevance is not going away. After $C 200 billion in investment over the past decade, the gigantic facilities in Canada’s north will keep supplying three-percent of the world’s oil addiction for a long time to come; to do so will require $C 10 billion to $C 15 billion in annual sustaining capital.

At the same time there is no denying that there are now more attractive ways of adding new barrels to the market.

It may surprise many Canadians that investment in hydrocarbon resources outside of the oil sands has been a major contributor to the economy for a long time, even during the boom days when capital spending peaked. In 2014, over $C 33 billion was invested into the oil sands; outside the oil sands region another $C 47 billion was spent in the Western Canadian Sedimentary Basin (WCSB). Spending on the latter is returning quickly on the back of innovation and productivity gains.

Shifting emphasis is nothing new in the oil business. Around the world, a century-and-a-half of hydrocarbon investment has followed a savvy pattern of migrating toward geological locales that deliver the best returns under the prevailing constraints of commodity prices, geopolitics, technology and other economic factors.

Although capital flows are clearly favouring US plays like the Permian Basin, the approval ratings of newly developing resource plays in the WCSB are increasingly positive too.