Commentary – The Big Themes for Canadian Oil and Gas in 2016

Source: www.Dreamstime.com © Forgiss
Source: www.Dreamstime.com © Forgiss

This commentary was originally published in the Petroleum Economist’s Outlook 2016. This version has been modified from the original publication, in order to account for the most recent information.

Gazing into the horizon to predict the future is always hazardous; especially when you consider the stormy conditions of 2015. Despite the choppy waters, the big themes that will shape the Canadian oil and gas industry in 2016 are gradually coming into view. Here are five themes to watch for on the horizon:

1. More Capital Spending Cuts

In 2015, the Canadian industry cut its capital spending by almost 50% compared to 2014. Even with these downsized spending plans, company cash flows still could not pay all of the bills, and the industry had to raise about $20 Billion of external capital (debt and equity) to make ends meet. In the first half of 2015, Canadian companies were relatively successful at finding the external capital they needed, raising about $C 12 Billion (a figure that was just 15% below the same period in 2014). However, after a strong showing at the start of the year, the flow of external capital declined to a trickle in the second half.

Assuming that oil prices remain less than $50/B in 2016, it is likely that external capital will remain in short supply. A lack of money will force companies to reduce spending to a level that is closer to the amount of cash they generate. Companies are already planning for less spending. On average, 2016 guidance is pointing towards about 25% less spending compared with 2015 (for both oil sands and non oil sands).

2. Improving Efficiency

Thin margins are forcing companies to devote their time and brightest minds to focus on cost cutting measures. Canadian industry costs were slashed in 2015. Oil field services were discounted by as much as 20-30% from a year earlier.  And, after years of inflation at near double digit levels, Canadian operating costs also fell. Company’s general and administrative costs are shrinking too.

The downturn is forcing companies to innovate and find more productive techniques and processes for doing things. Assuming prices stay low in 2016, the industry will make even more progress in improving their efficiency and competitiveness, helping to put companies on a more profitable path when prices do recover.

3. Growing Canadian Oil Sands Production

As a result of final investment decisions that were made when the oil price was higher, over 400,000 B/d of new oil sands capacity was commissioned in 2015,  and almost 400,000 B/d more is still under construction. The additional capacity of these projects guarantees that oil sands production will grow until the end of the decade.

But do not be fooled into thinking that the oil sands are immune to low prices. In 2015, 17 oil sands projects were announced to be either delayed or canceled. However, the full impact of these postponement decisions will not be completely apparent until the latter part of this decade, when investment in current projects under construction ramps down and there is a void of new development following behind.

4. Slow and Steady Progress on West Coast LNG

Western Canada has world-class shale rock deposits. But to realize the full potential of Canadian shale gas, Canada needs to export LNG beyond the saturated North American market. Compared to the United States, Canada’s LNG projects are more complex. Upstream resources must be developed, expensive pipelines must be built through remote mountainous areas to reach the coast, and new LNG facilities must be constructed in isolated communities on Canada’s West Coast.

Despite the challenges, Canada has some considerable advantages over the US projects, including shorter shipping distances to Asia and a lower natural gas price compared to Louisiana’s Henry Hub. Because of these advantages, Canadian projects will continue to make progress in 2016. Indicators still suggest that the first LNG tanker will set sail from Canada’s West Coast sometime in the early 2020s.

5. Ongoing Focus on Expanding Crude Oil Market Access

Three years ago, due to a shortage of pipeline capacity, Canadian crude oils were frequently discounted. But over the past few years, despite the Keystone XL (KXL) saga, the situation has improved. Discounts have shrunk as a result of expanded options for crude oil transportation.

But, even considering the improved situation, there is still a need for more crude oil pipelines. The oil sands are still expanding and the KXL cancelation has only intensified the desire to export crude oil beyond the United States. Despite fiscal challenges for the oil industry and public opposition to pipelines, efforts to expand market access will remain a priority in 2016.

We are not even two weeks into the new year, and already 2016 is looking like another very tough year for companies and workers in the Canadian oil patch.  But there is still reason to remain optimistic. Ongoing oil sands expansion will help the economy this year, projects aimed at diversifying the customer base for both natural gas and crude oil will make progress, and the industry will continue to lower its cost structure. While 2016 is expected to be another difficult year, it will ultimately help to position the industry for a more profitable future when prices recover.