The price of a barrel of oil is determined in far off lands, displayed instantly on nearby screens.
How long does it take that dollar-per-barrel flicker of pixels to trickle down to the sound of swipes and taps of buying stuff in our broader economy?
That question relates to a wider collection of FAQs that I’m being asked these days, including: Has the oil and gas industry hit bottom? When are things going to turn? What is the outlook for jobs; for drilling activity and services in rural communities? For inter-provincial employment? The real estate market? Restaurants? Coffee line ups? And so on.
Anyone with a stake in the oil and gas business – which is almost everyone in Alberta’s resource-dependent economy – is wondering about the timing of a recovery from the deepest downturn in four decades.
And for good reason: Every positive dollar change in the price of oil at Cushing, Oklahoma – sustained over a year – translates into around $C 1.5 billion worth of upstream revenue that first funnels through the office towers of downtown Calgary. Since the costs do not change much at this higher price level, the extra revenue almost all streams into cash flow and can be reinvested back into field activity, which then multiplies into the broader economy. Consider this: Every buck-a-barrel on the upside can provide an economic kick that’s the magnitude of a government stimulus program.
But cause-and-effect is seriously lagged coming out of a cash drought. It’s like turning the tap on an empty garden hose – you have to wait a while for the water to come out the other end to hydrate the garden.
Here is a timetable for how a change in up-front price, flows out the back-end nozzle of economic growth.
Time zero: A trader sells an oil producer’s barrels for an incremental buck. His screen flashes the trade. All in a day’s work. Repeat tomorrow.
One month later: Cash is received by the oil producer. A banker eyes the account balance and taps a few numbers into a spreadsheet. Good news, the overdraft is in order. Producers pay routine salaries, rents, interest, royalties, taxes and other bills. Finally, there’s a bit of left-over coin that may be used for re-investment.
Three months later: Producer has a board meeting. Directors have a heated debate about the sustainability of the higher oil price. Plenty of warranted skepticism. Also diarized: Bankers want some money back. The board discusses spending more on new drilling activity. Discussion ends. Caution prevails: Only a few of the best-inventoried prospects get some funding.
Six months later: Next quarterly board meeting. Oil price rise is now convincing. But raised palms still urge caution. Directors expand the producer’s budget to drill some new wells. Investment banker called up to raise some equity capital. Starving service companies called up shortly thereafter. Anticipation of activity builds. Savvy stakeholders can hear the metaphoric water coming down the hose. The turn of the tap is believable.
Nine months later: Drilling activity picks up. Peripheral service companies return to work too. Some paychecks start looking better. Decimated oilfield service companies need more people; hiring in the field begins again.
One year onward: Water finally comes sputtering out of the hose; the first convincing signs of “green chutes” on the ground. Spending begins to multiply into the local Alberta and Saskatchewan economies. Cautious re-hiring begins for professional staff at head offices (assuming positive price trends sustain). Coffee line ups form again.
Eighteen months later: The sun finally shines on pent up retail therapy. Dollars spill over into the rest of Canada. Traffic buildup erodes the previously pleasant Calgary commute.
Since February, the monthly average price of West Texas Intermediate (WTI) oil has risen from $US 30/B to $US 49/B. The 60% appreciation was significant, but rising back above $US 45/B only stopped the average producer from losing money.
From the perspective of generating broader economic activity and employment, the drought persists, and the hose is empty for any price below $45/B.
So where are we in this flow now? Macro indicators suggest that oil prices have probably seen their lowest trading days. From now on, every sustained dollar-per-barrel above $US 45 will flow into the economy – but only in time. It will take at least a year to see the growth on the streets.
Nevertheless, smart stakeholders already have their ear to the hose, and are seeding their gardens in anticipation.
© 2016 ARC ENERGY RESEARCH INSTITUTE. All Rights Reserved.