Commodity Blog

Archive for October 21st, 2008

With oil prices tumbling below $70 US per barrel on Thursday — to their lowest levels since August 2007 — one might think the sky is falling. It’s equally tempting to start pointing fingers at all the elected officials who were crying for inquiries last July regarding the high price of oil; if they were so convinced the price had been driven upwards to the record close of $145.29 price by speculators, it’s surprising they are not suggesting the short-sellers have driven it down.
But no. The high price is about politics. The low price of crude means consumers are no longer phoning constituency offices to complain about be gouged at the gas pump. It’s safe to assume, therefore, taxpayers dollars will not be wasted looking into why oil prices have fallen so far, so fast.
All kidding aside, however, it would be foolhardy to suggest that there hasn’t been a collective gasp in Canada’s oilpatch as crude prices have plummeted; investors had gotten used to seeing a triple-digit price for crude, even though the market was not valuing energy stocks at that level, nor were companies planning capital expenditures with oil beyond the century mark.
While no one really believed an oil price beyond $100 was sustainable, companies and investors had gotten used to it. It’s now back to reality — where prices will be a more accurate reflection of supply and demand, at least for now.
Here are a few things to chew on.
First, the oilsands projects that are up and running are not at risk. As FirstEnergy’s William Lacey was quick to point out Thursday, oilsands operations did not shut down when oil hit $10 a barrel in 1998 and early 1999.
“They will keep running, no matter what. .. unless there is a massive shift somewhere. .. these are not easy projects to shut down or start up. But it’s the new projects like Fort Hills that we estimate need a $115 oil price to achieve a 10 per cent after-tax return, that are in the territory of now being uneconomic,” he said.
As to what the break-even oil price is for these operations, Lacey says the way to look at it is the cash cost per barrel to operate. The cash cost calculation typically includes operating costs, including expenses such as general and administrative costs, royalties and interest expense.
He says Suncor’s all-in cash cost is $46 a barrel, with $33 being associated with operating costs. Canadian Oil Sands Trust pays out $43 per barrel, of which $27 is related to operating expenses.
Meanwhile, Imperial Oil’s Cold Lake operations are the cheapest to run — $30 per barrel, with $17 being the operating component.
In the context of Suncor and its $20-billion Voyageur expansion that was announced in January, Lacey says the company has the luxury of slowing down the development of the four-phase, in-situ development.
“At $60 a barrel, Suncor doesn’t have enough credit to get through 2009 in terms of funding Voyageur from debt and cash flow, but at $80 a barrel it can easily meet the costs through 2009,” he says.
The good news, then, is that in each of these cases, a $60 oil price doesn’t shut anything down. Besides, the lower commodity price environment that is driving down the value of the Canadian dollar means cash flows go up for any company producing a commodity priced in U.S. dollars. The price for WTI might have closed at $69.85 US per barrel on Thursday, but Edmonton Light ended the day at $85.89 Canadian.
So that’s one argument against the ”sky is falling” sentiment. And that’s the short-term view.
The long-term view gets more interesting.
That’s because a low oil price — and therefore low gasoline price — is going to do nothing in the context of encouraging conservation or prompting reinvestment.
If the oil price — and therefore prices at the gasoline pump — remain low for the next 12 months, there is no reason to believe that the dramatic drop in gasoline consumption that has been recorded in the U.S. will continue; low gas prices means the mothballed Hummer will soon be back on the freeway. And this does nothing to solve the long-term issue of the U.S. addiction to oil.
The second point is that low prices, tight credit markets and no possibility of raising money through the sale of shares means companies will not be stretching themselves on the reinvestment front. When the global economy resumes its growth, the supply issues will not have been solved; they will have been made worse. Don’t forget that the Middle East accounted for a big share of the growth in oil consumption in 2007, while China was responsible for about a third. Then there’s the subsidy factor — with Venezuela selling gasoline at 16 cents a litre; these practices or consumption patterns are not about to change.
The only thing that might come out of all this is a round of acquisitions by companies — especially the super majors — that have big cash positions on their balance sheets and have struggled to add reserves. ExxonMobil has been one company whose name keeps surfacing; it could easily scoop up the 30 per cent of Imperial Oil it doesn’t already own for about $8 billion and still have money left over. There were also reports Thursday that BP — which has suffered in Russia with its BP-TNK joint venture — might just be looking at natural gas producer Chesapeake Energy because it too has been challenged in terms of reserve additions. Royal Dutch Shell is another company whose name keeps coming up, for similar reasons.
As they like to say in these parts, all these companies with sizeable cash positions are sporting big hunting licences.
In the short-term, however, hard as it may be, it’s important to remember that the oilpatch has been through much worse over the years. It is better capitalized than it has ever been and even at $60 oil will be generating more than enough cash flow to fund operations — even reinvestment — because costs are coming down.
The reality is that the high prices over the past year had stymied the asset sale world because of the huge gaps in terms of expectations between buyers and sellers; lower prices and the tight credit markets means the old-fashioned values of succeeding on the basis of competitive advantages, looking for growth opportunities at reasonable prices and using plain vanilla financial instruments to meet financing needs are back.
The world has changed. But in the context of long-term oil prices, the question of supply has not been solved and low oil prices only serve to push up demand. All this does is set the world up for higher prices in the years to come.