Another day, another setback for Canada’s producers

By Nathanial Gronewold | 11/09/2015 07:44 AM EST

The Obama administration’s rejection of TransCanada Corp.’s Keystone XL oil pipeline project Friday is only the latest setback for Canadian oil producers.

Its oil and gas industry has suffered blow after blow this year, and more pain is in store as companies there struggle to cope with an unexpected economic and political storm that has sunk their fortunes.

The rejection of Keystone XL follows two political defeats, the huge plunge in oil prices and continually weak natural gas prices on the list of mounting challenges facing Canadian oil and gas firms. Tax increases and revisions to royalty structures are next.

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The oil industry across North America is reeling from the oil price crash. But Canadian oil producers are getting hit especially hard. Conventional drilling activity has fallen substantially, and high-cost oil sands projects continue to be canceled, though ongoing work continues. Data from oil field services company Baker Hughes Inc. show 225 drilling rigs have been pulled from service in Canada compared with the active rig count one year ago.

"The energy-related economic sectors are definitely taking a strong hit in Canada," said Dinara Millington, vice president for research at the Canadian Energy Research Institute (CERI).

With huge fanfare, President Obama publicly rejected TransCanada’s request to cross the border with Keystone XL, citing the lack of substantial economic benefit to the United States along with the current push for progress on addressing climate change (Greenwire, Nov. 6).

The news came very shortly after TransCanada formally asked the Department of State’s review of its proposal be postponed, citing regulatory uncertainty in Nebraska. By then, Keystone XL’s delayed status was the least of the industry’s concerns north of the border.

In two back-to-back stunning electoral defeats, staunch allies of Canadian drillers were unseated from power, first in Alberta and then nationally, when firm Keystone XL supporter Stephen Harper was unseated from his decadelong rule by new Prime Minister Justin Trudeau (EnergyWire, Oct. 22).

New governments in the oil-heavy province of Alberta and nationally in Ottawa have promised to partner with the industry, but also indicated that the special treatment afforded to it by the prior conservative regimes is over. In a formal statement, Trudeau expressed regret over the U.S. decision on Keystone XL but also vowed to move beyond the contentious topic, arguing that "the Canada-U.S. relationship is much bigger than any one project."

"We are disappointed by the decision but respect the right of the United States to make the decision," Trudeau said.

Millington at CERI estimates that the oil price plunge has resulted in up to 38,000 direct job losses for the industry in Canada. Echoing other forecasts, CERI sees total Canadian oil output climbing as new oil sands projects currently being built enter into service, but she said the steep drop in other drilling activity could see up to 350,000 barrels per day of new production simply not becoming reality in the current business climate.

A recession is projected for Alberta, and Canada as a whole, but CERI sees the overall economic picture as mixed.

"They’re negatively impacting the energy sector but positively impacting non-energy-related sectors," Millington said of the low oil prices. "We’re seeing net results overall that Canadian GDP [gross domestic product] would be negatively impacted from low crude prices. However, among all the other variables, such as compensation taxes … employment is an interesting number because we are seeing this is the least-impacted variable."

The low crude price is being matched by weakness in the Canadian dollar. That’s benefiting Canadian manufacturers two ways — lower energy costs help them save on transport, and the weaker loonie aids them in exporting to the United States and globally.

The lower value of the Canadian dollar is also helping Canadian drillers in bringing down their production costs, something that’s critical for companies to survive the current downturn.

Carlos Murillo, an analyst with the Conference Board of Canada, says industrywide costs in Canada have come down by 15 to 30 percent. It won’t be enough to put the industry back on a healthy path forward in the short term.

"We’ve been calling for a recession in Alberta, which is the largest oil-and-gas-producing region in Canada," Murillo said.

As in the United States, the financial health of Canadian oil producers depends on how diversified their businesses are.

Canadian Oil Sands Ltd. reported a third-quarter 2015 net income loss of 174 million Canadian dollars. Suncor Energy Inc. reported a net loss of CA$376 million but reported that it was helped by the exchange rate and strong refining and marketing profits. Both companies are currently in dispute over Suncor’s proposal to purchase Canadian Oil Sands, a move regarded by the latter as a hostile takeover.

Lost conventional and unconventional rigs are followed by postponements or outright cancellations to some oil sands expansion work. Two weeks ago, Royal Dutch Shell PLC announced suspension of its Carmon Creek project.

Growth expected in oil sands

The Canadian and U.S. oil sectors differ in one important respect. Whereas oil production in the United States is now believed to be declining, Canada’s total oil output is expected to rise over the coming years. CERI, the Conference Board and the National Energy Board all hold this view.

"On the oil sands side, we’re actually forecasting an increase in production," Millington explained. "In terms of the growth rate, it is not growing as fast as it has over the last five years, but it is growing. We’re forecasting that production between 2014 and the end 2015 is going to grow by 100,000 barrels per day, and approximately the same amount for the following years after that."

Cost-cutting efforts underway across the Canadian oil industry "are not going to impact projects that are currently under construction," she added.

Murillo expects declines in Canadian conventional and shale production to be more than offset by an addition of 800,000 barrels per day of capacity from the ongoing oil sands expansion projects. But once those projects are completed, no one really knows whether output will grow or plateau.

What is for certain is costs to Canadian producers will increase, even as they struggle to bring them down.

Cost increases will come in the form of new taxes. Alberta’s new left-of-center government is proposing a budget that will increase the corporate income tax in the province, from 10 to 12 percent.

"It’s not huge, but it is a 20 percent increase," Murillo pointed out. "It’s still one of the lowest-taxed jurisdictions in North America and around the world, but it’s still an increase in taxes."

And the industry in Alberta knows there are more government-imposed cost increases to come. Alberta’s new government has put together two panels to review oil and gas royalties and the province’s climate change policies. While the outcomes of those reviews aren’t expected for several more months, Murillo said it’s almost guaranteed that the panels will propose an increase to royalties paid by the oil industry.

Major carbon emitters are also bracing for an increase to a levy paid for companies that generate more than 100,000 tons of CO2 a year. "They’re going to increase the levy from $15 [Canadian] per ton, which is what it currently is, to up to $30 per ton in three years," he said.

Still, Murillo stressed that the relationship forming between the oil industry and the new political establishment is far from adversarial. Both the ruling New Democratic Party in Edmonton and the Liberals in Ottawa understand how important the oil industry is to the Canadian economy, he argued. Rhetoric both during and after the campaign suggest a more conciliatory approach can be expected from the governments and industry.

"What we’re hearing over and over again is that the conversations that are taking place between the industry and the different levels of government have been more of a collaborative tone than anything else," he said.

But the industry there very much understands that golden years of support from Progressive Conservative and Conservative parties is over, he conceded. "On the other hand … they know a change is coming, whether they like it or not."

Keystone XL lives on

Meanwhile, debate over Keystone XL is unlikely to go away completely, even though the Obama administration has effectively killed the idea for the time being.

TransCanada vowed to keep its options open. The company has already completed one segment of the larger project, a connection between the Gulf of Mexico coastline and oil storage tanks at Cushing, Okla.

Reactions from both sides of the debate were swift and fierce Friday. Industry trade groups slammed the decision to reject Keystone XL. Climate change advocates celebrated it.

Analysts at IHS Energy, an industry research firm and consultancy, said preventing Keystone XL from moving forward will not keep oil sands crude from reaching the market. "Research has consistently shown that oil sands production does not hinge on any one infrastructure project and alternative projects and rail exist," IHS director Kevin Birn said in a statement.

The Canadian Association of Petroleum Producers also struck a defiant tone. "Canadian oil will find new paths to markets and continue to create jobs and wealth for Canadians, despite U.S. President Barack Obama’s political decision to deny the Keystone XL permit," CAPP said in a release.

Researchers at Wood Mackenzie agree that the supply growth in Canadian oil sands is unlikely to be impaired out to 2020, either from the Keystone XL rejection or the current oil price bust. Beyond that, it’s an open question.

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