How do you summarize the situation for Alberta’s oil and gas industry?
Peter Tertzakian: The last two years have been by far the worst in the last 100 years in terms of cash losses and write-downs for the sector: $80 billion in two years. It’s a staggering amount of money and value. And now the industry faces one of the most interesting periods of my career, if not of the last 100 years: We not only have big changes within the industry in terms of innovation and new processes to find oil and gas that are radically changing the business, but it’s also the first time we’ve seen credible assaults against the industry from new technologies and new energy systems like renewables and electric vehicles. So the industry’s 100-year dominance in the transportation and mobility business is being challenged. Then there’s the environmental dimension, which is facilitating uncertainty but also facilitating the potential for substitution. And then we can talk about geopolitics and everything that goes around that. There’s more uncertainty today than I’ve witnessed in my entire career. It’s crazy. AV : Uncertainty is not popular with investors. PT :
And in the next five or 10 years we’re going to witness things we haven’t thought about. It’s that uncertainty that investors have to take into account, and it’s having profound implications. Given that the outlook 10, 15 years and beyond is uncertain, an investor today will wonder if they want to expose their capital for anything beyond a few years. All of a sudden investments into large mega-projects – offshore platforms, “the ends of the earth,” massive 4,000-person camps building oil sands projects that take seven to 10 years to build and another five to 10 years to pay out – don’t look so good. (When I say “investors,” it’s a cocktail of institutional investors like pension plans and hedge funds, private equity, individuals and the companies that are putting that money into the ground.) AV : But we’ve recently seen a fairly healthy amount of spending announced by large oil and gas players. PT:
The question is not, “How much are these companies going to invest or not invest?” I can always give you a pretty accurate forecast if we have a pretty good forecast of pricing. The question is: Where are they going to put their money? When we came out of the financial crisis, which was the last time we had a severe downturn, and spending was crimped, the price of oil went from a low of about $30 and rose to $100 plus. The investment that ensued went into all types of projects, from offshore Angola to the oil sands to Kazakhstan to fracking in the Marcellus, Texas, Alberta and B.C. Globally, the upstream industry started spending around $700 billion a year and it was broadly based. After two years of low oil and gas prices, spending is down into the $450 billion per year range. Now, as investment starts to rise, the question is, where does it go? The answer is smaller, faster, lower-carbon projects.
What do companies do when they come under assault from competitive forces? They wake up and say, “I have to innovate to get my costs down and I have to improve my product.” This being a commodity business, we can do a lot of process innovation and we’ve seen a lot in both oil sands and non-oil sands.
Then, how do you get product innovation in a commodity resource business like oil? The answer today is that a better product is a lower- carbon product. It’s not well recognized but Alberta has a tremendous spectrum of carbon content in its geology, all the way from the driest of natural gas through the condensates and light oils to medium and you get into the heavies and then the oil sands. The carbon content can be anywhere from 30 kilograms per barrel to over 80 for extraction and upgrading. (That figure doesn’t take you all the way to burning. When you add in burning, you’re up to 600 kilograms per barrel because 80 per cent of the emissions are on the tailpipe.) What we’re seeing is that 80 is too high.
AV : How do the provincial climate leadership plan and similar efforts at the federal level play into this? PT : The low oil price has done far more to drive
“There’s more uncertainty today than I’ve witnessed in my entire career. It’s crazy.”
greater efficiency than has the carbon tax. The price has been like a massive carbon tax because it’s given companies incentive to improve their process efficiencies, and by definition if you improve your efficiency you’re using less energy and burning less carbon.
The carbon tax is a complicated thing, and it will add greater incentive to innovate, but to be honest, the forces of competition are a greater impetus. The carbon tax should be more meaningful on the consumption side, because 80 per cent of emissions are on the consumption side. If you really want to do something meaningful, it has to be on that end.
AV : When it comes to carbon emissions, that culpability of the consumer does not seem to have broadly entered the public’s consciousness. PT: There are certain countries in the world – Japan, the European countries – that have been able to bring it to the fore, to actually bring forward the notion of energy conservation and respect for our energy sources. Some of that is through the heavy hand of policy and meaningful taxes, but it’s in the culture now.
I actually favour the tax more on the device that creates the carbon – the internal combustion engine. A lot of countries in Europe and some in Asia demand a ridiculously high road tax if you want to drive a Hummer. Effectively it’s a carbon tax.
The internal combustion is incredibly inefficient. By the time the rubber hits the road you’re using 15 per cent of a barrel. It’s a pretty dismal statistic. The rest is blown out an exhaust pipe or refinery stack as heat. The internal combustion engine is more of a heater than it is an engine. We banned the incandescent lightbulb because it was so inefficient. If you banned that, logically you should ban the internal combustion engine too, because it’s incredibly inefficient.
AV : What do you tell investors when they ask you about the Trump effect? PT : There is a polarization in society that is happening, and a lot of people are becoming disenfranchised with low real income growth and the one per centers. >
It’s incumbent on people who are surprised [by Trump’s win] to get out of their bubble and go into the trenches and see what’s really happening in their country or state or province. This is nothing that’s going away fast. You can do all the scientific and granular polling you want, but you get a much better sense of what’s going on in the real world if you go have a beer in a bar in Kentucky or in rural Alberta.
It’s part of a much broader thing that extends into discussions about pipelines. The decision makers and investors and influencers have to get away from their office towers and go see what’s happening. I like to say close your spreadsheet and open your eyes. Go talk to people. I grew up in my career as an analytical person, but things started to change for me in 2007. I was looking at these fantastic numbers coming out of China – growth and the other classic indicators. But I didn’t have anything to hang that on, so I went to China, and not only to the big cities but to the countryside. I came back and was even more bullish than the numbers were.
Another example was I decided about five years ago I really didn’t have a good feel for what was going on with Northern Gateway – all these numbers were being thrown around. So I went and spent a week travelling the pipeline route on the ground, from small town to small town, and talked to people. I came back from that and told industry they needed to wake up. You can philosophize all you want and talk to governments, but that’s the air war. The real issue is on the ground, and if you’re not prepared to fight there, you won’t win. That really was formative for me.
It’s nice to have pipeline approvals, but let’s talk about getting people on board by interacting with them as human beings rather than just as numbers. I still don’t see that happening.
AV : And the future with President Trump? PT : It’s really hard to say. On the one hand, we can look at his appointments and say, “Some of these people are accomplished people, and therefore from the perspective of investment, it’s very good.” On the other hand, you can look at these appointments and, in the context of what we just talked about, I could say these appointments are really bad, because all they’re going to do is breed more polarization and antagonism between groups. For example, listen to the rhetoric on energy and the uproar that has been caused in the climate change and environmental community. This is not a healthy thing. At least, with the past administration, there was a channel of communication into the White House for these groups. Some would argue maybe it was too much. But leave that aside, the other extreme is that they’re completely shut out. If they’re shut out, they’re going to double down on the ground. Is it any surprise that we’re seeing the standoff in North Dakota? If you’re shut out of the halls of decision making, you’re going to go to the fields of the people. So stay tuned.
AV : What of the uncertainty that creates? PT: It will amplify this idea that, “I don’t want to put my money in anything long term.” It’s like the way a lot of traders close out their books at the end of the week because they don’t want their money exposed over the weekend and coming into Monday morning. Now it’s amplified to a global level. Unfortunately the world of investing is going to become more high frequency.
AV : What do you see for 2017? PT: We look for improvement, but the investment coming back is going to be selective. Importantly, there’s a premium for investors on the shorter cycle and faster payback. Why is that? First of all, it relates back to the uncertain world we live in. You don’t want to expose your capital for very long. You want to put your money in, make your money, and get out.
It’s all price-dependent, but if you can drill, complete, bring to market and sell a project, and through the cash flow pay back that whole exercise in two to three years, it’s hard to argue that that is going to be a stranded asset. On the other hand, if you put your money in a massive oil sands or offshore project, your return may be the same over the long term but there’s a lot of uncertainty in that return. The risk has gone up, and it’s not clear the reward will, too. So, now, the guys with the big projects have to think a lot about how to innovate.
AV : Any notes of hope early in this new year? PT: I’m very optimistic about Alberta right now. There’s a renaissance going on and not only in our oil and gas businesses. If we can keep the emphasis on better process and product and efficiency and, importantly, if we can keep the focus on profitability rather than growth at all costs, I’m very excited about the industry’s prospects, even with the prices as they are.
More broadly, Alberta has so much to offer. The difference between coming out of this downturn and coming out of prior downturns is we now have a lot more infrastructure and critical mass, certainly in our two big cities. If you travel the world and you come back here, you realize how privileged you are, and other people are starting to realize that our two cities are manageable in their costs and offer so many things. We have clean air, clean water, natural beauty that is unsurpassed, incredible diversity of geography. On top of that we have cultural attitudes that are appealing to young people. Many countries are going the other way.
“It’s incumbent on people who are surprised [BY Trump’s win] to get out of their bubble and go into the trenches and see what’s really happening.”