How do you sum­ma­rize the sit­u­a­tion for Al­berta’s oil and gas in­dus­try?

Alberta Venture - - The Money Book -

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.”

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