Oil, gas industry producers need help and they need it now

Ottawa must show courage, writes Brian Livingston.

Government financial assistance to the oil and gas industry has been in the news recently. The huge drop in demand and physical limits on storage have forced producers to shut in an estimated 500,000 to one million barrels per day.

Producers and service operators need a bridge to get them across the chasm of reduced revenue caused by this shut in volume and the precipitous drop in the price of oil. The rationale for such assistance would be to give liquidity to producers that will in turn stimulate activity for service operators. This will avoid disorderly bankruptcies, with the resulting loss of employment and destruction of going concern value. Letting producers go bankrupt will also increase the already large number of orphan wells.

One possible structure to provide financial assistance is referred to as the “Shut and Swap.” The government advances an unsecured interest-free loan to a producer that has shut in production in an amount of say $20 per barrel, representing the difference between current and futures prices. This advance in effect makes up for lost revenue due to shut in volumes. The producer agrees to repay this $20 in the future when prices rise and production resumes from shut in capacity. This structure would help low-cost producers that only need a bridge loan until oil prices recover.

The purpose of Shut and Swap would be to increase the liquidity of producers during this time of heightened uncertainty. While the federal government has pledged credit support from EDC and the BDC for smaller producers with reserve-based lines of credit, Ottawa has been slow on details and the amounts look to be insufficient, particularly for larger producers.

Steps by producers to preserve liquidity include shutting in production, reducing salaries of executives and other employees, cutting capex, cutting dividends, receiving income from oil price hedges (particularly smaller producers), extending debt maturities and accessing existing lines of credit.

The important point to realize is that the emphasis on preserving liquidity has caused producers of all sizes to defer capex on what will likely be economic projects in the future. First-quarter earnings reports indicate that these capex cuts are in the range of $10 billion, which is many times the $1.75 billion of capex in the orphan wells program. This loss of capex is destroying the cash flow of the service operators, and may well result in numerous bankruptcies with the accompanying unemployment and destruction of value.

If governments do provide this Shut and

Swap financial assistance, the obvious question to ask is, what will producers do with this cash? The answer should be that producers will be contractually required to use this new liquidity to revive some of the capex they cut. This revived capex would provide much-needed cash flow to service operators. Just as with the announced orphan well program, the cash payments for this revived capex could be routed from the government directly to the service providers.

Some of these revived capex projects could have an environmental aspect to them, which may make it more attractive from a political perspective. Suncor could revive its $1.3.-billion investment in its 800-megawatt cogeneration project, which would reduce GHG emissions. It could also revive its $300-million investment in the 400-megawatt Forty Mile wind project. Other producers are investing in technologies to reduce GHG emissions.

Finally, some of the revived capex would create additional producing capacity that would not come on stream for a year or two. Futures markets show that the expectation is that by then demand and supply will be back in balance, causing prices to increase. In addition, pipeline egress from Alberta should have increased through a completed TMX pipeline and renewed Enbridge Line 3.

This suggestion is a classic example of a counter-cyclical investment cycle — make the investment when there is blood on the streets, with the expectation that things will recover in the future. It would also be a classic example of Keynesian stimulus in times of recession, much like the New Deal spending in the Depression.

For governments, it will take courage to act now to ensure that Canada has a viable petroleum sector on the other side of this crisis.