Risks rise in Alberta office market

CALGARY • Fewer real-estate investors are purchasing commercial buildings in Alberta’s two major cities, as the market for office space weakens following the collapse in oil prices.

A report released Monday by Colliers International shows that commercial landlords in Calgary and Edmonton expect the market for office space and commercial real estate investments to continue to slow in both cities in the coming months.

Colliers expects capitalization rates, which measure investment risk in commercial real estate, to rise in downtown and suburban office buildings in Calgary and Edmonton this year. Rising “cap rates” signal that landlords should earn a lower return on their office space investments in the future.

“Increasing cap rates are considered a weakening fundamental,” managing director of Colliers’ Calgary office Laurel Edwards said.

She added that the spending pullback among Calgary’s largest companies, oil producers hard hit by the more than 50-per cent fall in crude prices, “would be the main factor” for the weakening office market. Downtown vacancy rates in Alberta’s cities have jumped in the 16 months since oil prices began to fall.

Bank of America Merrill Lynch thinks U.S. crude prices may rally to US$50 per barrel on falling output from non-OPEC sources by the end of the year, and expects much healthier global supply-demand balances next year.

“Since we see forward oil prices floored at US$50-60 per barrel on production costs, we believe the risk of a price collapse to US$20 per barrel over the next 12 months is very low,” BAML analysts said in a report last week, countering rival Goldman Sachs worst-case scenario of US$20 price.

With oil price hovering below US$50 per barrel, output from U.S. shale basins such as Permian is set to fall seven per cent next year, Eagle Ford production by about 13 per cent and Bakken production by around six per cent, according to investment banking firm Tudor Pickering Holt & Co.

Also lost in the focus on supply glut is global demand that’s set to grow at 1.7 million bpd this year, a five-year high, followed by an abovetrend 1.4 million bpd expected in 2016, the IEA estimates.

Demand from the key markets of China, India and the United States also remains strong.

While Hittle cautions that higher oil consumption is partly a function of lower prices, global supply is set to contract by about 500,000 bpd next year, even taking into account Iran’s return to the market, and higher production from Iraq and Saudi Arabia.

“It’s a real switch to go from that kind of supply growth (1.7 million bpd in 2015) to a year-on-year decline next year,” Hittle said. “This could come as a bit of shock to the oil market.”

As high-cost producers scale back production, a key concern for most forecasters is a supply squeeze over the medium term.

The world is expected to consume an additional 2.4 million barrels per day — roughly equivalent to Kuwait’s crude oil production — over the next two years. However, projects worth nearly US$204 billion have been delayed because of the price crash and for political reasons, Rystad Energy data shows.

“The longer the oil price stays where it is, more projects are getting delayed,” Martin said. “Then the price response will be higher, as there will be a much bigger shortage.”

The dearth of new supply may be a boon for the oilsands that offer longlife supply despite being high cost.

Martin says Rystad Energy is “quite bullish” on oilsands production, compared to other research houses. “We see a huge supply cliff potentially looming in 2017 if things are not taken care of prior to that.”

Of course, there are no guarantees that prices will improve, given the uncertain outlook for the Chinese and wider emerging economies, and if shale producers snuff out any advances in prices by turning on the taps once again.

Even so, the list of analysts predicting a price reversal is growing. A Sanford Bernstein & Co. survey of 160 investors in September showed the majority of respondents expected prices to rise by 19 per cent during the next 12 months.

“We believe the current price environment is on par with 2008/2009 and 1998/1999 in terms of severity,” said Bob Brackett, analyst at Bernstein said. “In both cases, the rebound was significant. We believe oil prices are significantly below marginal cost and as they rise, E&Ps will benefit.”