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Canada's Energy Future is Assured, Right? Think Again

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Alex Carrick

Positions:
Alex Carrick is Chief Economist for Reed Construction Data. He specializes in economic forecasting and statistical services.

Economists

Most Canadians know that, thanks to the Athabasca Oil Sands in Alberta, we have the second largest reserves of crude in the world after Saudi Arabia. We’re self-sufficient in both oil and natural gas and exports of the latter to the U.S. have historically driven the Alberta economy even more than exports of the former. Compared to almost all other developed countries, we’re in an enviable position. The future looks even rosier, right? Not so fast. There are forces at work making our energy sector less than the sure bet it once was.

Most Canadians know that, thanks to the Athabasca Oil Sands in Alberta, we have the second largest reserves of crude in the world after Saudi Arabia. We’re self-sufficient in both oil and natural gas and exports of the latter to the U.S. have historically driven the Alberta economy even more than exports of the former. Compared to almost all other developed countries, we’re in an enviable position. The future looks even rosier, right? Not so fast. There are forces at work making our energy sector less than the sure bet it once was. That’s the problem with expectations. They may become less flexible, but economies are always in flux. Life evolves and circumstances change. Let’s look at the points of contention for our energy sector. Our oil is more expensive to produce than Middle Eastern Oil. We’re no longer just drilling holes in the ground, expecting a gusher. For our new production, we’re primarily employing steam assisted gravity drainage (SAGD). Or we’re delving into the waters off the coast of Newfoundland, Nova Scotia or (potentially) the high Arctic. The cost of producing such oil raises the break-even point to perhaps $60 to $80 per barrel. With West Texas Intermediate selling at $100, that’s not a problem. Emerging world demand will likely keep the price high and geopolitical tensions in the Arab world will continue to add a $10 to $20 per barrel risk premium. At a selling price of $100 per barrel, our oil companies can make money, but not an inordinate amount. Still, there’s no impediment on that score. But consider the environmental objections. “Green” advocates say that heavy oil sites scar the land. Watersheds become tainted. And pipelines leak. It’s supposedly a no brainer. Should that halt development? The energy companies have very publicly stated their commitment to act responsibly. They’re putting tremendous efforts into property stewardship and reclamation activities. Their contributions from an economic standpoint extend well beyond employment in construction and production. Their royalties help pay for social programs and for infrastructure that serves the wider community. Some of the best careers for our young people will lie in researching and monitoring how best to extract resources with minimal environmental impact. There are doors of opportunity that are opening up for our native populations. Jobs in mega-project construction are the way to break free from government dependency for many aboriginals. A case can also be made that, whether we’re actively conscious of it or not, we’ve been living with existing oil projects and pipelines for many years; and with tankers plying both coasts. These activities have provided essential boosts to our economic well-being. Advances in materials and monitoring systems are making new projects safer than ones built decades ago. For example, how much better would it be to have oil or gas delivered in a new pipeline where non-corroding materials minimize problems with rust? The system isn’t perfect. The energy companies know this. In the new world of full accountability, in which the backlash from social media can be vicious, they want to avoid public relations disasters at all costs. BP’s initial public reactions to its problems in the Gulf of Mexico serve as the template for what not to do. The ensuing financial penalties and lawsuits have carried enduring consequences. The New Democratic Party has traditionally been a strong advocate for the environment. No one’s quarreling with that approach. The problem comes when the party’s leader, Thomas Mulcair, pushes the envelope into the economic realm. Although he has since backtracked, earlier this year he postulated that heavy oil development in Alberta helps promote a Canadian version of the Dutch disease. The latter requires some explanation. When North Sea oil was first discovered, Dutch oil wells brought in so much money that the value of the nation’s currency skyrocketed. In turn, this hurt the export-dependent manufacturing sector of the economy. Mr. Mulcair, and Ontario’s Premier Dalton McGuinty for that matter, have both used the Dutch-disease analogy at times to gain some traction with their constituencies – unions and manufacturers respectively. The Canadian dollar has, to a degree, become a petro-currency, with its value moving in tandem with some commodity prices, especially oil. Segments of manufacturing lose export opportunities when the loonie rises. Others pick up domestic sales opportunities from energy project go-aheads. Plus there are the wider-ranging benefits that arise from greater construction employment and a stronger tax base in the resource provinces. The spillover benefits to the rest of Canada from our oil and gas sectors are unmistakable and should not be taken for granted. In a speech in Calgary on September 7th, Bank of Canada Governor Mark Carney clarified where he stands on the issue. The press release that accompanied his presentation was entitled Elevated Commodity Prices (are) “Unambiguously Good” for Canada. Mr. Carney pointed out that there are factors other than just commodity prices that are lifting the value of our currency. For example, there is our newly-acquired status among the international financial community as a safe haven for investment funds. That’s causing foreign capital to flow into the country. Our governments reap a major benefit through the lower interest rates they can offer to finance their deficits and debt. Mr. Carney reaches the conclusion that regardless of the cause of a higher loonie, “the resulting improvement in Canada’s terms of trade causes income, wealth and GDP to rise.” According to the BOC’s estimations, trying to curtail the strength in our exchange rate would have negative consequences for wages and inflation and would leave non-resource exporters (i.e., manufacturers) with the same competitiveness challenges they already face. In other words, let’s face it. Major forces of globalization have made it a tough competitive world for manufacturers in developed nations. Quoting directly from the press release, “The cost of this misadventure is lower output of about 1 per cent and higher volatility in inflation, output and employment than when the exchange rate is allowed to do its work.” I have a final point to make on the changing world energy scene and it’s a shocker. Circumstances may be bypassing us anyway. All Canadians should be aware of something major that’s occurring in our neighbor to the south. The U.S. is rapidly approaching self-sufficiency in natural gas. It’s also making significant progress in reducing its dependence on foreign oil. How is the U.S. achieving this feat? Seeing a way out of its foreign energy dependency – with all that would mean in terms of disentanglement from complicated and volatile Middle Eastern geopolitical affairs – the U.S. is whole-heartedly embracing a new technology with the tongue-twisting name of hydraulic fractioning (colloquially known as “fracking”) Fracking is a drilling technology whereby water laced with chemicals is shot into the ground through one pipe to break up shale rock and release oil or gas to be carried to the surface by way of a second pipe. Huge new fields have been opened up quickly in unexpected places such as North Dakota, Ohio and Pennsylvania. So far, regulations have hardly put a dent in the rush to capitalize on these stake-holdings. The resulting increase in reserves is why the price of natural gas has stayed below $5 per million cubic feet. (Based on energy equivalency, the price of natural gas should be about $16 per million cubic feet – i.e., 6 million cubic feet of gas produces the same number of British thermal units as one barrel of oil). The amount of natural gas that is now available in the U.S. is so abundant there are proposals to send some of it north into Ontario. Pipeline expansions flowing in the opposite direction to the norm (i.e., south-north as opposed to north-south) are on the drawing boards. Such American product would replace what is currently available from the East’s traditional sources in the West. Where does this leave Canada? With underutilized capacity and less certainty about our energy future. In the oil market, the U.S. will most likely supplant supplies from less reliable sources (the Arab World, Nigeria and Venezuela) first before there is much impact on Canada. So we gain a respite and probably a decade-plus to prepare for the change. With respect to natural gas, Canadian producers are already seeing reduced export demand, although partly on account of the still struggling U.S. economy. The low price reduces returns for producers and takes away the incentive to develop new fields. The Mackenzie Delta has been one obvious casualty. The Mackenzie Valley gas pipeline languished on the drawing boards for decades. It finally cleared environmental hurdles and received approval from native bands along its path, only to prove uneconomic on a profitability basis We have our own shale deposits of both oil and natural gas. There is every reason we should want to go ahead with development of these sites. But there has to be an alteration in our thinking about the potential customer base. Rather than looking to the U.S., we must seek customers in Asia and elsewhere. Such an adjustment in strategy carries two key implications: First, we must build the infrastructure to move our product east rather than south. That means overcoming objections that might stand in the way of such projects. Hearings are underway in B.C. right now on key transportation proposals to the coast and across the Pacific. And second, we must demonstrate a willingness to commit to new customers. We’re not the only nation wanting to supply China, Vietnam, South Korea and others with oil and natural gas. The biggest liquefied natural gas project in the world is currently proceeding on the West Coast of Australia. The Gorgon project for Chevron, Exxon and Royal Dutch Shell is centred on Barrow Island about 130 kilometres out to sea. A sensitive underwater eco-system is being guarded and nurtured. Once completed, Australia will have four largely export-oriented LNG facilities. Yes, Canada has oil and natural gas in abundance. They’re a fantastic natural source of wealth. But not if they end up locked in the ground. If we want to realize all the opportunities our legacy provides, we’re going to have to invest more “emotional energy” in seeing development proceed to its full potential. Alex Carrick

Find Canadian construction-related economic articles in Canadian Construction Market News and in the Economic Outlook section of Daily Commercial News.

by Alex Carrick

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