Taking the pencil from out behind the ear, the first thing a manager of any business asks is, “What are the sales figures for the week?”
The boss will be pleased after running the numbers on the oil and gas division of Canada’s economy. Five months into 2013, the top line revenue of the industry is on track for a robust year, second only to the peak recorded in 2008.
The chart at left shows the weekly revenue report; the dollars generated from upstream product sales. Each point on the chart represents revenue generated from eight product streams that include bitumen, synthetic oil, heavy oil, conventional light oil, natural gas liquids (NGLs) and natural gas.
After the Financial Crisis years of 2009 and 2010, Canada’s oil and gas industry experienced a broad, choppy two-year downtrend in revenue. The history is worth reviewing: U.S. shale gas production pounded down the price of continental natural gas, which led to a 25-per-cent contraction in sales by volume. Falling natural gas prices multiplied by falling Canadian production, meant that the once $45-billion-per-year segment of our domestic business shrank to less than $20-billion.
The oil side of the industry suffered similar misfortunes during the same two-year time period. Growing oil sands and light, tight oil (LTO) production amidst declining North American consumption was already a yellow flag to price. Constraining the oversupply to a closed-off continent lacking export outlets led to code red: Wide price differentials. Discounts to world prices were hardest felt in the far-flung wilderness of Canada where the products are furthest from populated markets. At one point in 2012, the domestic discounts were as steep as 60 per cent, up to $50 per barrel on light oil and $65 a barrel for heavier grades.
But the free market has a way of sorting out price distortions. And incumbent industries that are under competitive assault often find innovative means to rally. Both of these turnaround factors have led to the abrupt revenue jump entering 2013. Natural gas prices have rallied by 120 per cent due to increasing demand and stagnating U.S. production. On the oil side, despite some weakening of global prices, the North American differentials have been narrowing due to the “re-piping” of infrastructure and the rapid buildup of takeaway capacity brought on by rail companies eager to cash in on the arbitrage. In fact, some Canadian oil benchmarks, like Edmonton Light, are now trading at a premium to U.S. prices.
The forecast line in Figure 1 represents our go-forward revenue projection, based on production estimates for the balance of the year and forward commodity prices quoted in today’s market. At an average pace of $2.4-billion per week, the industry is set to rack up $125-billion in revenue for 2013. That’s only 14-per-cent less than the peak year of 2008, when $145-billion was topped.
Revenue, akin to a blood pressure check, is a quick metric for assessing business health. Relative to 2012, our domestic oil and gas industry is now tracking an extra $300-million per week – that’s substantial even on a scale of Canada’s national accounts. The GDP accountants have not yet tallied the impact of the bump up, but give it a few quarters and the numbers should start reflecting the healthier tone of nation’s largest commodity business. Royalties, especially in Alberta where over 75 per cent of the industry’s revenue is banked, should be considerably better this year, though it’s too early to gauge, let alone get excited. Although the $125-billion forecast based on forward strip pricing looks smooth, the balance of the year is unlikely to be so even-keeled; the massive changes to upstream, midstream and downstream operations – the likes of which have not been seen for decades – will ensure some price and revenue volatility yet.
After two years of broad decline, higher upstream revenue on the top line is a welcome, positive indicator. But it says nothing about other important health metrics or the bottom line. There is no point high-fiving the accounting team for posting greater revenue if profitability is not responding. And in a world that is increasingly competitive for capital, how much money the oil and gas industry reinvests back into Canada will be based on profitability, not revenue. To look deeper beneath this recent revenue rise, our manager will need to sharpen his pencil. We’ll report soon on what he finds out.