A billion dollars every week. That’s the rate at which the oil and gas industry invests capital into Canada. Other than 2009 – the depths of the financial crisis – that pace of injecting money into the economy has been fairly steady since 2006. However, leading indicators suggest that corporate wallets are getting leaner. Spending is likely to slow down in the second half of this year, contributing to a year-over-year decrease of about 15 per cent.
Going from $55-billion last year to an estimated $47-billion in 2012, will constitute the weakest rate of investment since 2005.
Commodity price weakness is the biggest factor contributing to the slowdown. Natural gas prices are at their lowest level in over a decade. Per barrel, North American crude oil prices have lost $15 of their lustre in the past month. Discounted Canadian oil prices relative to U.S. markets are further eroding revenue and cash flow. And it’s cash flow that matters, because producers typically reinvest every dollar of what they realize back into the ground.
Right now the industry’s fortunes are particularly sensitive to variations in oil price. In Canada, the combined sale of conventional oil plus oil sands now represents 90 per cent of the revenue mix. The remaining 10 per cent is natural gas, which has been marginalized by low price and declining production.
The dollars are big on 3.7 million barrels a day of Canadian oil production (all grades). Every $10 (U.S.) per barrel drop in the benchmark price of West Texas Intermediate (WTI) oil trickles down into a loss of about $125-million (Canadian) per week in after-tax industry cash flow.
Even before the recent oil price slide, the talk around the Calgary Petroleum Club was one of greater austerity. Those sentiments were echoed in first-quarter financial reports and recent announcements. A review of the guidance of 29 publicly-traded oil and gas producers – large and small companies representing about 40 per cent of Canada’s conventional (non-oil sands) volume output – reveals that 21 of them are cutting back. Year-over-year, the announced spending cuts average 20 per cent, although this theme of frugality is not uniform.
From our 29-company sample set, Figure 1 shows a histogram of the expected change in conventional capital expenditures (excluding the oil sands), 2012 versus 2011. The range varies from a near complete shutdown (-75%) to a robust increase (+50%). There is a predictable polarization of spending behavior in Figure 1; companies leaning to the left of the spectrum are those with a lot of natural gas baggage. Cashed up companies with a good inventory of light tight oil (LTO) prospects are on the positive side of the scale.
The guidance expressed in Figure 1 was taken back at the end of March, when the price of oil was well above $100/B. Not anymore. If the price of oil remains in the mid $80/B range, we should expect to hear of further spending restraint, especially on the conventional side of the business that represents 60 per cent of the industry. The other 40 per cent is composed of oil sands projects that are funded by deep-pocketed multinationals that are less affected by near-term fluctuations in cash flow. So, current spending on oil sands is unlikely to budge much from $20-billion per year.
A lagging consequence of commodity price weakness is lower drilling activity (non-oil sands), which is already a reality in natural gas play areas. Conventional oil drilling is now likely to pull back too. Summer rig activity is already looking a bit weak. It’s not that $85 (U.S.) is a bad price for a barrel of light oil; the issue is that cash flow for investing into high-cost horizontal wells will be crimped relative to prior years. And much of the industry is now exclusively dependent on cash flow, because debt is reigned in and the public markets are in a foul mood to finance with equity.
Appropriately, we can say that the well for new capital is dry. So, in the near term the industry must live within the means of its flagging income statement.
After the Financial Crisis, capital expenditures by Canada’s oil and gas industry fell from $54.4-billion in 2008, to $33.6-billion to 2009. That 40 per cent cut was momentarily disastrous. By comparison a 15 per cent drop in 2012, to an estimated $47-billion, is a mild correction. And not quite a billion dollars a week.