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Report On Business Canadian oil producers thriving with their big-box business model

There are many ways to run a business. For example, purveyors of luxury goods don't sell big volumes, but make money on wide margins. Department stores don't make as much profit, but sell more stuff. Innovators rely on technology for their value. Fast followers copy the innovators.

Here is a business model we all know: Discount prices, take share from smaller players, create new channels of distribution, and gain cost efficiencies through scale. "Big-box" stores like Wal-Mart, Costco and Best Buy are champions of these market-bulldozing tactics.

The approach sounds a lot like today's Canadian oil and gas industry.

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Becoming a high-volume price discounter wasn't a conscious, collective strategic business decision. Most would say that the big-box model was imposed on Canada's industry because of price differentials resulting from constrained pipes and oversupply. That's certainly how it all started. Regardless of how things have evolved, another way to look at the market is from the other side of the till: Canadian oil and gas producers are undercutting the market and taking share with the cheapest oil and gas in the world.

Canadian oil exports to U.S. refineries have grown to record volumes, at a record pace, coincident with discounted oil prices that started around 2010. Any Wal-Mart executive will tell you that if you cut the price of a product, customers will buy more. As well, those buyers will shun higher price vendors of the same product. Why would an American refinery pay full global price for oil when it can get the same goods about 5 to 10 per cent cheaper from big-box Canada?This is why Canadian producers have taken market share away from other global suppliers such as Mexico, Venezuela, Nigeria and others. And it's also why Canada has grown to be the world's fifth-largest producer of oil by volume, selling more oil to the U.S. than ever before.

To some it's unsettling to think of Canada as the Wal-Mart of the world's oil and gas industry. But let's not prejudice the big-box model. Plenty of these mega-enterprises do extremely well. Their price-and-cost-cutting business strategies are aggressive and legitimate in a highly competitive world; their efficiencies second to none.

In fact, many companies in Canada's oil and gas industry have been adapting to suit the big-box model. Unprecedented process innovation in the field is driving scale and cost reduction. Information technology, logistics and streamlined midstream processes are taking the cost fat out of supply lines. New modes of transport like oil-by-rail and barge are creating many new sales relationships with refineries that were never customers before. On all these fronts, leading Canadian companies have been advancing to expand their businesses under discounted prices.

An unsettling aspect of muscular big-box stores is that they put the "little guy" out of business in the domestic market. That's generally true. Gone are the days when the corner bookstore can make a buck in the shadow of Amazon. Such Darwinism is alive in the Canadian oil patch too. The mom n' pop oil company can ill compete with a skinny balance sheet, a high cost structure and a patchwork quilt of un-scalable land.

Yet there are high-value roles for smaller independents in the fray. Producers with superior geology, access to capital, cost control discipline, and the ability to innovate will continue to command a market share. The challenge and opportunity for smaller companies is to adapt their business plans to co-exist in the competitive fray. Innovators and niche players in the Canadian oil patch are already playing a strong role as the developers of new, high-quality, scalable plays to feed the big-box machine.

Canada's oil and gas industry will continue to strengthen its business processes, just as big-box stores do, until such time that North American oil and gas prices equalize with the rest of the world. When that happens it will be time to adopt a new, premium-pricing model. Starbucks anyone?

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Peter Tertzakian is chief energy economist at ARC Financial Corp. in Calgary and the author of two best-selling books, A Thousand Barrels a Second and The End of Energy Obesity.

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