Oil's slide below $50 (U.S.) a barrel is the latest turn for a bear market that looks to be settling in for an extended stay. In the oil patch, hope springs eternal that prices will rebound and the cyclical industry can begin a long and profitable march up the curve of another upswing. A glance at the supply and demand forces weighing on crude prices, however, suggests such wishes won't come true any time soon.
What will spur a price recovery? North American producers may not want to hear it, but the most likely road to higher prices is one that will see them end up as smaller players in tomorrow's oil market.
To be fair, global producers are suffering as well. The price collapse has left a gaping hole in the fiscal and trade balances of major exporting countries, such as Saudi Arabia and Russia, with social and economic repercussions to match. Still, even at the current depressed price levels, production, for the most part, in those countries is still profitable. In contrast, much of the production across North America, home to some of the most expensive oil in the world, can't make the same claim.
The recent surge in growth in North American non-conventional oil production, whether it's light oil from North Dakota or the heavy stuff that comes out of Alberta's oil sands, is made possible by high oil prices, which are in turn linked to world demand remaining robust. As today's falling crude prices attest, global demand these days is anything but.
Oil markets were betting that double-digit economic growth in China would be a steady constant that would keep driving prices higher indefinitely. That growth is now much harder to find than it was a few years ago, particularly in the country's energy-intensive manufacturing sector. Indeed, fuel consumption there is pointing toward an even sharper deceleration. The official statistics are sobering enough; let alone what the numbers might say before they're scrubbed by officials in Beijing. More and more, it looks like the structural imbalances in China's economy are finally catching up with its economic performance. If that proves to be the case, then the rest of the world will have to grapple with the fall out.
For oil markets, in particular, a slowdown in China is coming at an especially bad time. It's not like resource demand in other markets is ready to pick up the slack. Whether it's Europe or Japan, economic growth around the world remains in the doldrums.
And that's just the demand side of the equation. For oil producers, the supply conditions look even worse. A plunging oil price should send a clear market signal to producers to cut output. Many key oil-producing nations, however, are taking the opposite approach. In order to prop up faltering petro revenues, they're pumping out more oil while at the same time hoping that the price weakness will be temporary. Of course, the more oil they pump into an already saturated global market, the worse it is for prices.
Where does that leave North American producers? Between a rock and a hard place it appears. While companies would like the Saudis to defend world prices by lowering output, in the current paradigm the onus is now on the world's high cost producers to exit an oversupplied market. That's something neither oil sands players nor shale producers appear willing to do. At least not yet.
Despite the growing columns of red ink, production is still increasing. While many proposed projects have been cancelled, others, like Imperial's massive Kearl expansion, are too far along to stop. Regardless of the sunk costs, though, how much more growth can the sector really take when current prices are telling companies it would make more sense to shut in mines as opposed to build new ones?
The answer likely depends on the market. As long as investors are willing to fund those projects, companies – and their falling cash flows – will be able to manage. Will that continue? A bear market for commodity prices has a way of turning even loyal investors against the resource sector. And right now doesn't seem to be the time to try to raise capital to extract some of the highest cost oil in the world.
Oil sands stocks have underperformed the TSX by more than 40 per cent in the last year. And that's not exactly setting the benchmark very high, given the TSX itself has fallen roughly 10 per cent in the last year.
Worse yet for investors, the recovery in oil prices the sector so desperately needs will require producers to churn out less oil, not more. That's not exactly a recipe for investing riches. Until it happens, though, this bear market is here to stay.
Jeff Rubin is the former chief economist of CIBC World Markets and the author of the number one best sellers Why Your World Is About To Get A Whole Lot Smaller and The End of Growth. His latest book is The Carbon Bubble.