Quick oil rebound unlikely as industry adjusts to new reality

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For Alberta's unnerved oil sands producers, Joe Oliver's soothing words were just what they wanted to hear: markets will rebound and the industry and province will prosper again.

The federal Finance Minister delivered his pep talk to the worried oil crowd in a speech to the Calgary Chamber of Commerce last week.

"Demand for oil will rise in the intermediate and longer term," he said. "For Albertans and their energy sector, that has meant – and will mean – prosperity at home."

But there are plenty of signs that point to a fundamental realignment in the industry. To survive for the long term, Canadian producers, many on the high end of the global cost curve, will have to adjust to a world of far tougher competition and sluggish demand growth that will keep a lid on their hoped-for recovery.

Producers shouldn't count on the future looking much like the recent past, when the industry expected ever-rising oil prices to justify $30-billion-a-year investment in oil sands expansion. With Saudi Arabia-led OPEC no longer willing to support prices by cutting production, the oil world is becoming a whole lot more Darwinian.

Fierce competition for global market share is occurring even as demand growth falters under a combined weight of economic, technological and environmental trends.

"Re-balancing of the market does not equate to a return to the status quo ante," the International Energy Agency warned in its oil market report Friday.

"It is clear that the market is undergoing a historic shift … While there might be light at the end of the tunnel for producers as far as prices are concerned, the next few years could nevertheless prove a period of reckoning for a market and an industry that, through the course of their 150-year history, have had to periodically reinvent themselves."

In his speech in Calgary, Mr. Oliver gave a classic assessment of commodity cycles: that the best cure for low oil prices is, in fact, low prices. "They reduce production from high-cost producers, and therefore constrain supply, and they stimulate economic growth and therefore ultimately drive up global demand," he said.

That response will take a while. Oil prices halted their free fall last week with West Texas Intermediate settling at $48.70 (U.S.) a barrel. But analysts don't see a sustained rally in the near future.

"The market is still trying to find a balance," Anthony Yuen, global energy strategist with Citi Research, said in an interview. "And at this point, if you look at both supply and demand balance, you are still looking at an oversupply environment."

Mr. Oliver's comment about high-cost producers getting squeezed out of the market was grim reminder for the Alberta industry. The oil sands sector and Canada's tight-oil producers face some of the highest costs in the world and billions' worth of new spending has already been sidelined due to the price slump.

Suncor Energy Inc., which has already slashed its 2015 budget by $1-billion and cut 1,000 jobs, is prepared to "take further action" if the oil rout persists, chief financial officer Alister Cowan said last week. As many as 16 oil sands-project phases that have yet to receive board sanctioning are at risk of further delays because of low prices, according to energy consultancy Wood Mackenzie.

Canadian producers will be working hard to lower their break-even costs. But they're aiming at a moving target: U.S. shale producers are laser-focused on boosting productivity and reducing costs so they, too, can be competitive in the global game.

Typically in a commodity market, lower prices stimulate demand growth, and analysts are expecting that to hold true in the current downturn. But the IEA warned that the weak underlying conditions around the globe – except in the United States – will delay and mute that response.

That's not to say prices will remain at $50. But like many forecasters, Citi Research predicts a slow return to $90 (U.S.) a barrel, which it posits as a new ceiling.

There are two major wild cards: war in the Middle East and climate change. The Persian Gulf remains a tinderbox, and eruptions in any of the major producers there would drive up prices.

The climate change threat is part of a larger demand picture that has seen oil consumption decoupled from economic growth, certainly in rich countries and increasingly in emerging markets such as China. Many analysts argue the world is in the midst of a resource productivity revolution that will permanently reduce our reliance on oil.

Under an aggressive climate-policy scenario, the IEA sees crude consumption peaking in 2020, and then declining. That scenario is likely unrealistic given political inertia, but is illustrative of the direction in which many world leaders wish to head.