What's in a buck? Or even a dime, for that matter?
Between the blur that was the fourth quarter of 2013 and now, average natural gas prices are tracking well over a dollar higher than last year, and the Canadian loonie has devalued by 10 per cent. Yet the effects of these recent market moves have not yet been fully felt among oil and gas stakeholders. Industry participants, governments, peripheral businesses like finance, and the country at large are just starting to feel a breeze from these sustaining market changes. Stronger winds will soon be felt.
Over the course of the next few months, higher Canadian dollar commodity prices will be like a high-pressure front that moves into the quaint bays on the west coast of B.C., the frenzied trading floors on Bay Street in Toronto, and everywhere in between.
Here are the stats: If natural gas prices average $4.50 (Canadian) a gigajoule, the loonie holds steady at 90 cents (U.S.), and oil prices remain relatively steady near current levels, the oil and gas industry will realize a $23-billion (Canadian) kick in annual upstream revenue (sales of crude oils, natural gas liquids, and natural gas) compared to last year. The top-line purse for 2014 is now tracking $152-billion (see Figure 1). For reference, back in the heady days of 2008, the high-water (or shall we say high oil?) mark was $145-billion – so this year already has the feel of a new record.
What are some of the implications of these seemingly superficial changes of a dollar and a dime?
Greater revenue in Canadian dollars means higher royalties and taxes for the government. We can only estimate a rough number at this point, because not all of the incremental value goes into the pockets of the producers – there are plenty of middlemen like aggregators, transporters and traders that do well by the price appreciation. A good rule of thumb is that royalties run at 10 to 15 per cent of revenue (closer to 15 per cent at higher commodity prices). So an incremental $23-billion in 2014 means another $3-billion in royalties is possible. Taxes are tougher to estimate, but another couple billion dollars could end up in public coffers.
Oil and gas producers will look more profitable, because while revenue is tied to U.S. dollars, operating costs are mostly in Canadian. Cash flow will be higher – around $70-billion, but it's too early to say how much of that will be reinvested. Capital expenditure budgets could increase, because improving profitability typically attracts more investment. We're already seeing some of this effect, especially in the publicly traded equities. The ARC Canadian Oil and Gas Growth Equity Index – a basket of the smaller independents – is up 35 per cent in the past eight months; the S&P TSX E&P index representing big oil and gas companies is also up, by 11 per cent. Contrast against U.S. producers: The U.S. S&P producers index is showing lacklustre performance in 2014. Capital attracts capital, and more is likely to shift toward Canada in the near term.
Yet, don't be fooled by averages embodied in the equity indexes. The proverbial tide won't lift all boats. The oil and gas industry is bifurcated. Low commodity prices and a high Canadian dollar over the past few years encouraged Darwinian forces to ordain winners and cast off losers. Future capital coming into Canada will be selective. Investors will fund only the most progressive companies and ignore those with the legacy baggage of poor assets and laggard historical performance.
It's the liquefied natural gas (LNG) proponents – the leaders of the 14 consortia that have clamored to western B.C. – who must be rubbing their chins the hardest. Despite relatively unchanged long-dated natural gas prices, a weaker Canadian dollar combined with increasing volatility in near-term natural gas markets, must be instilling uncertainty into the economic viability of these megaprojects.
Admittedly, big multinational companies that are championing these projects hedge their currency baskets around the world. Still, quarterbacking with Canadian dollars from a Canadian armchair is not comforting. A lot of the costs for building multibillion LNG liquefaction facilities are incurred abroad, mostly in U.S. dollars. So LNG projects just got a lot more expensive on Canadian paper. In addition, a higher North American natural gas price erodes the once-wide arbitrage relative to global prices.
By our estimation, "a dollar and a dime" is enough to squeeze the viability of many of the 14 projects, and that's not even considering what sort of tax the B.C. government will announce. It's fair to say that many of these megaprojects to the West Coast could stop on a dime – or that a buck might not buy a cup of LNG.
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.