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peter tertzakian

"Your numbers must have a bust!" exclaimed my disbelieving friend who produces oil for a living.

"I don't think so," I said as I led him through some rough calculations. "If the price of a barrel of U.S. light oil averages $60 in 2015, the hit to the Canadian industry will be worse than in 2009." I noted that at $80 (U.S.) a barrel, there was some immunity to the shock, but a sustained price below $60 will cause the industry to lose most of its white blood cells.

"Thanks," he muttered with a wince, like a kid that had just opened up a disappointing Christmas present.

"Yup," I said, "A lump of coal is forthcoming in the stockings of many Canadians this year – or at least a squirt of oil."

Let's look at the numbers. Slashing more than $30 off the price of an average Canadian barrel of oil means that even considering production gains, revenue from the sale of upstream hydrocarbon products will be down by $45-billion in 2015. Putting that loss in context, it's like removing the entire Canadian mining industry from the nation's economy.

But the root problem will be cash flow. Or lack of it. That's the profitability at the wellhead that allows companies to reinvest their gains back into the economy. Diminishing cash flow squeezes out employment, cuts dividends and clobbers the stock market (which affects every pension plan in Canada). Hollowing out the industry's profitability also crimps governments' take at all levels – from municipalities that benefit from oil field exploration, to non-oil-bearing provinces whose migratory workers repatriate their income taxes back home.

Assuming that $60-a-barrel oil is realized next year, sales of upstream hydrocarbons in 2015 would exceed what was realized in 2009 by almost $14-billion; however, the gut feeling will be worse. That's because the industry's operating costs are up 50 per cent over the past five years; labour is one driver. Inflation in the patch has been running around 6 per cent a year; for example, oil field worker wages are up from $1,600 (Canadian) a week five years ago to $2,200 just before the price of a barrel rolled off the cliff.

If there is any tin lining to this story it's that today's fall in oil prices will hose down an industry that was starting to overheat like circa 2006. The re-emergence of an inflationary cycle was suggestive of an industry that was having difficulty absorbing too much investment. Now, costs will necessarily have to fall too. It will be painful, but necessary for competitiveness. As one oil field service executive put it to me last week, "We are going to be having some serious conversations about pay with our employees."

All upstream segments combined, this year's record investment of $75-billion could shrink in the range of 20 to 30 per cent next year.

Conventional investment, outside the oil sands, will likely be cut by a third to $32-billion – already some public companies are announcing spending cuts in the range of 40 per cent. Field activity – mostly drilling and completions – will mirror the budgetary shrinkages.

For the oil sands, spending will continue on established projects already in motion, but some belt-tightening should be assumed. Anything non-essential will be axed; a 15-per-cent spending cut to $25-billion for 2015 is a reasonable estimate. Where the oil sands business is likely to feel it the most is the potential deferral or cancellation of some long-term projects slated for startup post-2017. This should not surprise anyone and it's not exclusive to the oil sands. Cracks in the appeal of uncertain, long-payback energy megaprojects around the world were starting to appear earlier this year, well before the oil price drop.

Geographically, oily Saskatchewan and Newfoundland are likely to be hit the hardest, followed by Alberta. On the surface, least affected should be natural-gas-prone British Columbia. However, gas prices aren't exactly booming and natural gas is often a byproduct of higher-value liquids that trade off the price of oil. The impact of this major global economic event will be felt across Canada.

It all sounds economically grim. But there is one gift in the stocking that's worth opening. Unwrap the rest of the world's oil producers and you'll see that Canada's industry is relatively less affected and more prepared. We have already lived with the lowest oil prices in the world since 2010; at times when everyone else was bathing in $110 (U.S.), we were living with $70. That means that if $60 is painful here, it really hurts everywhere else, and is unsustainable.

A lump of coal or a squirt of oil? Take the latter in your stocking. It should be worth a lot more by next Christmas.

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.