If peddling wares in one market gets too price competitive, then it's time to pack up the fruit stand and seek spendthrift buyers elsewhere. That's what any savvy vendor would do. We know that's what Canada must do: find new, high-paying, international outlets for its energy exports. Otherwise, like picked over fruit, Canada's oil and gas products will only fetch discounted prices in North American markets.
But why does the fruit stand need to be moved?
Econ 101 tells us the superficial reason: There is too much oil and gas in North America, like too much fruit and a dearth of herbivores. We know a lot more fruit is being grown and offered, but how has the consumers' diet changed? By analogy, is Canada's principal customer eating less fruit, switching to granola, or going to another market? In other words, are Americans burning less oil, switching to other fuels, or redirecting energy needs elsewhere? In fact, it's all of the above.
Figure 1 shows historical U.S. petroleum demand by consuming segment. Transportation is dominant, representing 70 per cent of the total. Industrial consumption is a meaningful second. Oil use in residential, commercial and power generation (bottom of Figure 1) pales compared with transport and industrial, but they are also noteworthy.
The sudden, downward kinks in both transportation and industrial demand are noticeable around 2007, well before the financial crisis of 2009. Why? Because an exponentially rising price of oil, doubling like a bacterial colony from $20 to $40 to $80, then to not quite $160 (actually peaking at $147 per barrel in July, 2008), finally triggered a consumer breaking point, the consequences of which are still in play today.
Here are four reasons why the largest customer for Canadian oil is reducing its need (we'll be exploring each one in greater detail in subsequent columns).
Fuel Substitution – Burning good food to idle in a traffic jam is a tenuous social proposition. Moral issues aside, diluting gasoline with biofuels like corn ethanol is the dominant reason for reduced American oil consumption over the past five years. A series of Policy Acts (Energy Policy 2005, Energy Independence and Security 2007 and Food Conservation and Energy 2008) has forced meaningful substitution. Gasoline has ceded more than 5 per cent of its market share to ethanol over the past half dozen years. Natural gas and renewable energy (wind and solar) have also taken lunch away from oil in the U.S. power segment. Figure 2 shows a magnified trend line of oil use in generating electricity, which is down 400,000 b/d since 2006. Using oil to power hair dryers, lights and TVs is now at a minimal level.
Behavioural Change – People are driving less and not just because the real price of gasoline has shot up. Teenagers and twenty-somethings are less inclined to get their drivers' licences than in the past. Who in the younger generation aspires to commute in a van pool? Virtual human transport via social media, gaming and telepresence technologies are the digital cars of tomorrow. Apps like FaceTime and Skype are already cutting into the fuel tank. At the peak of driving, after decades of year-over-year increases, Americans logged more than 3 trillion vehicle miles in 2007. Last year is likely to be only about 2.9 trillion. The transportation segment is no longer a growth business for oil in North America.
Efficiency Gains – The fuel economy of new vehicles sold is up by almost 30 per cent since 2007. The overall impact of driving more on a tank of gas has not been fully appreciated yet. High-grading the existing fleet of 240 million vehicles, at a rate of about 15 million a year, will start to show meaningful gasoline reduction by the end of the decade.
Offshoring – The shifting of energy-intense industrial manufacturing from western economies to emerging ones – as part of the globalization trend – began in the 1980s and accelerated in the 2000s. Offshoring the manufacturing of goods to places like China has led to less U.S. industrial oil consumption as an energy source.
"Know your customer" is a salesperson's motto, especially if the customer's buying patterns are changing. As Canada's oil and gas industry seeks to diversify into global markets, it's worthwhile to assess what's happened with the longstanding business model and strategize accordingly, lest newfound customers abroad undergo similar patterns of change over the next decade. It would be a shame to have to pack up the fruit stand again.
Peter Tertzakian is chief energy economist and managing director with Arc Financial Corp. in Calgary and provides analysis on technology and energy-related businesses to fund managers and portfolio companies.