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  • Record Capital Stoking the Oil and Gas Industry

    10 September 2014

    Money is being shovelled into the Canadian oil and gas industry like coal into a furnace. Year to date, hot markets have already offered up $19.6-billion to oil and gas producers. By the end of the year, upstream companies are on track to take in $26-billion from banks and equity investors. The dollar volume will stoke a record year, exceeding the $25.5-billion haul in 2007.

    Here are five reasons why the money is coming in at a record pace:

    Profitability

    Over the past year, the Canadian dollar is down a dime, natural gas prices have doubled off 2012 lows, and oil price discounts have narrowed. These top-line fundamentals have helped decompress the industry’s bottom line. Compared to the dark period between 2010 and 2013, average industry profitability at the wellhead is running 30 to 50 per cent higher this year, depending on company type and commodity focus. Savvy producers are making money again and investors have noticed.

    Innovation

    Nothing instills a sense of urgency more than collapsing margins. Between 2010 and 2013, Canadian producers were realizing the lowest oil and gas prices in the world (they still are, just not as low). Empty pockets sharpened the need to innovate processes and make cost discipline an imperative. Progressive companies became lean and mean by scaling up and using new technology. Lower costs served this group well when the prices rallied. These are the same producers that are attracting a lot of the new capital inflow.

    Resource potential

    Ten years ago, the oil sands region was recognized as the only multibillion-barrel resource left in the free-market world of oil. Natural gas in the U.S. and Canada was considered “mature.” Then came the shale gas revolution, followed shortly thereafter by tight oil. American plays like the Marcellus, Bakken and Permian Basin demonstrated that billions of barrels of new oil, and trillions of cubic feet of natural gas, could be liberated through new drilling and completion processes. Yet neither geology nor capital recognizes political borders.

    Outside investors have been correctly sensing that Saskatchewan, Alberta and northeastern B.C. are ripe for the same innovative extraction techniques that have made Pennsylvania, North Dakota and Texas immature again.

    Continentalization

    No it’s not a word. But it means that the U.S. and Canadian oil and gas businesses are becoming increasingly integrated, especially on the oil side. The advent of shipping oil by rail began creating many new supplier (producer) and customer (refiner) relationships across the U.S.-Canada border. Savvy investors looked beyond the Keystone XL issue and saw alternatives to one steel pipe. In part, greater market access is why average profitability between the U.S. and Canadian industries has equalized over the past year. During the dark period, U.S. mid- and small-capitalization producers were realizing between $7 to $10 a barrel of oil equivalent more than their Canadian brethren. Not any more. A tighter knit, continental market has led to continental investing.

    Risk and return

    Canada’s oil and gas industry does have social, political and environmental friction that tends to add to cost. But contrast that kind of rub with civil war, corruption, the threat of expropriation and sanctions found in the rest of the world. Events over the past twelve months have made investment into places like Iraq, North Africa and Russia riskier without any proportional improvement in returns. In fact, the application of new technologies to shorter cycle time projects here is improving the risk-return profile of North America’s industry, while that of the rest of the oil and gas world is deteriorating. This widening risk premium makes it more appealing for foreign capital to come to Canada (and the U.S.); the record inflow of investment capital validates the sentiment.

    Canadian investment is set to surpass the 2007 high. Back then the fires of investment were stoked too hot, causing imbalances in the demand for labour and services. Today’s industry has greater capacity to absorb capital, but how much more has yet to be tested. We’ll be watching the gauges carefully.

    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.

    @ 2014 The Globe and Mail Inc.

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