Copyright of the Daily Oil Bulletin 2017
Can We Flatten Out The Boom And Bust Cycles?
Steven Berg isn’t sure he can trust himself to politely discuss how to remedy the pernicious cycle of booms and busts that have plagued Canada’s oil and gas industry for generations.
“I don’t know if I can say anything without a bunch of swears coming out of my mouth,” the vice-president of operations of the Canadian Association of Oilfield Drillers Contractors (CAODC) tells the Daily Oil Bulletin.
During the booms, producers make windfall profits and go on spending sprees; operating costs rise and get out of control, then when the oil price inevitably drops, producers squeeze the service providers on costs, the service companies lay people off en masse, companies go bankrupt, then oil prices rise again and the cycle repeats.
While some people say there are steps both producers and service companies can take to smooth out the cycles, there is a general consensus that they are an unavoidable part of a commodity-based business that is at the mercy of global prices.
Berg suggests that tinkering with lease regulations, taxation, permitting and especially royalty structures would encourage drilling when oil is at $40 or $30 per bbl “as opposed to waiting until we hit $55 [oil] before the rigs start working again.”
WTI oil prices have recovered from lows in the $20s per bbl last February, to over $50 (although they sit just below that now), the service sector is hiring again, but some companies report that’s been a challenge too.
Many of the skilled workers that were laid off have returned to their homes in Eastern Canada and they are reluctant to head west again until they know they have enough work to make it worth their while.
“They took with them industry knowledge and experience and we lost tens of thousands of people with [that] knowledge and we can’t replace them,” says Berg.
According to the Government of Canada, in Alberta alone, the industry has seen direct job cuts of nearly 30,000 since the fourth quarter of 2014; meanwhile a report by EY and the University of Calgary says 80 per cent of companies surveyed have reduced headcount over the last two years (DOB, Feb. 23, 2017).
Fernando Aguilar, Calfrac Well Services Ltd. CEO, recently estimated the industry has seen 200,000 to 300,000 people leave (DOB, Feb. 24, 2017), while worldwide, that number is 440,000 jobs cut in the last two years according to Reuters news agency (DOB, March 6, 2017).
A study by PetroLMI, which specializes in providing petroleum labour market data and insights, estimates 53,000 direct oil and gas jobs have been chopped the last two years, for a 25 per cent reduction from 2014 employment levels.
Indirect job losses are estimated at 132,500 in industry goods and services support industries, primarily in the construction, manufacturing, transportation and other technical and business sectors.
PetroLMI says about 40 per cent of those jobs could be regained in a modest recovery scenario in the next five years but they may never recover to 2014 levels.
In the previous downturn, in 2008-2009, Canada’s oil and gas industry cut approximately 15,000 to 20,000 jobs, mostly within oil and gas services, it says.
During that period, layoffs also occurred within the exploration and production sector, particularly due to mergers and acquisitions. For the most part, companies held on to as many workers as they could, in anticipation of a quick recovery and expansion plans. Meanwhile, unlike during the current downturn, oilsands companies actually increased staffing levels.
Now, a few thousand people have been hired back — about 10 to 15 per cent of the service workers who had been laid off — and they are in positions “right across the sector,” says Mark Salkeld, president and CEO of the Petroleum Services Association of Canada (PSAC).
Several service companies folded during the depths of the current downturn. The survivors are picking up the slack and looking to hire, notes Salkeld.
People are needed in areas such as drilling, pumping, testing, environmental, construction and manufacturing. “It’s an uptick right now and there’s a certain level of optimism going into the spring and summer, looking at the producers’ drilling [and] completions programs,” he says.
In the past couple of years, PSAC has lost 50 per cent of its membership, going from 60,000 employees to the current 34,000, and membership is starting to grow back up again, but “it’s not going to be a fast uptick; it’s going to be a slow, steady uptick,” says Salkeld.
Essential Energy Services Ltd. is one such company that is hiring, seeking at least 100 people but they have to have a very specific skill set, be strong, willing to work long, hard days in cold weather and pass a pre-employment drug test.
At the end of what had been a very good year for the company, in December 2014, just before Christmas, Garnet Amundson, president and CEO, pulled all of Essential’s staff together to apprise them of the current state of affairs: the price of oil was falling and many service companies’ share prices had dropped.
“It was basically like standing and looking out onto the sea as the ocean begins to change and saying, ‘There’s a really bad storm coming and here’s what it’s going to do to us,’” says Amundson.
He told them he was going to roll back their wages and he warned them to prepare for layoffs. People were in tears, he recalls.
A similar occurrence took place a little more than two years later when Essential had a second round of layoffs and cutbacks. “By the time we got to the end of March 2016 we had reduced our head count from about 1,000 employees to about 343 employees: 65 per cent of our labour force,” says Amundson, whose company provides completions and workovers.
His and other executives’ first wage rollback was 20 per cent. He took another 10 per cent cut in 2016.
But since then the price of oil has doubled, the natural gas price has more than doubled and producers are reporting cash flows so healthy that some of them are considering reinstating or increasing their dividends, while service companies are still in the doldrums, he says.
In competing with the United States, the Canadian oil and gas industry is faced with unique challenges, among them carbon taxes, cold weather, two months of idleness during seasonal breakup, vast distances and an undiversified customer base, thus intensifying producers’ need to keep costs down, and looking to the service industry for that to happen, says Amundson.
“We’ve decimated our labour forces, we’ve rolled back wages, we’re getting no return on our investment and equipment, and the producers are saying, ‘nah, you should stay there,’ and the service companies are going, ‘so how do we do that, plus innovate, plus add labour?” he says. “The answer is, it’s a broken model. It doesn’t work.”
Amundson says one way to help provide producers’ low-cost needs is to have fewer service companies that are more specialized, but as soon as there is any sign of economic recovery, there is a massive influx of new service providers keen to take advantage of any growth.
Meanwhile, the capital markets — private equity and public investors — seem ever ready to quickly fund new competition. Service companies then “build too much iron,” they go into debt and then they crash, he says.
“By definition, those who perform less effectively should drop off the turnip truck,” says Amundson. “What didn’t happen in 2015 and 2016 was there were actually far fewer bankruptcies than there probably should have been and that’s the banks’ choice, not mine.”
He suggests producers could provide their own services and manage their own costs and cycles, but he knows that’s a lot of costs to carry during times of idleness.
Government and regulators can also help, says Amundson.
The Alberta, Saskatchewan and federal governments can comply with PSAC’s request for a loan to decommission orphan wells (DOB, Jan. 10, 2017), thereby putting people back to work, he says. (The federal government is providing some modest assistance).
Governments can also lower carbon taxes, income taxes and high net worth taxes, he says.
Jon Stringham, royalty and fiscal policy advisor at the Canadian Association of Petroleum Producers (CAPP), agrees there are steps governments can take to help, such as lowering property taxes and facilitating access to tidewater to expand producers’ markets.
Regulators can also help, he says. To assist producers in wise use of their capital, regulators can alter the land tenure system so that operators aren’t forced, in order to retain the acreage, to spend money drilling on lands they are not necessarily targeting that year, says Stringham.
It helps that investments in oilsands megaprojects has abated so that the fierce competition for labour and capital that was present six or seven years ago has cooled, he says. Also beneficial is that companies are being more efficient in their investment opportunities, prioritizing plays with shorter time horizons, he adds.
“I think over the longer term, companies will be a little more rational in the portfolio decisions they make,” he says.
Gary Leach, chief executive of the Explorers and Producers Association of Canada (EPAC), believes if anything good has come out of the most recent downturn, it’s that Western Canada will see a more sensible pricing environment in future, in recognition that it is an expensive place to do business and it is a long way from its markets.
The desirable outcome of this is some stability, which should last for the next few years, says Leach.
He, too, says producers will be more disciplined in their spending. “[That] may not be happy news for the drilling and services sector who would like to see higher prices, but at the end of the day we’re going to have to live with the market we have in front of us, which is dictated by what energy prices are, what our costs are to operate in Western Canada.”
Companies are closely scrutinizing what their best prospects are to ensure that only their best prospects get drilled. The price of natural gas and crude oil imposes that discipline, he says.
“I think everybody’s confidence in high energy commodity prices got shattered two or three years ago and everybody realized the one thing we can control are costs so we better concentrate on that,” he adds.
Recovery has begun, says Leach — rig activity is up over the previous year, oil prices have risen significantly from the depths of 2016 and producers are able to be more profitable at current prices because costs have come down.
“I don’t think we’re going to see a v-shaped recovery where things plunged and they’re going to go rapidly up again,” says Leach. “I think we’ll see more of a gradual incline with, hopefully, a lot more discipline around costs in Western Canada that keeps us in the game.”
However, Jim Hand, vice-president, Canada business unit at Spain’s Repsol S.A., is not convinced the downturn is over, especially for natural gas.
“I don’t see anything in the markets that give confidence that we’re going to see anything but flat gas pricing for the foreseeable future. Yes, oil has partially recovered but it’s still half what it was,” says Hand, whose company (formerly Talisman Energy Inc.) produces about 60,000 boe per day, around 75 per cent of it liquids-rich gas.
Repsol Canada is drilling 35 wells this year. The company recently completed a nine-well drilling program in Chauvin, Alberta, and it had four rigs running before breakup: one in Chauvin, one in the Duvernay, one in Edson and one in Wild River, Alberta.
Hand says it’s been a tough environment and as long as OPEC and the Saudis are in control of a large portion of the world oil supply, Canada’s industry, which operates on supply and demand, is at their mercy on continuing the cycles.
“I think what companies have to do is recognize that is our world, and figure out how we manage our business to minimize the impact of those cycles on our performance,” says Hand.
That can be done, he says, through efficiency, collaboration with service providers and others via organizations such as CAPP and other producer groups, integration, innovation, fiscal discipline and having a robust portfolio.
Repsol’s six refineries — five in Spain and one in Peru — have provided stability during a difficult time, allowing the company to avoid making any desperate decisions such as selling low and gutting staff, says Hand, because when its upstream business was struggling, its downstream business was generating free cash flow.
Another advantage it has is a research and technology centre, near its headquarters in Madrid, where people are working to help the company better understand its reservoirs, fluids and various technical services on its Duvernay project, thereby making it more economic, he says.
Hand believes what some companies fail to learn after every cycle is fiscal discipline.
They need to show the discipline to invest only in acquisitions and field development “when an opportunity meets a discipline criteria that isn’t tied to the prevailing commodity prices,” he says.
“For example if oil goes back to $100 per barrel, companies need the discipline to say, ‘You know what? Long term, we shouldn’t be expecting much over $55 or $60 so I’m not going to chase opportunities that can’t at least break even in that lower-commodity-price environment,’” says Hand.
Much depends on the assets, he says. “If you maintain and high-grade your portfolio to create a resilient asset base, even in times of low commodity prices you’ll still be able to weather that storm.”
Cenovus Energy Inc.’s goal has been to have a robust business when prices are around mid-US$50 WTI.
Efficiency is key, says Brett Harris, the company’s media lead.
There will always be upturns and downturns in the energy sector, says Harris. “We can’t run our business by focusing on what oil prices are doing or what OPEC or U.S. tight oil producers are doing. The best way we can address competitiveness and volatility in our industry is to focus on cost leadership.”
That doesn’t mean doing things cheaper, he adds. It means doing things smarter and more efficiently to reduce cost structures and provide the best return over the long run.
During the past couple of years, the company, predominantly an oilsands producer, scoured every area of its business to find efficiencies, change the way it does things and improve processes to lower its overall cost structure.
As a result, in 2016 its oilsands non-fuel operating costs were 30 per cent lower than in 2014 while sustaining capital was down by 50 per cent, notes Harris.
Also that year, Cenovus laid off 31 per cent of the workforce it had in 2014 (DOB, April 1, 2016).
In 2016, the company was able to cover its capital program, pay its dividend and generate free funds flow with WTI prices averaging below US$45 per bbl for the year.
But Essential’s Amundson believes that until Canada and the industry get to a point of greater pain than it was in during 2015 and 2016 there is not enough motivation or incentive amongst either the service companies or producers to change from what they have always done.
That’s sad, he agrees. “And we’re heading into another cycle and we’re going to do it all over again.”