Lauerman: Oilsands Producers Should Take Advantage Of Respite
The hard hit western Canadian oilsands industry has seen some rays of sunshine in recent weeks, after suffering a downpour over much of the past six years. Unfortunately, this is no more than the calm before a far more powerful storm. As a result, oilsands producers should use this respite to better position themselves for long-term survival, not party like it’s New Year’s Eve 2013.
Rays of sunshine
Oilsands producers have recently received three pieces of very good news. At the end of November, Enbridge Inc. obtained final approval for its Line 3 replacement project in Minnesota, allowing the company to begin laying new pipeline in the state a few days later. After years of delay, crude pipeline starved Western Canada — at least until the global coronavirus pandemic temporarily took a huge chunk out of global oil consumption — should see a significant boost in capacity exiting the region by the end of 2021.
In addition, for the first time in years, a large number of Wall Street firms — including Goldman Sachs Group, Morgan Stanley and BofA Securities — have been recommending the purchase of stocks in major oilsands producers such as Suncor Energy Inc., Canadian Natural Resources Limited and MEG Energy Corp. Their stocks have become relatively popular, especially compared to U.S. shale producers, to a large degree because of a greater ability to generate free cash flow in a lower oil price environment. Oilsands projects need relatively small amounts of maintenance capital to support their long-life and low-decline production profiles. It doesn’t hurt oilsands stocks have been hammered down to bargain basement prices over the past six years.
Finally, after some drama at the OPEC+ meeting over the first week of December, an agreement was achieved that should allow West Texas Intermediate (WTI) to trade in the US$50 to US$60/bbl range in 2021. The group appears committed to sopping up the massive oil inventories overhanging the world oil market — currently estimated to be around 1.3 billion bbls —over the coming year.
These major oil exporting countries had been scheduled to add 1.9 million bbls/d back onto the market at the beginning of next year based on the schedule agreed upon at its April meeting — decreasing cuts to 5.8 million bbls/d — but compromised on a 500,000 bbl/d production increase, in at least January, instead. Global oil consumption has rebounded less than expected due to the latest wave of COVID-19 and roughly one million bbls/d of Libyan crude oil recently returning to the market. Libya is a longstanding OPEC member, but not party to the OPEC+ agreement due to supply disruptions related to its ongoing civil war.
A hurricane cometh
However, these three pieces of very good news for Western Canada’s oilsands industry are more than counterbalanced by three other developments in the longer term. After years of dithering, the Trudeau government is finally getting serious about meeting, and possibly even exceeding, our Paris Agreement greenhouse emissions (GHG) emission target for 2030. A $170 per metric ton carbon tax by 2030, compared to $50 in 2022 and $30 presently, as well as the new Low Carbon Fuel Standard in 2022, will add significant costs to already high-cost oilsands production.
At the same time, environmental, social and corporate governance (ESG) is on the fast track to become the dominant global investment theme, with carbon emissions by far the most important criteria. “ESG is nothing less than an all-encompassing shift in the investment landscape; placing financial and non-financial performance criteria on a level playing field,” global consultancy PwC said in a report released in mid-October. According to the research firm Opimas, the value of global assets under management applying ESG criteria to drive their investment decisions hit US$41 trillion in 2020, almost doubling over the past four years and more than tripling over the past eight.
And most importantly for the oilsands industry, Russia appears to have orchestrated a coup against Saudi Arabia at the recent OPEC+ meeting, after sharing leadership with the kingdom since the group’s creation at the end of 2016. This apparent power shift will likely mean a lower oil price paradigm once global oil inventories are brought back into balance.
Saudi Arabia has been the leader of the OPEC+ price hawks and Russia the leader of the doves due to their differing financial needs and objectives. The kingdom needs high crude oil prices to balance its budget and finance Vision 2030, the program to diversify its economy away from oil. In contrast, the Kremlin only needs moderate prices to balance its budget, and has been much more concerned about losing market share, especially to the U.S., partly for geopolitical reasons.
This difference in opinion between Riyadh and Moscow contributed to the brief oil price war earlier this year, before the global coronavirus pandemic forced OPEC+ unity and a massive production cut to avoid an extended period of extremely low oil prices and economic Armageddon for most major oil exporting countries (see Oil Price War 4.0 Series Part 5 – Putin’s Masterstroke).
Since then, the concern about losing market share to higher-cost lower-reserve countries has spread among low-cost high-reserve countries in OPEC+ such as Kuwait and UAE with the specter of ‘stranded oil’ assets becoming more imminent. Demand destruction associated with COVID-19 has moved forward the timeline for peak oil demand (POD). The subsequent drop has been made more precipitous by rapid declines in the cost of battery packs putting future oil consumption in the all-important transportation sector under threat, as well as numerous countries and companies recently committing to net-zero emissions anywhere between 2030 and 2060.
Kuwait and the UAE aligned with Russia at the recent OPEC+ meeting, not Saudi Arabia “for the first time in OPEC history,” according to one Gulf delegate, refusing to maintain cuts at 7.7 million bbls/d through the first quarter of 2021 as proposed by the kingdom. Saudi Energy Minister Prince Abdulaziz bin Salman was so miffed by the surprise Russia-UAE proposal on the final day of the meeting — after the Kremlin forced a two day delay — winning the group’s support that he threatened to step down as a co-chair of OPEC+, with the final communiqué from the meeting mentioning he had ultimately agreed not to.
It was reported prior to the meeting that UAE officials have been debating the relative merits of remaining a member of OPEC, also for the first time ever. The UAE is planning to increase crude production capacity by one million bbls/d to five million bbls/d by 2030 after increasing it by 500,000 bbls/d since 2018 despite producing a mere 2.5 million bbls/d in November.
The Kremlin’s preferred price for crude oil currently appears to be around $40 to $45/bbl, a price that should put a cap on U.S. light-tight oil (LTO) production, if not cause it to suffer additional declines on top of COVID-related ones. Assuming Russia retains control over OPEC+, the price range would likely ratchet down over time as global oil consumption goes into permanent decline, to keep low-cost high-resource countries from holding proportionally more of the stranded oil bag.
To conclude, oilsands producers would be wise to take advantage of higher crude oil prices and greater investor interest in the short term to make their balance sheets as bullet proof as possible by maintaining capital discipline — including avoiding M&A activity financed with debt — retiring debt, and selling as many shares as possible in their companies once stock prices rebound to decent levels.
In addition, and equally important, oilsands companies should invest far more than in the past in plant, equipment and processes to cut costs and significantly reduce carbon emissions, including the R&D needed to achieve dramatic improvements in costs and emissions, not just incremental ones. If our oilsands producers do so, they should be able to enjoy many more Merry Christmases through to mid-century and beyond.