We recently caught up with Peter Hall, who is VP and Chief Economist at Export Development Canada (EDC), to talk about the state of Canada’s oil and gas industry, which has experienced a drastic downfall over the last 12 months. During our discussion, he provided a rare opportunity to gain unprecedented insight into a sector that is facing significant challenges as well as changes.
In this article, we will share with you Peter’s perspective on the industry from three distinct levels or regions: provincial, national, and global.
While each market segment presents a uniquely different picture as to how the COVID-19 pandemic has had an impact on its fortunes, there is ultimately a collective mosaic of overlapping influence. It is precisely in the areas of this overlap that we gain a “big” picture understanding of both the economic evolution of the regions and the resulting impact on supply and demand.
A Provincial View
To the everyday Canadian consumer, who in March and April had not seen prices at the pump so low since the late 1990s and early 2000s, the price drop is one of the few economic benefits of the social distancing measures imposed by the government to halt the spread of the virus. It meant other things for oil executives in Alberta, Canada, where oil and gas is largely produced.
It is ominous in that many are watching the markets with concern that there will, with a potential second wave of the virus, be another “brutal price crash.” What this means is that while the current $40 per barrel delivers a somewhat modest profit, it is not enough to warrant a full-scale return to drilling.
However, buoyed by the interim return to profitability, there is reason for some optimism. The reason, according to Peter, is that this is not the first (nor will it be the last) time that the Canadian Oilpatch has encountered price drops of this magnitude.
Back in 2008, when the price per barrel fell from a July high of $147 to a low of $32 by December, an upset was turned into an opportunity as the industry found radically new and innovative ways to cut costs to become profitable in even the direst circumstances.
In other words, and even in an obfuscating cloud of economic uncertainty, Alberta’s oil and gas industry has both the experience and the smarts to persevere, adapt, and ultimately rise from the ashes of a global crisis.
Notwithstanding the precipitous uncertainty of the upcoming U.S. Presidential election and the volley of retaliatory tariffs over a mostly symbolic border wall when it comes to oil and gas, America might be Canada’s most dependable customer.
In July 2020, Natural Resources Canada reported that in 2018 Canada exported 3.5 million barrels per day to the U.S., which represented 96% of all Canadian crude oil exports.
As Peter puts it, this represents a certainty of demand with a close and, for the most part, “friendly” customer. As a result, even with a potential second wave of infections weighing on prices, overall economic recovery should build on what we are now seeing. The “V-shape” bounce back may not persist, but prices are well up from their worst mid-crisis levels.
The reason Peter explains is that unlike past economic crises, such as what happened in 2008 or going even further back in time to the great depression of 1929, the current financial crisis was not the result of a bubble burst. In other words, it was not due to a self-inflicted wound, but an external force beyond our control.
However, given that the U.S. is by far Canada’s biggest and most dependable customer, what are the near-future risks with having so many eggs in one basket—even with a healthy economy?
Clark, Fourastié, and China
Developed by Colin Clark and Jean Fourastié, the “three-sector hypothesis of industry” divides a country’s economy into three sectors of activity: the extraction of raw materials (primary), manufacturing (secondary), and services (tertiary).
According to the Clark and Fourastié hypothesis or model, under a “general pattern of development,” a wealthy nation will progress through each phase. While such progression is a positive in that it reflects a mature or developed economy such as what we have in the western world, it is not necessarily a good thing for the domestic oil and gas industry—nor the middle class.
According to Peter, one of the main reasons why China is rebounding as quickly as it is, particularly with the consumption of oil and gas, is that they are a developing economy with a growing versus shrinking middle class.
With the growth in the size of the middle class, there is a greater demand for products. However, there is a lack of clean energy to drive their production. Conversely, as the middle class shrinks in North America, the level of demand, by comparison, will progressively decrease over time.
What this means is that the future “big” markets for oil and gas are in developing countries where the middle class is expanding and with it the demand for more energy to fuel said expansion.