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Canada Oil And Gas Industry: Shrinking Profits May Be A Sign Of Things To Come

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Canada's energy industry may be facing more than a blip. Revolutionary changes in energy extraction pose a real long-term threat to the industry. (AP photo)
Canada's energy industry may be facing more than a blip. Revolutionary changes in energy extraction pose a real long-term threat to the industry. (AP photo)

The talk coming out of Canada’s oil patch in recent months has been increasingly tinged with panic. Industry leaders are growing worried about the oil sands’ future prospects, and the earnings reports coming out this week are a good sign of why that may be.

Oil producer Cenovus on Wednesday reported a 40-per-cent decline in profit in the latest quarter, falling to $396 million from $655 million a year earlier.

Things were even worse for Calgary-based natural gas producer Encana, which recorded a whopping quarterly $1.48 billion loss. It had recorded a profit of $383 million in the same period a year earlier.

(And Canada's largest energy producer -- Suncor -- said on Wednesday it's mulling delaying some of its new projects. The company denied market conditions were behind the move, saying only that the company is "looking at how we get the best economics for those projects.")

On the surface, the reason for this is obvious: Declining energy prices. Natural gas prices are at rock bottom, and prices for oil have been under downward pressure as the world economy faces a tough summer thanks to Europe’s credit crisis and a slowdown in China.

But beneath the surface is a rapidly-changing global energy industry. With the U.S. rapidly developing its shale oil and gas deposits, Asia increasingly looking to renewable energy, and the controversy over the environmental impact of the oil sands showing no signs abating, Canada’s energy exporters could find themselves in a seemingly unthinkable situation: Lots of oil, and few markets to sell it.

All this is happening just as Canada’s dependence on energy exports has been reaching new heights. As the Globe and Mail reported, oil and gas sales, as well investment in oil sands infrastructure, accounted for one-third of Canada’s economic growth in 2010 and 2011.

So what happens to Canada when energy and commodity prices go down? One thing that happens is it becomes cheaper to tank up your car. But at a certain point, as prices come down, the benefit to Canada of lower gas bills and cheaper commodities is overtaken by the cost to the economy of lost exports.

“If oil prices get to a point where they are going to deter investment in the [energy] sector, the negatives outweigh the benefits,” TD Bank economist Diana Petramala told the Globe.

That scenario -- unthinkable just a few years ago -- may be exactly what Canada’s natural resource sector may be facing. And it’s not just a temporary blip in prices Canada is facing -- it may be a permanent and revolutionary shift in energy extraction that makes Canada’s oil sands far less desirable than they seemed until now.

One thing threatening Canada’s energy sector is the new American oil and gas boom. With new extraction techniques like hydraulic fracturing coming online, U.S. energy companies are busily starting to drill on domestic soil again. The oil industry in Texas is booming in a way it hasn’t in more than three decades, and plenty of other, less expected, places are becoming oil meccas. Meanwhile, new supplies of natural gas have pushed prices for the energy source down to near-record levels.

This boom is already having tangible effects on Canada’s oil industry. Insiders estimate that Canadian exporters, unable to export to markets other than the U.S., are facing a $15 per barrel discount on the oil they sell, when compared to international Brent crude prices.

But it’s not just supply and demand that’s cutting into Canadian energy profits -- it’s Canada’s lacklustre response to the world’s concerns about oil sands carbon pollution.

Secret government documents obtained by Postmedia earlier this month argue Canada’s oil exports have become “landlocked” by the lack of pipeline infrastructure, and by environmental concerns surrounding carbon-heavy bitumen. The report urged the country to “address the environmental issues surrounding the current and projected growth of the industry.”

It may seem paradoxical, then, that Canada is pushing so hard to get the Keystone XL pipeline to the U.S. built. But as many observers argue, the point of the pipeline is not so much to get more Canadian oil to the U.S. market -- it’s to get Canadian oil to the U.S. ports that can take it to other markets -- particularly Asia. And the Northern Gateway pipeline project, which would carry oil and gas between Alberta and the ports on the B.C. coast, is obviously meant for this purpose.

(The ease with which President Barack Obama delayed the Keystone XL pipeline is, according to some, a sign that the U.S. simply doesn’t need more Canadian oil; if it was necessary as an energy security prerogative, there would have been little question as to approving the pipeline.)

Canada’s new strategy -- as Prime Minister Stephen Harper enunciated it after President Barack Obama delayed the decision on the Keystone -- is to refocus to Asian markets. No doubt the recent Canada-China trade talks, and Canada’s insistence on joining the Trans-Pacific Partnership, stem in part from this new strategy.

On the face of it, it seems like a good one: If the U.S. won’t buy or doesn’t need Canadian oil, booming Asia will take it instead. After all, projections show that demand for oil in Asia’s rapidly developing economies will continue to grow. The continent is now the largest consumer of oil in the world.

This week's announcement that Chinese state-owned oil firm CNOOC has made a $15.1-billion offer for Calgary-based Nexen is a clear sign that China is interested in the oil sands. Yet despite this, Asia is beginning to look uncertain as a market for Canadian oil, both in the short term and long. OPEC is projecting lower demand for oil in the near future, potentially jeopardizing any hopes of new markets for Canadian oil in the next few years.

In the long term, Asia is already looking to renewable energy. With their large, dense populations, and dependence on Middle Eastern oil, Asian countries see diversification of energy sources as a prerogative, if not an absolute necessity.

China is already arguably ahead of Canada on that front. The country is embroiled in a trade war with Europe over solar panels, as it seeks to expand markets for its green-energy goods. China is also planning on increasing wind power generation by sixfold within the next eight years. Wind turbine construction is a booming business.

All of this makes for a very uncertain future for Canada’s energy exports. Even the projections for future production are entirely up in the air. CIBC recently estimated oil sands production would hit 880,000 barrels per day by 2016; the Canadian Association of Petroleum Producers put the mark at less than half that -- 425,000 barrels.

To many environmentalists around the world, the uncertainty around the oil sands is good news. Dampening the demand for western Canadian bitumen has been part of the environmental movement’s strategy in addressing the oil sands.

But with environmental concerns eating away at Canada’s potential markets, relatively weak oil demand projected to continue in the near future, and Canada’s potential new oil markets focusing on renewable energy, it may be time for the Great White North to take the standard advice given by investment advisors: Diversify.

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