Uncertainty clouds fundamental strengths of Canada's industry - 1998 forecasts for the Canadian oil and gas industry - Industry Overview

World Oil, Feb, 1998 by Robert Curran

Uncertainty has emerged as the central theme in 1998 for Canada, making it difficult for oil and gas producers to gauge what their capital expenditure programs should be. However, the industry's fundamentals remain strong, suggesting the year ahead will still be one of the best on record for drilling activity.

OVERVIEW

Until the fourth quarter, 1997 was shaping up to be an outstanding year. Production levels continued to surge, setting another record for combined output from conventional crude, synthetic crude (from the Suncor and Syncrude) oil sands projects, natural gas liquids and natural gas. Oil and gas stocks also had shown terrific strength through the third quarter, and rumors of aggressive exploration and development programs began to circulate in oil patch haunts. Not surprisingly, the stock market's oil and gas index was booming.

Financial activity in 1997 was similarly frenetic. Led by the acquisitions of Wascana Energy Inc. by Northstar Energy Corporation, CS Resources Ltd. by PanCanadian Petroleum Ltd., and Elan Energy Inc. by Ranger Oil Ltd., there was a total of 161 mergers and acquisitions last year. They were worth approximately C$14.8 billion (US$10.3 billion), according to Crosbie & Co.

But a series of events in the fourth quarter quickly brought the high-flying industry back to earth. The strong support from equity markets disappeared quickly, due primarily to the so-called "Asian Flu," which sent Asian stock markets tumbling, pulling Canada's resource-oriented markets along with them. The various oil and gas indices lost about 40% of their value, as panicked investors hastily dumped their resource-based holdings. Overall, the oil and gas index fell about 11% in 1997.

Adding to the sudden downturn were other factors that had emerged slowly as the year unfolded. The ongoing slide in the average gravity of oil in the Western Canadian Sedimentary basin began to impact financial results, as costs continued to rise. Costs had remained low and relatively constant through the first half of the 1990s, while suppliers fought hard to keep their businesses afloat. Heavy consolidation became the norm in the service sector, as larger firms seized the opportunity to strengthen their position by taking over their struggling competitors.

Once the industry began to show signs of a turnaround, service and supply contractors were reticent to raise their rates quickly, fearing the upswing in activity might be short-lived, resulting in a loss of business. However, 1997 - a record 12 months for drilling - was the fifth consecutive year of robust drilling activity, and the fourth in a row when 11,000 or more wells were drilled. Costs, which had been creeping up slowly over the past two or three years, finally caught up to the oil patch.

Commodity prices were not cooperating, either. A continued glut of oil supply on world markets, plus the United Nations-brokered, US$2-billion oil-for-food deal with Iraq, dropped oil prices to a four-year low in the fourth quarter, putting further pressure on producers to achieve reasonable netbacks on oil. The markets are watching the Middle East closely, and prices could spike or plummet, depending on how the ongoing saga with Iraqi President Saddam Hussein plays itself out.

Gas prices have fared better, particularly for the Canadian industry's target markets in the U.S. However, Western Canadian pipeline capacity [TABULAR DATA OMITTED] last year remained insufficient to meet shippers' demand, trapping gas in the basin, and exerting downward pressure on prices. However, scheduled pipeline capacity increases late in 1998, plus increasing North American demand for cleaner-burning natural gas, should push gas prices higher, overall.

In December, the beleaguered oil patch took another body blow, when the Canadian government - swept up in the fervor of the moment in Kyoto - reversed its earlier position of constraint and agreed to reduce carbon dioxide emissions to 6% below 1990 levels. The oil industry has cast a wary eye on the current Canadian administration since it first came to power in 1993, and the specter of some sort of "carbon tax" has been raised on more than one occasion since then. Given that Canada's greenhouse gas emissions are expected to be 19% above 1990 levels by 2000, meeting the requirements of the Kyoto accord will be virtually impossible without drastic measures.

Canada's cold climate, sparse and far-flung population, and resource-based economy are three strikes against the country in the battle to keep emissions down. There is more than a little concern among oil and gas producers over the way the federal government intends to enforce the Kyoto accord.

There are several members of the sitting government, including Prime Minister Jean Chretien, who played a role in the disastrous National Energy Program of the early 1980s, from which the industry has recovered only recently. Kyoto may or may not emerge as a significant determinant of activity in 1998, but it will play a role sooner or later.