Thursday, 28 April 2016

David Yager - In Closing...........

This will be my last column for MNP. I am moving on to other opportunities in the oilfield
service industry, probably as a player instead of a coach. My 3.5 years at MNP have
been great and the firm has made significant investments in training, processes and
systems to be the best-in-class provider of accounting, tax and consulting services to
this key component of the Canadian economy. Please consider MNP as your trusted
financial services supplier.
David Yager
For more information contact:
Jeremy Rondeau
Vice President - Oilfield Services
T: 306.770.3679

Canada's Oil Industry May Never Be the Same -- Here's Why!

Never is a long time. The dictionary definition is, “at no time in the past or future; on no occasion; not ever.” In the volatile oil and gas industry, those who try to look that far into the future and predict anything with certainty are invariably wrong. Here’s hoping.
But it’s not all bad Oil prices are gradually rising because of market physics and investor sentiment. Federal and provincial politicians are softening their opposition to, and have even publicly declared support for, pipelines to tidewater. The worst is over.
However, it is increasingly certain the future will not be like the past. Previous downturns have been equally devastating but the primary causes eventually reversed themselves; low commodity prices recovered and damaging government policies were rescinded.
This recovery will be different for a variety of reasons which will combine to cap growth, opportunity and profits, even if oil and gas prices spike. The following major changes appear permanent.
Oil Is Destroying the World
“New research shows that the fossil-fuel era could be over in as little as 10 years, if governments commit to the right policy measures… If you think workers are suffering in Alberta now, wait until you see what Canada’s economy looks like if we miss the huge opportunities for jobs and prosperity offered in renewable energy and a truly climate-friendly economy.”
Written by a climate and energy campaigner for the Sierra Club, this appeared on top of page 13 in the April 23 edition of Victoria’s Times Columnist, under the headline, “Pipelines not the pathway to Paris solutions.” B.C.’s views on pipelines are well known.
Whether you or the tens of thousands of laid-off oil workers believe the first paragraph or not, on April 22 at the United Nations in New York, 171 countries signed the Paris climate change agreement negotiated last year. At the event, UN Secretary-General Ban Ki-moon said: “Paris will shape the lives of all future generations in a profound way – it is their future that is at stake.” He said the planet was experiencing record temperatures: “We are in a race against time. I urge all countries to join the agreement at the national level. Today we are signing a new covenant for the future.”
Showing support, in the Globe and Mail April 26, the Minister of Foreign Affairs for the island country of Maldives wrote, “Our ratification (of the Paris agreement) is based on the clear and present danger of losing our country completely to rising tides. How critical this has become can be seen in a report released only this month that questioned the stability of our polar ice sheets. We now know March, 2016 was the hottest month in recorded history.”
This is all caused by burning carbon fuel. True or not, this debate will not die anytime soon.
The anti-carbon movement is already affecting the oil industry in ways nobody would have imagined two years ago. Alberta’s comprehensive carbon tax regime will become law January 1, 2017 apparently to prove the province deserves a social license to stay in the oil business from carbon fuel opponents. The recent Canada / U.S. commitment to reduce methane emissions will come at an enormous cost to the oilpatch if implementation is not preceded by significant study and comprehensive cost / benefit analysis.
These are just part of a growing trend to dismiss and / or deny the essential role hydrocarbon fuel plays in powering the world’s economy. Oil doesn’t matter any longer University endowment funds have been pressured for years to divest shares in oil and gas companies. The Royal Bank of Scotland now refuses to provide funding for oilsands development. Historically, people sought jobs in the oilpatch and were proud of their work.  This is changing fast.
Canada is one of the few major oil and gas-producing jurisdictions determined to push rapidly forward with major and expensive anti-carbon policy changes despite being only a nominal contributor to global emissions. We won’t be followed anytime soon by Russia, Saudi Arabia, Kuwait, Kazakhstan, Iran, Iraq, Mexico, Venezuela, Nigeria and so on. They will be happy to supply Canada with oil, whether Canadian supplies continue or not.
“Quantitative Easing” No Longer Stimulating Economy
Following the 2008 / 2009 recession the world’s central bankers embarked on a program of near-zero interest rates that would be expanded into something called “quantitative easing.” Investopedia’s definition is, “Quantitative easing is an unconventional monetary policy in which a central bank purchases government securities or other securities from the market in order to lower interest rates and increase the money supply.” This has now been expanded in some countries to include experimental negative interest rates where banks and, ultimately, savers are penalized for holding cash and not spending their money.
The purpose has been to juice spending to keep the western economic miracle alive while government debt balloons and the economy stagnates. If interest rates ever approached the double digit levels of 30 years ago, the economic devastation would be staggering. Prime lending and mortgage rates peaked at 22.5% in the early 1980s, long before it was believed (then accepted) governments could print money without collapsing the economy or creating runaway inflation.
But it isn’t working anymore. Past recessions were caused by high oil prices and cured when they fell. Not this time. An article in on April 19 by Gail Tverberg read, “…consumers are the foundation of the economy. If their wages are not rising rapidly, and their buying power (considering both debt and wages) is not rising very much, they are not going to be buying many new houses and cars – the big products that require oil consumption. In fact, in order to bring oil demand back up to a level that commands a price over $100 per barrel, we need consumers who can afford to buy a growing quantity of goods made with oil products.”
Oops. This time oil prices collapsed and so did demand. The International Energy Agency is forecasting, despite low prices, demand growth of only 1.2 million barrels (b/d) per day this year compared to 1.6 million b/d or higher in 2015 and prior years. Middle class incomes, the main driver of growing oil consumption in the past, are no longer rising in the western world. Quantitative easing has run its course. What growth in oil demand may occur will be in Asia and other foreign markets. Should governments reverse policies on near-zero or sub-zero interest rates or people lose confidence in the long-term stability of central banks printing money as required, oil consumption and prices are doomed.
The U.S. Shale Boom Was Financed By Low Interest Rates
The hunt for yield in the era of lower to zero interest rates leads to peculiar investment decisions. In 2008 the collapse of the housing bubble – driven by an endless investor appetite for high-yield mortgage bonds of questionable quality – was said to cause the global recession. This precipitated the collapse of major financial institutions like Lehman Brothers and the bailout of many more. Regulators frowned and tried to bring in policies to ensure it would not happen again.
The great light tight oil (LTO) or shale boom in the U.S. since 2010 has all the hallmarks of a similar asset bubble. Exploration and production (E&P) companies were able to finance significant drilling through the sale of subordinated bonds with an attractive yield of 6% or more. They were for the most part interest-only and due in several years. The problem with drilling high decline LTO wells with high yield debt is by the time the bonds mature, the production from the wells the debt paid for has declined to the point the assets are only worth a fraction of the leverage outstanding. Many companies in the U.S. are already broke and more will follow. Much analysis has been done to show some of the top LTO drillers in the U.S. spent $2 on drilling for every $1 of cash flow prior investments had generated. The difference was made up by seemingly limitless capital inflows.
This has created two problems for Canada’s oil future. The first is even if commodity prices rise and transportation issues are solved, the ability of companies to raise cheap debt will be impaired for some time, perhaps forever, depending on what happens to interest rates. Historical E&P spending has almost always exceeded cash flow providing investment, jobs and opportunity that would not exist otherwise. External capital inflows are essential to feed the machine.
The other is the impact debt-financing has had on oilfield services (OFS) sector balance sheets. As has been written on these pages before, in 2014 and 2015 alone 21 diversified Canadian OFS operators invested $37 billion adding new rigs, frack spreads, camps, processing plants, midstream facilities and pipelines for a growing North American oilpatch. Three large Canadian pressure pumpers alone carried a combined $2.6 billion in debt and one has gone broke. A lot of E&P demand was financed by debt, which is no longer available. Now OFS is overbuilt and many operators over-levered. It will take some recovery to clean this up.
Middle East Production About Volume, Not Price
Why Middle East producers do what they do remains a mystery. But whatever the plan or strategy, the cash cost of finding and producing the next barrel in this region remains the lowest in the world. In the past it seemed Middle East oil strategy was about price with oil sales assured. Now it looks like volume and market share.
The Middle East may soon be the world’s most active market for drilling rigs. According to the Baker Hughes worldwide rig count, the only area of the world (Latin America, Europe, Africa, Middle East, Asia Pacific, U.S., Canada) still operating about the same number of rigs in 2016 as it was in 2014 is the Middle East. The only region that has increased its active rig count from 2013 and 2012 and its share of the global active drilling rigs is the Middle East.
MNP Graph5
Source: Baker Hughes Worldwide Rig Count April 22, 2016, average rigs operating for the period
Why? Because they can and to sustain output they must. Whatever the financial situation may be for the governments in charge, there is clearly sufficient cash flow from existing production to fund more drilling. With the Baker Hughes U.S. total active rig count for April 22 down to 471, the average 403 rigs drilling in the Middle East in the first three months of 2016 make it the second-busiest region in the world. Unless prices recover soon, it could become number one.Source: Baker Hughes Worldwide Rig Count April 22, 2016, average rigs operating for the period
This is not a price war Canada can win. One of the attractions of Canada in recent years is foreign capital was welcome to develop massive, if expensive, oil reserves. Now Iran is said to be open for business. As is Mexico. Saudi Arabia wants to diversify its economy away from oil and sell its refining operations to global investors. The Saudis are talking bravely about an economy no longer dependent upon oil profits as soon as 2030.
Western Canada is not the only oil-producing jurisdiction wondering about its future. It is, however, the highest cost oil-producing jurisdiction wondering about its future.
Canada Down But Not Out
Canada produces 7 million barrels of oil equivalent per day of bitumen, crude oil, natural gas liquids and natural gas, making it the fifth largest hydrocarbon-producing jurisdiction in the world. The country won’t be going out of the oil and gas business anytime soon, so keeping it going will remain good business and the largest resource industry in Canada.
But the current mantra of “lower for longer” is wrong. This is only the price of oil. In terms of the Canadian oil and gas industry there are multiple reasons it could be “lower for a long time, possibly forever.” As a country that performs all elements of producing still-essential hydrocarbons as well or better than anyone else in the world – everything from broad economic participation to worker safety to environmental protection – that is a tragedy.
This will be my last column for MNP. I am moving on to other opportunities in the oilfield service industry at the end of April, probably more as a player than a coach. My 3.5 years at MNP have been great and the firm has made significant investments in training, processes and systems to be the best-in-class provider of accounting, tax and consulting services to this key component of the Canadian economy. Please consider MNP as your trusted financial services supplier.
David Yager

Tuesday, 26 April 2016

The elephant in the room: Alberta's oil and gas exports

Posted: April 26, 2016
Author: Rob Roach - Director of Insight
Published in - The Owl

Alberta is not the only province dominated by a single export product category, but we do lead the nation in this respect. Like Alberta, oil and gas forms the largest slice of Newfoundland and Labrador’s export pie. New Brunswick exports a large amount of refined petroleum and, as such, joins Alberta and Newfoundland and Labrador in the oil-and-gas-is-our-largest-export club. Nationally, vehicles and transportation equipment (18.8 per cent) vies with oil and gas (18.5 per cent) as Canada’s largest single export category.
Alberta’s oil and gas exports in 2015 worked out to just over $15,000 per Albertan. The sway of agriculture in Saskatchewan is not far behind at $13,505 per person. What is startling is that Alberta’s per capita oil and gas exports are almost three times greater than Ontario’s auto industry exports. This is why so many Albertans can quote the daily price of WTI and why our province’s economic fortunes are so tightly bound up with the oil and gas sector.
Watch for a more detailed examination of Alberta’s export economy in the May edition of Perch.
- See more at:

Largest export product category, graph

Monday, 18 April 2016

Oil and the economy

The oil conundrum

Green and black
After the Paris summit on climate change in December some pundits reckon that the latest oil crisis reflects a structural change in oil consumption because of environmental concerns—what some call “peak demand”. It is true that as climate consciousness grows, oil companies are developing more gas than oil, hoping to deploy it as an energy substitute for coal. But it may be too early to assume that the era of the petrol engine is coming to an end.
More likely, the oil price will eventually find a bottom and, if this cycle is like previous ones, shoot sharply higher because of the level of underinvestment in reserves and natural depletion of existing wells. Yet the consequences will be different. Antoine Halff of Columbia University’s Centre on Global Energy Policy told American senators on January 19th that the shale-oil industry, with its unique cost structure and short business cycle, may undermine longer-term investment in high-cost traditional oilfields. The shalemen, rather than the Saudis, could well become the world’s swing producers, adding to volatility, perhaps, but within a relatively narrow range.
Big oil firms would then face some existential questions. In the future, should they carry on as before, splurging on expensive vanity projects in hard-to-reach places, at the risk of having “unburnable” reserves as environmental concerns mount? Should they reinvest their profits in shale or in greener technologies? Or should they return profits to shareholders, as some tobacco companies have done, marking the beginning of the end of the fossil-fuel era? Whatever they do, the era of oil shocks is far from over.

From the print edition: The Economist

Wednesday, 6 April 2016

Murray Edwards And Why Tax Rates Matter to Oilfield Services

MNP LLP - Oilfield Service News April 6, 2016
By: David Yager, National Leader, Oilfield Services

"Who will stand up for Alberta's persecuted billionaire community?" the headline of popular political blog site sarcastically blared after the story broke last month about how wealthy and successful Calgary entrepreneur N. Murray Edwards had apparently relocated his residence to London for tax reasons. The article opened with the sentence, "A billionaire is moving from Calgary and we should all be worried, the newspapers tell us." Obviously, some don't think this is a problem.

The story broke in the Calgary Herald on March 24 after publicly traded Magellan Aerospace Corp., a company controlled by Edwards, disclosed in its annual year-end filings its chairman resided in London, United Kingdom, not Calgary/Banff as had previously been the case. A few days later in its Annual Information Form, oil and gas producing giant Canadian Natural Resources Limited (CNRL) released the same information about its executive chairman. The Herald wrote, "Two sources familiar with the situation who asked  not be identified said Edwards is switching his residency to the U.K. For Tax reasons."

The increasingly reclusive Edwards has yet to publicly confirm or deny his departure from Calgary. But it is illegal for listed companies like Magellan and CNRL to knowingly publish false information in their regulatory filings. Therefore, it is safe to assume Mr. Edwards has indeed physically left Calgary. Whether rising corporate and personal income taxes are the reason is only speculation. However, it is not speculation to observe wealthy and successful entrepreneurs like Murray Edwards pay very close attention to tax rates. That's why they are wealthy and successful.

Canada's battered oilfield services (OFS) sector should certainly be worried when a serial entrepreneur and wealth creator of Murray Edwards' reputation concludes for whatever reason Calgary is no longer his preferred place of residence. Besides CNRL, Edwards has been a driving force behind one of Canada's most successful oilfield service companies, drilling giant Ensign Energy Services Inc. plus other high profile investments like the Calgary Flames hockey team and Resorts of the Canadian Rockies.

In the past 20 years Calgary has become the headquarters location of every major Canadian exploration and production (E&P) company and the majority of the larger OFS companies. In turn, Calgary has attracted or developed a massive financial, technological, legal and administrative support infrastructure to allow these companies to support domestic and global operations from a city once best known for its annual rodeo. This century, Calgary has grown into one of the world's most important oil and gas centres and is now comparable to places like London and Houston. When one of Calgary's most important company builders and dealmakers decides to leave, everyone in the oilpatch should wonder why.

When people talk about how the Canadian oil and gas industry began a near-continuous 20-year growth spurt in the mid-1990s, the most obvious reference point is commodity prices. While oil didn't do that well until the 21st century, natural gas certainly did. Deregulation of gas and the opening up of U.S. export markets through the construction of new pipelines unlocked opportunities for all participants. Oil got more attention with rising prices and oilsands expansion early last decade. While there were small dips in 1989-99, 2001-02 and 2008-09, the general trajectory for Canada's oilpatch was upwards until last year.  

While too many in this industry are insufficiently modest to credit factors beyond their own genius for their success, another big growth driver was major changes to Alberta's corporate and personal tax regime in the early 1990s. Following nearly 15 years of difficult times following the National Energy Program of 1980 and the oil price collapse of 1985, Alberta was in tough shape. Deficits had skyrocketed. The economy was stagnant. There was little, if any, capital flowing into Alberta.

To improve the economy, the government of Premier Ralph Klein reduced corporate tax rates, introduced a flat personal income tax rate and slashed provincial government spending. The message to the world was Alberta was a great place to invest. Taxes for corporations and executives would be low and very competitive. Two major royalty reviews -- 1991 for conventional oil and gas in 1996 for oilsands -- ensured this key element of the fiscal regime was globally attractive. With government spending under control, investors could be confident the fiscal regime would remain competitive and stable.

The program was called "The Alberta Advantage." While it was not certain at the time it would work, what followed can only be described - and would frequently be described -- as a modern economic miracle.

The first sign this strategy would be successful occurred in 1996 when venerable Canadian Pacific Railway Limited (CP) - the ribbon of steel across Canada that helped create Calgary and arguably Canada's longest established major corporation - moved its head office to Calgary from Montreal. This decision was precipitated by the actions of two provincial governments. Alberta was selling itself as open for business, while Quebec was governed by the Parti Quebecois, which had barely lost a referendum to separate from Canada October 30, 1995.

Another major move that further legitimized The Alberta Advantage was the 2004 decision by Imperial Oil Limited (IOL) to move its corporate head office to Calgary from Toronto. Montreal and Toronto have long considered themselves Canada's urban cultural epicenters while Calgary has long been regarded by both cities as a redneck cultural backwater. But when the executives of CP and IOL learned they would earn the same salary but pay lower personal income taxes and no provincial sales tax, most held their noses and accepted they ought to at least give Alberta a try. Most came to like Calgary and Alberta very much and are still here.  

Alberta's oil boom continued to the point that some started taking it for granted. In 2007 the Alberta government concluded it could substantially raise oil and gas royalties without affecting business decisions or investment. The ill-fated New Royalty Framework was all but entirely reversed by mid-2010 spurring another round of growth and investment. At the same time it tried to raise royalties, the province abandoned fiscal probity and the province hasn't balanced the budget since. Ultimately, all these things matter to keep the prosperity train on the right track.

Which brings us back to Murray Edwards and 2016. The new NDP government won the provincial election in May of 2015 led by premier Rachael Notley who said many times, “When times get tough, those who are profitable should be paying a little bit more.” The corporate tax rate was increased by 20% on July 1, 2015. People in upper income brackets also faced higher taxes. The 10% flat personal provincial tax rate that worked so well for so long was ridiculed and is now 50% higher at 15% for those
earning $300,000 per year or more, a target group of The Alberta Advantage in the 1990s.

Campaigning on a similar strategy of supposedly helping lower and middle income earners by raising taxes on the more successful, the new Liberal administration in Ottawa has jacked its rate on higher incomes from 29% to 33%. This means Alberta’s marginal tax rate for top earners has jumped from 39% to 48%, a 23% increase. While defenders of Alberta’s tax hikes continually cite how the new rates are still lower than in other provinces, those in favor of higher taxes are not asking if the new rates are still
low enough to justify moving the entire head office and executive team and uprooting families from all across the country. This is expensive and disruptive. You need every tool in the toolbox to make these decisions attractive and minimize risk.

This has been tried before in other jurisdictions and ultimately the costs have been greater than the perceived benefits. One of the better-known countries to raise taxes and spending but ultimately reverse them out of economic necessity is Sweden. Back in the 1970s, that country had cranked its marginal tax rate to 70% or more, causing well-known individuals like tennis star Bjorn Borg and filmmaker Ingrid Bergman and pop band ABBA to flee the country as tax refugees. As result, Sweden collected significantly less tax revenue than central planning had forecast. According to a 2012 article in Forbes magazine, in the hundred years from 1850 to 1950 Sweden’s productivity growth was the highest in the world. Forbes wrote, “By 1995, Sweden had fallen to sixteenth place – the most dramatic relative decline of any affluent country in history”. Sweden began to reverse its high tax course in 1980 and since has recovered significantly.

What does this mean for OFS? Again, while we can only speculate why Mr. Edwards relocated to London, it is much easier for one rich executive to move than the head office of the company. But at some point, when the fiscal regime which attracted major corporations and capital to Alberta is removed, head offices will leave and capital inflows will stop.

Having and keeping E&P company head offices in a Calgary is incredibly important to OFS. As the Petroleum Services Association of Canada has demonstrated on multiple occasions, the OFS supply chain is much broader than drilling rigs, trucks and construction equipment in the field. It also includes products and services primarily used only in the E&P head office such as software, technology, data
processing and business support and professional services.

The combination of the downturn and the myriad of new taxes and programs being introduced by the NDP caused an unprecedented written plea on March 15, 2016 by 15 major business associations in Alberta for the government to immediately meet to discuss the precipitous decline in the economy. This included the Canadian Association of Geophysical Contractors, the Canadian Association of Oilwell
Drilling Contractors and the Petroleum Services Association of Canada. Other groups included road builders, homebuilders, manufacturers, retailers and restaurants.

While the letter admitted Edmonton wasn’t responsible for the oil price collapse the groups wrote, “… We have also seen the rapid deployment of a series of ambitious government policies that have further undermined business confidence and competitiveness. Rising corporate personal taxes, a costly carbon
tax and historic increase to the provinces minimum wage are impacting Alberta’s economy when it most needs a boost.” The government was not amused and how much it is listening will be apparent when the Alberta budget is released April 14.

If Murray Edwards moving to London was the only piece of bad news besides collapsed commodity prices, this event would be immaterial. But it is not. What is occurring is a steady and systematic reversal of the major fiscal and economic policy changes in the early 1990s which helped create the oilpatch as we know it as recently as a year ago. Be very cautious.