Challenges Continue To Mount For Junior/Intermediate Oil Companies As Commodity Prices Lag And Policy Changes Add To Uncertainty

By: Paul Wells

Article originally posted by the Daily Oil Bulletin on Dec 23, 2015. It has been altered slightly, and it has insight from EPAC President, Gary Leach. Original article can be found here: http://www.dailyoilbulletin.com/article/2015/12/23/challenges-continue-mount-epac-member-companies-co/ 

The Canadian oilpatch has witnessed a monumental shift this year in the political environment under which the industry operates, not only provincially in Alberta, but federally as well.

In essence, the climate change policy in Alberta has been sold by the government as necessary to secure pipeline approvals, and support generally for the industry, both on the national front and abroad.

To wit, while unveiling its new climate change strategy, the government received support on the stage from both environmental non-government organizations and some heavyweight industry CEOs. But will these new policies, in terms of oilsands emissions caps and planned methane emission reductions, achieve the desired goal of support for infrastructure projects, or will it just turn into another hoop for industry to jump through, as some fear? 

Leach said the political changes in the last six months, both federally and in Alberta, have been “sweeping and de-stabilizing” for an industry already facing major challenges. And, at least at this point, it’s a wait-and-see scenario that has yet to fully play out.

“Who, this time last year, could have predicted the current political landscape? Forty-four years of Progressive Conservative government in Alberta swept aside by a completely untested NDP that had never been more than a small, irrelevant opposition party,” Leach said.

“And federally, we had nearly a decade of Stephen Harper’s steady Conservative government … although let’s not forget how they stunned and angered our industry when they wiped out the trust structures in the early years of their government,” Leach said.

Leach noted that the industry are still working to build new working arrangements and channels of communication with a government in Alberta that, “at best, previously had a distant and cool relationship” with the industry.

“Having said that, the [Rachel] Notley government does seem prepared to put its weight behind the Energy East pipeline and, less visibly, the Trans Mountain project to Vancouver. The trade-off is the massive re-orientation of the energy sector in the province: phasing out coal, bringing in more natural gas and renewable power, and the centrepiece: a big re-distribution of money via a carbon tax.

Federally, Leach said that industry is starting to re-build contacts with the Justin Trudeau-led Liberal government.

“The Trudeau election campaign was pretty short on details about the energy sector.  But it seems clear they will design their policy framework for our industry primarily through the climate change and GHG reduction lens,” Leach said.

The carbon tax conundrum

Leach said that the current design of the Alberta carbon tax is something EPAC and its membership have “serious concerns” about.

Unlike British Columbia’s “revenue neutral” carbon tax, Leach noted that Alberta has made no attempt to use this money to reduce the overall burden on taxpayers.

“In Alberta the money collected will be distributed as directed by the government to subsidize renewable power generators, incentivize selected technologies and efficiency programs, and reduce the cost of the carbon tax for lower income Albertans,” he said.

Leach added that the economy-wide carbon tax to be imposed on Alberta businesses and consumers is deductible for royalty payments only by the oilsands sector.

“Thus the conventional sector is distinctly disadvantaged relative to the oilsands sector, let alone our competitors elsewhere in North America who don’t shoulder this type of cost. We have urged the royalty panel to take this into account in their recommendations, particularly to level the playing field with the oilsands sector,” he said.

“We know this carbon tax and the oilsands emissions caps are being promoted as a way to reduce opposition to new pipeline construction. But the carbon cost is a definite hit to cost competitiveness for Alberta producers whereas the promise of new pipelines is just that — a promise with no guarantee. In fact, the new Trudeau government has said it will move ahead with a re-design of the National Energy Board’s [NEB] mandate to include a broader evaluation of environmental impacts.”

So, what does this mean for pipeline projects currently in front of the NEB or on tap — is the Canadian oil and gas industry ahead or behind? Time will soon tell.

“The first one up is the Kinder Morgan [Inc.] pipeline expansion to Vancouver, which will be decided by the NEB sometime in 2016. So this will be in front of Trudeau’s cabinet fairly soon … and we’ll know then whether the rhetoric around Alberta’s improved image is indeed providing momentum to advance new pipeline projects,” Leach said.

The shift away from coal-generated electricity. Is this a positive for the Oil and Gas Industry?

A vital part of the provincial government’s climate change plan is the phase-out of coal and a shift to more renewable and natural gas generation.

However, Leach said that the government has not disclosed “how many billions of dollars” it could cost taxpayers to compensate the owners of coal-fired power generation facilities that would be forced to shut down decades earlier than originally planned.

“The government will offer incentives to renewables, like wind and solar, and natural gas will also be expected to take up an increased share plus be available as an expensive redundant back up for the unreliability of wind and solar power generation,” he said.

“Overall this will drive a significant increase in demand for natural gas in Alberta, which is important to producers here because it will be a struggle to compete in traditional markets in Eastern Canada or the U.S. Perhaps we’ll see some additional gas demand growth in Saskatchewan for the same reason, although the power market there is much smaller than Alberta.”

The bottom line, though, is Leach doesn’t see an Alberta electric power shift as favouring any particular segment such as junior, intermediate or senior producers. “As always, lower cost producers will benefit most.” 

The future role of juniors

With lower oil and natural gas prices, the role that smaller producers play going forward could change. Will we see an erosion of the junior/intermediate sector and a move into a new world where the small and micro juniors disappear; in other words, will we see fewer but larger producers in Western Canada? Will we see a change in business models? How does the sector survive?

Leach is confident many member companies will adapt to the new reality. However, there will be casualties.

“The last few years have seen old business models discarded and new leaders emerge. This has been driven by trends that are relentless — selective market sentiment that favours larger, more liquid companies, the need to scale-up to develop resource play opportunities, increasing regulatory compliance costs and stronger balance sheets to survive extended periods of low commodity prices,” he said.

That said, the largest companies have more options to adjust as they can pursue opportunities elsewhere, rationalize their portfolios, unload assets or sell debt to raise cash and focus on their best projects.

“This flexibility has not been open to many small producers. One obvious sign is that the number of publicly-traded juniors is much smaller than a decade ago,” Leach said.

“Private equity has emerged as a more visible factor. The larger junior and intermediate producer segment is much healthier than the smallest tier and there are some very exciting companies in this space that are EPAC members. I think we are seeing the end of an era that has lasted for many decades since Western Canada’s oil industry really took off after the Leduc discovery.”

Leach believes that the Canadian oil and gas industry will see “fewer but stronger” large junior/intermediate players competing successfully among the large Canadian senior and international players.

“We still need a strong junior and intermediate sector to develop the full spectrum of resource opportunities in Canada. We like to remind the politicians and senior bureaucrats of this fact,” he said.