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It’s impossible to talk about the energy business in Calgary these days without discussing the impact of BP’s rogue well in the Gulf of Mexico.


No one wants to convey an inappropriate sense of competitive Shadenfreude as the environmental disaster worsens, but there is quiet and guarded optimism among domestic stakeholders that the unintended consequences of the blowout will benefit the Canadian oil industry, especially the oil sands. But such optimism should remain very guarded, because the tragedy in the Gulf poses unintended and unwanted risks to Canada’s oil and gas industry too.


There are many consequences to consider, too many for one column, but let’s focus on what the blowout means to capital investment into oil exploration. Extra safety measures, higher insurance rates, more stringent regulation and drilling moratoria in the Gulf of Mexico will all translate into higher costs that lead to the diversion of exploration dollars to other free-market jurisdictions where there is oil to be found. It’s uncertain how much of the $US 15 billion that is spent annually in the offshore United States will migrate elsewhere, but those in the oil business know that options are highly constrained and Canada represents one of the few attractive choices for investment.


The world of oil reserves is divided into two; restricted barrels under the control of national oil companies (NOCs) are paired against barrels open to investment in a free market environment. This two-sided oil world is far from equal. Estimates vary, but a country-by-country scan combined with consensus opinion suggests that around 80% of the world’s oil reserves are under state control, which means that only 20% of the world’s oil is open to freely flowing competitive capital.


Let’s look at the numbers. Total proved oil reserves in the world (2009) were estimated to be 1.34 trillion barrels. Slicing 20% out of that pie means that only about 270 billion barrels are open to free market investment. And within that 20% slice, the largest bite of those free-market barrels are under the feet of Canadians, about 178 billion. In short, 64% of the world’s free-market oil is in Canada, the vast majority of which lie in Alberta’s oil sands (170 billion barrels). So, it’s reasonable to think that any future capital spending that is diverted away from the Gulf of Mexico will have a difficult time avoiding a pass through Canada.


Nobody wants to say no to more investment dollars, yet stakeholders in the Canadian oil and gas industry should be cautious what they wish for. The negative offshoot of surging investment dollars into an economy is inflation. Alberta is especially susceptible to cost inflation with its relatively small labour pool and tight access to services. We’ve seen the scary inflation movie before, between 2005 and 2008, when costs within the upstream oil and gas industry were rising by an average 15% per year.


The real problem of inflation due to rapid capital inflow is not confined to the oil sands. Localized cost increases act as a regional pesticide across the entire economy, because peripheral businesses have to match rising wages and higher prices paid for goods and services, lest they lose good employees to the oil industry. Even within the oil and gas industry there is collateral damage when oil dollars flow in too fast. Notably, western Canadian natural gas producers suffer a loss of competitiveness when costs are pushed up across the board.


Since the great recession many costs have moderated in the Canadian oilpatch. As well, over the last three years the upstream oil and gas industry has done a great job improving its productivity, consolidating its assets, repositioning itself geographically and regaining a lot of lost competitiveness. The most recent adjustments to Alberta’s royalty regime have been positive too. Capital that fled the upstream oil and gas business a couple of years ago is coming back, and of course the availability of capital is much more welcome than not. But it’s not welcome at a frenzied pace that drives up the cost of everything from a cup of coffee to drilling mud (sometimes the former tastes like the latter), and that is where the vulnerability lies.


Finally, the risk of recurring inflation is paired against another consequence of the BP blowout. Slicks washing up on marshes and beaches are making large oil consuming countries like the United States increasingly resolute to “get off oil.” To be sure, it will be a long time before the world cures its addiction to petroleum products, but there are many demand mitigating forces that are gaining momentum – induced by technology, policy and societal change – that are likely to significantly offset new growth barrels over the next five-to-ten years. When that happens (not if), the first barrels that will be cut from the world’s consumption will be the highest-cost barrels. Let’s hope those barrels aren’t Canadian barrels.


(Courtesy of The Calgary Herald)

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