​2017 Oilweek outlook survey shows industry expecting recovery that is more tortoise than hare

Majority of survey respondents see slight improvement in 2017, but business environment will remain cautious at best

Battered and bruised by over two years of low commodity prices, Canada’s energy industry isn’t expecting a return to the good times before the late 2014 oil price crash anytime soon, according to Oilweek's 2017 Oil & Gas Industry Outlook Survey.

While there is some expectation of higher oil and gas prices in 2017, there remains a great deal of uncertainty about where the industry is headed as the year unfolds.

Around half of survey respondents expect oil prices to climb to an average US$50–$60/bbl range in 2017. A third expect prices to average $40–$50/bbl.

A little over 50 per cent of respondents expect gas prices to average US$2–$3/mmbtu in 2017. A third of respondents were more optimistic, expecting prices in the $3–$4 range.

Count Rick Grafton, founder and chief executive officer of Grafton Asset Management, among these natural gas optimists.

Grafton told a CFA Society Calgary outlook breakfast in late October those expecting gas prices to remain low could be in for a surprise this winter. “I often hear that commentary: ‘Natural gas prices will never go up—there’s just too much cheap supply,’” said Grafton. “I can remember multiple times in my career that experts told me that prices won’t go back up. And they were always wrong.”

While the headlines have focused on the oil markets, Grafton says gas markets are “the most interesting and underappreciated story—especially since our basin is 75 per cent natural gas.”

He also believes gas prices will rise next year, though he didn’t forecast a specific number.

“Absent a really warm winter, the fundamentals continue to support a strong natural gas price through 2017,” he said.

A Toronto-based fund manager doesn’t share Grafton’s outlook for 2017 gas prices.

While acknowledging at least one forecast for a NYMEX gas price of US$4/mmbtu, Andrew McCreath, president and chief executive officer of Forge First Asset Management, believes North American gas prices will “have a tough time” topping $3 next year.

A colder-than-usual winter has been forecast for much of North America in 2016-17 due to La Niña ocean currents. One of the agencies trying to predict season temperatures is the National Oceanic and Atmospheric Administration (NOAA) of the U.S. Department of Commerce. But as the winter draws closer, each NOAA monthly forecast calls for less frigid temperatures than the forecast issued a month earlier, says McCreath.

While acknowledging the forecasts for the coming winter vary, “I find that, generally speaking, the hype of severe La Niña is diminishing,” he says.

McCreath expects the North American gas glut to worsen with planned increases in takeaway capacity from the Marcellus/Utica shale gas plays flooding regional markets.

“There sure is a heck of a lot of pipe coming on stream over the next two years in the northeast United States,” he says. “And so consequently I think the differential at AECO versus Henry Hub is going to grow over time with the potential of ultimately making a lot of western Canadian gas uneconomic—especially given that LNG is a forgotten dream that I don’t think will ever come back.”

McCreath, who expects strong oil production growth from the Permian oil play in Texas, said Permian oil production also includes large volumes of associated gas, which will add to the gas glut.

McCreath has a similar view of oil markets.

“I think oil is going to have a tough time sustainably staying above $50 for, let’s say, the next two or three quarters,” he says.

McCreath believes U.S. gasoline consumption will fall because demand for new cars seems to have peaked. He implies U.S. car sales are being propped up by automakers who are offering incentives of US$3,800 a car.

“That is a big, big number,” he observes.

McCreath doesn’t expect OPEC will be able to implement its preliminary agreement to cut production because there are “too many rogue players” such as Iraq and Iran.

“So I just see a problem between the supply and demand for oil,” he continues. “I just think there’s too much oil out there. It’s as simple as that.” He noted he’s been “offside lately a little bit” after predicting several months ago oil would be “landlocked between $42 and $50 for the foreseeable future.”

Michael Tran, a New York–based energy strategist at RBC Capital Markets, presented a more optimistic view.

“We expect prices to really grind slowly higher,” Tran told the conference. Rapid oil price growth, he believes, is constrained by the ability of U.S. tight oil players to quickly ramp up output on higher prices.

“If we shoot to $55 or $60/bbl over the very near term, that rally could be self-defeating,” he said. Tran believes a “slow and steady” prise rise will ultimately provide a “stable and sustainable recovery.”

RBC expects WTI crude to average $51/bbl through the rest of this year and to average $56.50–$57/bbl through 2017. Tran expects WTI to start 2017 in the low $50s, then “inch higher” to finish the year in the low $60s.

Tran’s presentation focused on three major oil themes—Saudi Arabia, global inventories and global demand.

Because of Saudi Arabia’s initial refusal to consider production cuts, the oil price collapse is seen by some as an effort by the desert kingdom to win back market share lost to U.S. tight oil producers.

Tran assessed how this fight is going more than two years into the campaign.

“When we look at what the Saudis have gained in the past two years, I have a very difficult time finding any single metric that would suggest that the Saudis have won this market-share battle, or benefited from this market-share battle,” he said.

Any gains were made at a steep cost, he suggested, noting the Saudi government has burned through about a quarter of $1 trillion of its foreign currency reserves, many young Saudis are unemployed and domestic tensions are rising.

The fact that the Saudis reversed their policy last month and decided to consider a production cut shows their strategy to increase market share wasn’t working, Tran said, noting Saudi oil exports to China, the U.S. and India are still lower than a few years ago.

On the storage side, Tran believes a disproportionate focus on the U.S. creates a distorted view of global oil inventories.

U.S. storage levels are closely watched because the U.S. government releases timely, detailed data every week. But at least some market watchers aren’t even aware that Japan releases similar data every week, Tran said. So if Japanese inventories fall by five million barrels, fewer people notice than if U.S. storage falls by a similar amount.

As for demand, Tran noted emerging markets have carried oil demand growth since the 2008-09 recession and OECD demand remains in structural decline.

But while Chinese economic growth is no longer in the low double digits, the current rate of less than seven per cent is still significant.

“What does this mean for Chinese oil demand growth? Well, the glory days where we saw 800,000–900,000 bbls/d are now in the rear-view mirror. But even in a weak year, China is still growing by 200,000, 300,000, 350,000 bbls/d,” Tran said. “You don’t need eight, nine, 10 per cent GDP growth to translate into pretty decent Chinese oil demand growth.”

The RBC analyst believes India will be the biggest oil demand growth region for many years. “When I say ‘many years,’ this could be a couple of decades…. India looks very similar to what China did 15–20 years ago.”

To illustrate this, Tran pointed to gasoline consumption data. China consumes three million bbls/d while Indian demand is only half a million bbls/d. In other words, even if Indian gasoline consumption tripled, it would still only be half of China’s current usage.

Industry expects improving revenues will drive investment

Around 42 per cent of survey respondents expect their companies to report slightly higher revenues in 2017—with nine per cent expecting a significant revenue increase—but they don’t expect those revenue increases to come from higher prices. Only 15 per cent expect higher prices to drive revenue upwards. Over 40 per cent expect new business opportunities to push revenues higher, while 18 per cent believe new growth projects will add to the top line of balance sheets.

Half of respondents expect to finance their operations with free cash flow. Appetite for debt and equity financing is very low, with only 11 per cent expecting to access debt markets and nine per cent expecting to tap equity markets in 2017.

Around 36 per cent expect to invest free cash flow in growth projects, with around 21 per cent focused on paying down debt. Around 19 per cent plan on spending their free cash flow on productivity improvements.

Barry Munro, president of Ernst & Young Orenda Corporate Finance, told a joint conference of the Gas Processing Association of Canada and the Petroleum Joint Venture Association in early November that companies focused on productivity improvements are the ones likely to win the battle for market share.

“Everything I do has to create value,” he said. “If that means I have to sacrifice growth, I will sacrifice growth because I am not actually going to get rewarded for growth because the only way to achieve growth is to expend a lot of capital.”

The industry is already seeing that shift with the cancellation of oilsands projects and attempts at gas plant rationalizations, Munro suggested.

In his presentation, he traced the various phases of the downturn in the industry. Companies first went through the stage of “driving to survive,” making the hard decisions and “the guys who were slow doing that are the guys who are with our restructuring group right now,” he said.

Around March of this year, when prices had rebounded from the January low of US$26/bbl, people started saying they needed to get out of survival mode (resilience) and figure out where they were going to go from there because “hunkering down isn’t going to work,” the conference heard.

“I think actually now people are focused on ‘How do I become a winner?’ and ‘What does what I call excellence look like?’” he told the conference. “This is the journey I think we are on.”

Excellence in the industry is threefold: operational, transactional and regulatory excellence, said Munro. “There should be this relentless focus on achieving operational excellence; this relentless focus on transactional excellence and this new dynamic of regulatory excellence because if you don’t do that, you are never going to be a winner.”

Operational excellence, though, is not just cutting costs, but actually driving fundamental and operating model changes to make the business better, he said. “We have done a tremendous job of cutting costs over the last two years. Now we’ve got to shift to say what does our business model need to look like with processes and procedures in the way we do business.”

However, bigger step changes will be needed if driving down costs through operational excellence doesn’t get a company to the point where it is comfortable with $50/bbl oil, according to Munro. “That’s where disruptive innovation really plays out when you drive down operating costs in a fundamental way, and that’s the big play around some of those technologies that people are looking at today.” However, disruptive innovation is also costly and hard, he warned.

Where the opportunities are

Twenty-three per cent of respondents see maintenance, repair and operations as the best place put their capital in 2017, while an additional 13 per cent see investing in technology and process improvement as the best bet for capital investment. Another 13 per cent are focused on new capital projects.

Around a quarter of survey respondents said their companies would be looking at adjacent or new industry sectors for growth opportunities. Nearly 29 per cent said they would be looking to horizontally integrate within the industry to grow.

Few companies are looking outside Canada for growth, but for those that are, the U.S. remains the preferred market with a little over 11 per cent expecting growth to come from south of the border.

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