This story originally appeared on CanadianBusiness.com.
Thank goodness for QE3. And the tension in the Middle East. Because when oil prices slip below a tipping point, Alberta’s economy goes from hot to not very quickly—and this summer, it almost happened.
As it is, the Alberta government is preparing for a $3-billion deficit instead of what was projected to be its first surplus in five years. Oilsands heavyweights such as Suncor and Canadian Natural Resources are delaying projects.
Conventional exploration companies have trimmed their budgets for the winter drilling season. And the natural gas sector, which used to be the breadwinner in the oil and gas household, lies mired in a four-year slump.
Yet Alberta’s overall economy continues to cruise along just fine: unemployment is low, retail sales are hot, and housing starts are on a steady upswing.
What’s the price at which Canada’s economic engine starts to sputter? The decline from more than US$100 a barrel to a low of $77 in June apparently wasn’t enough. But it was close.
Canada is one of the highest-cost oil-producing regions in the world. For heavy oil and oilsands production, $75 or $80 is the price at which new projects start to struggle to earn a rate of return in the current cost environment, says Robert Fitzmartyn, managing director of institutional research at First Energy Capital.
For Robert Schultz, a professor with the Haskayne School of Business at the University of Calgary, the magic numbers are 50-60-70. At $70, the newcomers to the patch are out of the game.
At $60, the next level down starts to feel the pain and claw back operational costs. The giants of the oilsands—the Syncrudes and Suncors—get walloped at $50.
“They’ve already paid for the land,” says Schultz. “They are likely to continue [operations] down to whatever the price is”—as they did when oil briefly dipped below $40 in 2008-09.
When London-based energy consultantcy Wood Mackenzie rang the alarm bell on oilsands profitability in June of this year, it exempted veteran projects from the proscribed panic, although not from delays and concerns about transportation bottlenecks and a “crude glut” resulting from increased U.S. Bakken production.
Today nobody is panicking. “People who follow the economy here in Alberta don’t need to be worried about daily, weekly or even monthly volatility in crude prices,” says James Pasieka, a Calgary lawyer and businessman.
“We need to be worried when capital budgets in the industry are permanently cut back.” The companies that put the brakes on their spending when prices dip are managing their cash flow responsibly. If they freeze capital programs indefinitely (as they did in 2008-09), that is the point at which Alberta’s economy nosedives.
What rattled Alberta earlier this year, industry insiders say, wasn’t the West Texas Intermediate (WTI) price of oil the province used to predict royalty revenues. It was the massive discount for Edmonton light crude, which, as a result of transportation bottlenecks, was effectively selling for $20 to $25 below the price of WTI.
That meant Canadian oil didn’t just dip below $80, it fell below $70, and stayed there until the bottlenecks receded.
“Cash flows really get slaughtered if you have a sustained sub-$70 Edmonton light,” says John Brussa, a Calgary lawyer and dealmaker. Key word: sustained.
With the price of WTI back up near the $100 mark, and the discount for Edmonton light down to just $2 or $3, hard times are not around the corner. “We continue to be bullish on crude oil,” says Fitzmartyn.
He’s not alone; the Paris-based International Energy Agency predicts the daily demand for crude will rise by 800,000 barrels on average in 2013, and expects the price to stay above US$100.