Violent market storms test the industry’s ability to dodge financial wreckage
Riding the most tumultuous economic waves since the 1930s Depression, captains of industry must grab the wheel with firm conviction that they can see their companies through the gales. Searching for safe harbors is essential, especially for oil companies carrying multibillion-dollar projects.
Corporate commanders need to know cash flow is secure and they turn to risk-aversion strategies to smooth out the storms.
“Companies need the assurance that they are able to make the capital expenditures to which they are committed. That’s a reason for hedging,” says Michael Tims, chairman of Peters & Co. Ltd.
The primary strategy for most oil and gas firms is to keep debts low. That means holding down operating costs to pay their way with production revenue. History is brutal to companies that combine high operating costs with high financial risks.
However, it is neither simple nor always possible to keep both risks and costs low, making calm waters tricky to reach without experience, skill and foresight. The current rough patch promises every oil and gas industry boss a test of all three.
“We’ve entered into a period of turmoil, anxiety and volatility as the world tries to rebalance and rationalize its energy needs,” says bestselling author Peter Tertzakian, ARC Financial Corp.’s chief energy economist and managing director.
Crude oil’s price on the futures market was violently volatile through much of 2008, soaring from US$87 a barrel to a July 11 peak of $147.27. The largest leap ever in one single day came on Sept. 22, when oil jumped $16.37 to close at $120.92. Speculators certainly had a role in that drama, although most industry experts insisted supply and demand were the dominant factors.
By late September, oil dropped into the $105 range, reacting to a United States government study detailing a 5.3 per cent decline in demand since mid-2007. Oil lost another $10 in the last week of September after the U.S. House of Representatives initially vetoed a $700-billion bailout package for ailing Wall Street banks. The slide continued, with oil futures losing more than $50 from their July high. As October began, a barrel of oil was below $90 and by the time it ended, it was priced at less than $65.
With its price tethered to fears of an international recession, oil faces a skittish dance down a steep slope of anticipated drops in consumption. “We are in an economic downturn globally which has taken the edge off the demand side,” notes Tertzakian. “It hasn’t solved the problems. Demand will return. Business cycles eventually resolve themselves. We will be going back into high gear.”
It’s a question of when. Troubled Merrill Lynch & Co.’s last actions before succumbing to a financial crisis takeover included revamping its 2009 oil price forecast to an annual average of $90 a barrel, and a warning that prices could careen to $50 if fears of global recession come true. The firm added this “worst case scenario” was “unlikely.” But markets were spooked. Toxic scenarios wreaked havoc on investors, while chief executives tried to steer clear of financial wreckage left by the growing bank credit crisis.
Past trends provide a few lessons about energy prices. Just a decade ago, oil sank to $10.72 a barrel. A decade before that, the National Energy Program clamped its regulatory reins on oil. From October 1980 to March 1985, then-prime minister Pierre Trudeau regaled his Liberal government with a double standard of low domestic but high export prices for Canadian oil and gas production. By the time the Conservatives repealed the NEP, global demand had softened and by 1986, world oil prices had plunged.