U of C report asks: Are junior companies really that nimble?
Sector myths lead to bad policy, report authors say
One of the oft-repeated narratives about the Canadian oil and gas industry is that it’s the junior companies that are the nimble innovators and risk-takers – at the vanguard of industry development. It’s a claim casual observers of the industry often take at face value. But is it true?
A summer report issued by the University of Calgary’s School of Public Policy examines that bit of conventional oil patch wisdom – and others – that should spark some debate in the corridors of power in Alberta.
The report, entitled Size, Role and Performance in the Oil and Gas Sector, tracked 340 public oil and gas firms from 2002 to 2010. The report tries to pull the curtain back on the “generalities and folklore” – as the report’s authors put it – that has grown up around the industry over the years and provide a baseline of information about how it is structured and how it performs.
“This lack of information presents a major challenge in terms of forming appropriate and effective policy for the oil and gas sector,” the report states.
The Alberta government currently has a lot on its plate, such as how to deal with a deficit it forecasts will be between $2.3 to $3 billion this year due in part to the $400 million less it pulled in from energy revenues during the first quarter of 2012. And as its dependence on oil and gas revenues to fund government programs and services isn’t likely to lessen, developing sound policies that help rather than hinder the sector is critically important.
That’s because it is the primary engine of economic activity in Alberta, typically accounting for 40 per cent of Alberta employment and around 50 per cent in government revenues, according to the University of Calgary report.
The report’s findings could inform some of that policy and prevent the government from repeating controversies such as former Premier Ed Stelmach’s ill-fated 2007 “Our Fair Share” royalty grab. “Before you make policy, you need to really know the industry you are making it for,” says Jennifer Winter, an economics professor at the University of Calgary and one of the report’s authors.
The report tracked all levels of companies in the industry: emerging juniors (annual production between one to 999 barrels of oil equivalent (BOE) per day), juniors (1,000 to 9,999 BOE per day), intermediates (10,000 to 99,999 BOE per day) and majors (over 100,000 BOE per day production).
One of the key takeaways from the report is that even though juniors create significant amounts of new employment, their survival rate is low – between 50-75 per cent for the emerging juniors group. So they also account for a substantial number of job losses in the sector.
And the jobs they create are not nearly as numerous as one would think. Taking employment numbers from Statistics Canada from 2000-2008 from the mining, quarrying and oil and gas extraction sectors in Alberta – with oil and gas firms dominating this category in Alberta – the figures show that 71 per cent of employment in the province comes from firms with 100 or more employees (i.e. majors and intermediates).
As a result, government must be wary of taxation or royalty policies that could negatively impact the province’s bigger players. In the Western Canadian oil patch, bigger is better.
Bigger doesn’t necessarily mean less nimble or innovative, either. In examining well data and land leases in Alberta, the report authors found that junior companies tend not to operate in zones in the Western Canadian Sedimentary Basin that require deep wells, nor do they focus on the oil sands areas. That’s because these zones are capital intensive, and often require innovative technologies to extract the oil and gas.
“I think the reason these companies are viewed as nimble and fast is that they have a role in developing the marginal assets,” Winter says. “They are followers more than leaders and they piggyback on the research and development of the majors. And there is a lot of turnover in these smaller firms and they have a smaller probability of survival. They go bankrupt or they get bought out.”
As companies big and small stare down depressed prices for natural gas, steep discounts for crude oil and slow progress on building new infrastructure to solve those issues (namely crude oil pipelines and liquefied natural gas export terminals), it’s a challenging time for the industry. They could benefit from better informed public policy.
Calgary-based investment bank Peters & Co. noted the precarious situation Canadian producers find themselves in in a recent research note. “Producers will need to scale back programs in light of weaker than expected commodity prices, weak capital markets which reduce financial abilities, and depressed share prices which reduce the willingness to raise external equity.”
Whether smart policies can smooth out the rough patches for Alberta’s economic engine remains to be seen. But in taking a closer look at this dynamic industry, Winter hopes the University of Calgary has given decision-makers some food for thought based on data, not generalities and folklore.
“We don’t believe this report provided evidence for favoring small firms over large firms or vice versa,” Winter says. “But we want policymakers to be aware that the consequences of any given policy can have different implications on the different firms depending on their size. The more information policymakers have on this, the better.