Capital impairment and falling prices eating into oil & gas
By Bruce A Stewart
You’d think it would be easy, wouldn’t you.
We have known, proven reserves of oil and gas.
We have a free market approach that lets a company buy in, develop, and profit. (Try that in most of the rest of the world, where the best deal you might get is a forced partnership and to be forced out once you’ve done the heavy lifting.)
So where’s the flood of projects that you’d expect with that almost one-of-a-kind situation?
Prices are the answer, but it’s probably not the price you’re thinking of.
We could double or triple the royalties charged and after the requisite grumbling and one or two companies made a big public play of “packing up and leaving this banana republic” nonsense things would settle down. Royalties are not the reason development projects aren’t lined up waiting to go, no matter how much fear there is that they’re an impediment.
Oddly enough, it’s not the fallen price of oil or the rock-bottom price gas is fetching these days, either. That controls timing, but not interest. We should still be seeing a lot of interest: leases trading hands to consolidate holdings, prep work being done, infrastructure laid in to service the resulting projects, all waiting for the “go” of a price that hits the return on investment planned.
No, it’s the lack of capital out there.
Yes, those same low, low interest rates that our profligate, deficit-loving governments and all us real estate-playing, renovation-doing mortgage and home line of credit holders love have been systematically crippling the formation of capital.
The guy with the orange shorts may be paying more than the staid old bank on the corner for your savings, but half a per cent instead of a quarter per cent still isn’t very much.
There’s a reason real interest rates have historically run in the 3-5 per cent range. (That means if inflation is 4 per cent, nominal rates would be 7-9 per cent, so that you get 3-5 per cent after inflation.) You get capital formation — enough to satisfy the needs of a continental-scale economy — that way.
Today, we don’t get that. We haven’t for most of the last twelve years, in fact. Remember the dot-com crash? Interest rates were jammed to the floor for years to “help recover” (it gave us a housing bubble, instead). Then as things went turtle in 2008 the central banks slammed them to the floor again — and all the tricks of money-printing (quantitative easing, Operation Twist, buying up distressed assets, etc.) have been used since around the world to keep them down.
Down they are, too: the last US Treasury auction for 10-year bonds went at 1.44 per cent. There just isn’t room under that for any meaningful return to anyone saving money and making it available as capital.
The shortfall of capital has bit home hard over the years. It’s why so many companies of all types are sitting on cash in their treasury, but not putting it to work. Ford, in 2007, could borrow $23.5 billion (and thereby restructured itself without government help). Today, finding $23.5 billion is becoming a bit of a challenge.
Cash in the bank, so to speak, is looking a lot better than doing anything with it. (Everyone also remembers that the commercial paper market just about died when Lehman Brothers went down: cash for payroll and operations is a constant concern now.)
So demand is down, which is why energy prices have fallen, too, and are staying down.
The net effect is that even for the energy giants, there’s just not much reason to go ahead in this market. Even if the price paid to the producer went back up, the rest of the economy is still capital starved and fearful of spending what’s on hand.
If I were running a royalty-driven province, I think I’d be rethinking my spending plans.