In the Centre of the Storm

This article on SEPAC chairman Stan Odut appears in the April 2009 issue of Oilweek magazine; graphic from here.

By Peter McKenzie-Brown

Toward the end of a long and thoughtful interview, a smile flickers across Stan Odut’s face. The topic of his grandchildren has come up, and he brings out a photo of the four who are aged seven and older. Wearing Ukrainian dress, they are dancing at a multi-cultural festival in Calgary. A Chinese dragon dance takes place in the margin of the picture, suggesting the great diversity of today’s Alberta. His pride is palpable and infectious, and he’s probably thinking back on a life well lived.

Odut’s story is exactly contemporaneous with that of Canada’s modern energy era. Born in Germany just as Imperial’s Leduc #1 well ushered in Alberta’s post-war conventional oil age, his family migrated to “a very poor farm” near Dauphin, Manitoba, where he grew up. The new chairman of the Small Explorer’s and Producers Association of Canada (SEPAC) moved to Calgary after earning an engineering degree from the University of Manitoba in 1969. Forty years on, no one is prouder of his city or his province than Stan Odut.

As SEPAC chair he is the voice of junior oil, and he urges small companies to join the trade association. “Membership isn’t expensive, and SEPAC can help you get your voice heard by provincial and federal politicians.” With more than 450 members, the organization describes itself as representing “Canada’s oil and gas entrepreneurs” – a tag line the association has actually trademarked.

According to Odut, the small companies need to “press for revised regulations, cutbacks in bureaucracy and a more efficient industry.” He has strong views on the changes needed to return health to the juniors.

Background: His early career included stints with Hudson’s Bay Oil and Gas, Texas Gulf and Canterra Energy – larger companies that were eventually absorbed by acquisitors. After finding himself at Husky after its 1991 takeover of Canterra, he left that corporation and began working with smaller companies.

He was one of the founders of Del Roca Energy, which eventually sold out to Tusk Energy. Five years ago he formed privately-held Sifton Energy, which he serves as president and chief executive officer. Sifton has 80 shareholders, ten employees and daily production of 950 barrels of oil equivalent. Odut’s original exit strategy was to sell out to a trust “but now with the downturn, we’re struggling a bit to keep on going. There would be no advantage in going public, though. Public companies are so badly discounted that there would be a real disadvantage to doing that.”

Now he begins to address his key messages. “The sources of capital for the junior sector are equity, debt and cash flow,” he begins. But in today’s environment, “many companies are already mired in debt and credit lines are being pulled. You can’t get additional debt coverage. You can’t raise any equity because there is no reason for investors to put money into the energy business right now. And governments (provincially in particular) have strangled cash flow. So help me with the equation: you’ve got to get one of those factors to change to get the business going again.”

Odut describes the economic situation as “dire”, and observes that it has built up over several years. The treatment of trusts has been a major contributor. Another has been the loss of the Alberta royalty tax credit. “Actions by provincial and federal government have debilitated our industry”, which is mostly headquartered in Alberta. The economic environment is becoming similar to that of the 1980s, when exploration and development collapsed, layoffs replaced hectic hiring, and Alberta’s rural areas found themselves with little work on the rigs or in oilfield construction. In both periods, the junior sector was hit particularly hard.

Just as westerners with long memories generally finger the National Energy Program as an important cause of decline in that earlier period, Odut places blame for the deteriorating situation on Alberta’s new royalty regime. “It has resulted in fewer jobs, less activity and less money in government coffers.” He acknowledges that it has been “more than the royalty regime that has killed activity…. It’s also been oil and gas prices – but those prices are the same in Saskatchewan and British Columbia” where activity is still relatively strong. In Odut’s view, Alberta’s new regime helped drive activity into the other western provinces.

“The Alberta advantage seems to have disappeared,” he laments. “You can see it in municipalities increasing taxes on infrastructure, the cost of obtaining surface leases or the new royalty system. Alberta’s bureaucracy now seems to be anti-development.” While he acknowledges that “there are land bargains out there,” he stresses that “you need cash to take advantage of them. And if I put on my Alberta resident’s hat, should I be happy that provincial (mineral rights) are being sold for a song?”

As this article goes to press, the Alberta government has promised measures that will provide relief for the juniors, and the government has agreed to consult with SEPAC and other trade associations. “My advice on help is the sooner the better,” says Odut. “We have already lost the winter drilling season. Now we have to concentrate on (getting activity going during) the summer drilling season.”

Incentives: Only two years ago, when oil prices dropped to $50 per barrel, there was no let-up in investment in Alberta. Yet last year, when average oil prices hit their all-time high, that changed. Why? Because investors no longer feel they can count on a stable regime in Alberta.

“Large companies are still going around the world and investing,” says Odut. “They know that one pass through (countries with immature petroleum basins) can give them a good short-term return. They are less concerned if the regime changes. (But Alberta) is not a one-pass-through basin. You need to know there will be a stable return over time.” After the recent changes in royalties, that certainty is no longer there.

Although Alberta is a mature basin, Odut is optimistic about its future. “Better than 35 per cent of the conventional oil resources are still there waiting to be recovered,” he says. Odut’s optimism about Alberta’s productive potential is qualified by deep skepticism about its exploratory potential. “Right now, only one (exploratory) well in seven is a decent well. I think there are still a lot of good opportunities in the conventional sector. The opportunities are in technology, because of improved recovery methods. We aren’t going to find a lot of great new fields, but we can get a lot of left-over barrels of oil using new technologies. We need incentives to do that.”

“The present regime,” he says, “penalizes you if you come up with a good well by increasing royalty rates from 35 percent max to 50 percent max”. While acknowledging that at present prices oil royalties are “at the bottom of the scale,” he stresses that the present system “penalizes horizontal wells, which reduce the industry’s environmental footprint. If you are successful, instead of having four 10-barrel-per-day wells, you could have a single horizontal well producing 100 barrels per day.” However, because the present regulations impose lower royalties on less-productive wells, “you shoot yourself in the foot by drilling (horizontally) under the existing regulations.”

At the end of last year, the Alberta government announced a 5-year window in which companies could apply the old royalty system to new wells. Stan Odut wasn’t impressed. “It doesn’t address the basic question of what you are going to drill with. You need debt, equity or cash flow to drill, and it really didn’t address any of those issues. Equity I can’t raise any, credit there isn’t any and governments are strangling cash flow.” The royalty regimes are better in BC and Saskatchewan, he says, “and BC is tweaking its system to make it even better. The biggest problem is here in Alberta.”

The outcome is that large companies have taken their cash flow and vacated the province, leaving it to the junior sector. Yet the junior companies have little to work with. To turn this around, he says, “You have to acknowledge that capital will flow to where it will get the best return. Our fiscal regime does not encourage the flow of capital into Alberta.”

What’s a government to do? Provincially, he suggests incentives for horizontal wells. Federally, he argues for changes in flow-through tax rules.

If Edmonton encouraged small companies to use horizontal wells, production would go up and the environmental footprint would go down. “You need to encourage investment in horizontal wells, as Saskatchewan does. They have a royalty holiday for horizontal wells – you pay a very small royalty on the first 100,000 barrels or so. That way the investor is able to recover his money before the government begins receiving its take.”

Ottawa, on the other hand, should take steps to expand flow-through investment. Under the present flow-through rules, companies can pass tax breaks associated with exploration directly to individual investors. The focus of that program, however, is exploration, the success of which is in decline. “Flow-through rules should (be changed to) enable companies to put flow-through money into development wells, where the risk is lower. (The federal government should) make larger sums available, so slightly larger companies could take advantage of it. This would encourage investment, and that investment would be used for drilling. Companies could choose whether they wanted to put money into exploratory drilling or development. It would give you much more cash flow.”

Peak Oil: Stan Odut is one of a growing contingent of oilmen now subscribing to the concept of peak oil – the notion that the planet’s maximum rate of oil extraction is at hand. After that point arrives, the rate of production will enter terminal decline. “I believe we probably aren’t going to see an increase on the supply side globally,” he says. “With the global economic situation there has been (crude oil) demand destruction, but I would add that there has also been supply destruction because drilling has been declining, producers are shutting in supply” and many large projects, world-wide, have gone on hold.

Prices are low because “right now oil is overbalanced on the supply side,” he says. “When things do recover, I think we are going to be in a really tight situation. The horizon might be shorter than many people predict. I think within the next five years – certainly within the next ten – we will meet a supply crunch probably like we have never seen before.”

“There’s a huge disconnect between developing world and developed world consumption,” he says. “Either we have to tap some alternative resources which we don’t really know about today, or many of us in the developed world are going to have to really cut down on our oil consumption. The developed world has to contract its consumption a lot.” This sounds ominous, and Stan Odut quickly adds that he doesn’t want to be a scare-monger.

“I’m getting a bit long in the tooth and I have an eye for what my grandchildren are going to face as we go down the road. I think they are going to be facing a different world from the one we are in today.”