Tuesday, January 26, 2010

Team of Rivals

As executive director of the Small Explorers and Producers Association of Canada, Gary Leach leads Canada's "Silicon Valley of oil"

This article appears in the February 2010 issue of Oilweek.
By Peter McKenzie-Brown

A year ago, Stan Odut was chairman of the Small Explorers and Producers Association of Canada (SEPAC), and he was deeply worried about the industry’s immediate future. “The sources of capital for the junior sector are equity, debt and cash flow,” he said, “but 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 (because of collapsing commodity prices). 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.”

In the last year, what has changed? I put the question to Gary Leach, SEPAC’s executive director. He describes a cautious sense of optimism within the junior sector of Canada’s petroleum industry. There’s been a strong recovery in oil prices, for example, although gas prices are still languishing. “In recent months equity markets have been more supportive of the industry,” he adds, although they have been “selective”. They are targeting companies with “strong management, in certain commodity niches. But there is no tide that is lifting all boats.” Bank credit is still a problem for some companies; many are carrying a lot of debt, and lower commodity prices have reduced the value of their assets in the ground. Technically, this is known as a double-whammy.

On the positive side, “Banks have tried to be nimble and flexible. They don’t want to cause a lot of financial wreckage in the junior and midcap sector. A lot of the equity raised in recent months has been used to reduce debt, so things are improving.” However, he cautions, “If we don’t see a sustained rebound in gas prices in 2010, that may change.”

The Gas Story
Gary Leach describes himself as a “pure prairie product”. He was born in Manitoba, raised in Alberta and received post-secondary education (including a law degree) at the University of Saskatchewan. He spent much of his strictly legal career putting together international joint ventures, petroleum production sharing agreements, and international financing loans with multilateral institutions such as the World Bank and the European Bank for Reconstruction and Development.

He joined Calgary-based Canadian Fracmaster in 1995 and stayed with the business after it was acquired by BJ Services Company, the Houston-based petroleum equipment and services giant. His background in down-hole completions is a notable asset for a spokesman in an industry being transformed by horizontal drilling and new fraccing technologies. Soft-spoken and articulate, Leach joined SEPAC – the trade association for 350 small oil companies – in 2006.

We began our discussion with the natural gas story. At time of writing, gas prices are sitting well below their ten-year average. Where are those prices headed? “I think right now there’s possibly a larger gap in opinions about where gas prices are going than any time I can remember,” Leach says. “There are people who say the potential international demand (for gas) has barely been touched, so prices should go up. Others talk about the huge international supply potential, and they see things the other way.” Perhaps remembering the adage that predictions are especially perilous when they pertain to the future, he says “We are never going to get out of these swings in gas prices. I think there are going to continue to be big swings in the gas market. I don’t think anyone can accurately forecast gas prices beyond a couple of quarters.”

“For companies carrying a lot of gas assets on their balance sheets, it’s not a great time to be selling. “There are going to be a lot of assets put on the market. A lot of big companies” – he mentions Talisman, EnCana and Suncor – “are talking about moving conventional gas reserves off their balance sheets. The lowest cost gas resources are the ones they are going to pursue, and those resources are now shale gas resources.”

Since gas-price volatility is a fact of life, he says, “The low-cost suppliers are the ones that are going to do best. Companies have to learn how to drive down their costs.” For the junior sector, which has a lot of conventional gas on the books, the outlook is particularly uncertain. “The leading shale gas resource in western Canada is in a place that’s so remote and so expensive that mostly big players can participate. However, as the technologies and the infrastructure are developed, the smaller players will get in.”

Behind the Curve
When you ask Leach about Alberta’s place in western Canada’s industry, he is oddly ambivalent. For example, on the matter of shale gas he says, “If we were further along the curve in Alberta in developing shale gas resources, the smaller players would be developing them. But Alberta’s industry is behind the curve.”

He notes that both British Columbia and Saskatchewan long ago introduced important incentives for the industry, but that those policy environments didn’t spur high levels of petroleum sector growth until the technological environment changed in recent years. For example, Saskatchewan’s “Bakken field has been known for years. We used to just drill right through it. However, it is only recent that the technologies of horizontal well completions and multistage fracturing” – the technologies that led to the shale gas revolution – “made that reservoir viable.”

Alberta, of course, is quite different from either of those provinces. “The (Western Canada Sedimentary) Basin covers the province from north to south. We have every conceivable hydrocarbon opportunity here. There’s a lot of excitement about using those technologies to improve production from formations in Alberta that are well past their glory days – the Viking formation, the Cardium formation. A lot of companies are looking at targeting oil in these formations, but using horizontal wells and multistage fractures.” Leach thinks the industry will soon successfully use these methods to increase oil recovery in Alberta.

What is SEPAC’s single biggest challenge? Here his message is particularly striking. “We have to help policy makers and politicians understand what a tremendously exciting, dynamic, vibrant group of junior and mid-cap companies we have in Canada. Almost half the world’s publically traded oil companies are here in Calgary. It’s a remarkable statistic. It’s the closest thing to a Silicon Valley type business culture and industry cluster we in Canada have ever developed. It’s emerged on its own without government help. But over the years, we have had all these companies competing with each other. Hundreds and hundreds of companies are competing with each other for land, for resources, for capital. They have a tremendous publically accessible database that puts small companies on an equal footing with big players. It’s the most unique oil industry in the world, and Canada’s most successful business story. We need policy-makers to understand that story, so they don’t see the industry as just eight or ten companies. Let’s see the big picture, and not do things to harm it. This industry is amazing. We don’t want to lose it. We want to nurture it. It’s a great incubator of new ideas.”

Leach sees the Alberta government’s recent adjustments to the royalty changes of two years ago as a SEPAC success. “Both times (Premier) Stelmach came out with revisions to the royalty regime, he specifically mentioned that he wanted to help Alberta’s junior petroleum sector. The Alberta incentives brought additional cash flow, reduced costs, drew some investment into Alberta that would. They helped, but they were not the complete answer. They couldn’t help everybody.”

SEPAC is now working with other industry associations, the financial sector and others in developing a study of investment competitiveness within the province, which will be complete in the New Year. The idea is to answer the question, “Compared to other investment places, how does Alberta rate?” The provincial government will then have to take all that information and decide on new policies. We think if the province can set itself up as one of the world’s best places to invest, its future will be bright.” Citing a report from a large bank, he points out that about 60 per cent of the world’s investible oil resources are here in Alberta. Big international oil companies have been boxed into smaller and smaller bits of the world. This is one of the few places in the world where companies can book meaningful reserves additions.”

Moving Ahead
I’m always interested in the responses of senior people in the patch to the issue of peak oil, so I put the question to Gary Leach. His response is forceful and direct. “I think we’re near peak cheap oil. I think we’re near peak easily accessible oil. But the amount of oil in the world is enormous. The biggest problem to developing oil has to do with policy restrictions – off-limits restrictions on resource development. The US has huge oil shale resources, for example, but they are politically inaccessible.” Working with their client national oil companies, oil-rich countries have put resource development off limits to private sector oil companies. He mentions Venezuela’s Orinoco ultra heavy oil belt, Alberta’s oilsands, the vast heavy oil deposits in Russia, then cites the old gag that the Stone Age didn’t end because we ran out of stones.

He’s now just warming up. “The petroleum age won’t end because we run out of petroleum. Western European countries are consuming less oil than they did 30 years ago, and the United States is consuming less than it did in 2007. The petroleum age may end in a gentle decline because some of the advanced countries begin to move away from (oil). I don’t think it will end with apocalyptic change. Price signals will put a limit on demand.”

I mention the often-cited rapid demand growth in China and India among developing countries and the rapid growth in OPEC countries like Venezuela, where consumer prices are greatly subsidized. “Rapidly growing countries like India and China are still poor countries,” he counters. “They can live with a price around today’s price (US$77 per barrel) but they cannot afford oil at $150-$200 per barrel. (If prices rise to those levels) there will have to be some kind of market response. Before 500 million Chinese own a car, they will be driving something that doesn’t rely on oil: Maybe electricity-fuelled vehicles charged from nuclear reactors.” Whatever those vehicles are, Leach has no doubt “there are going to be other factors on the demand side, the technology side, that will temper those straight-line graphs that say oil demand will outstrip oil supply and prices will skyrocket.”

Of course, a basic principle of free-market economics is that supply and demand must always be in balance. Neither does a world with global economic growth constrained by energy shortages sound reassuring. Indeed, the situation he is describing seems compatible with mainstream peak oil theory, so I wonder whether his arguments against worldwide economic destabilization have settled the issue. All the same, I have thoroughly enjoyed the discussion. We shift gears, moving to lighter topics.

Has he read any good books lately? Yes, he says. He reads a lot, and is now reading Team of Rivals: The Political Genius of Abraham Lincoln by Pulitzer Prize-winning historian Doris Kearns Goodwin. This thick book describes Abraham Lincoln’s leadership skills by focusing on his war cabinet, which included three of the political rivals he beat in the 1859 presidential campaign. According to Leach, “it was amazing how he turned these diverse people into a team during the most cataclysmic period of American history.”

For a guy with responsibility for managing SEPAC’s affairs and representing its views to government, the news media and the public, political genius may be just what the doctor ordered. Bear in mind that “nearly half of the world’s public oil companies are here in Calgary.” Within the modern petroleum age, those hundreds of companies have become a team of rivals for the global oil industry to reckon with.
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