Lucky Guy

Ralph Klein had a knack for being in the right place at the right time – especially for the oilsands 

This article appears in the June issue of Oilsands Review  

By Peter McKenzie-Brown

Former Premier Ralph Klein’s death at the end of March was greeted quite differently from that of Peter Lougheed, who had also been premier and had died six months earlier. Lougheed was seen as an elder statesman, and his passing was mourned across Canada. The mourning that followed Klein’s death – caused by a rare lung disease, and complicated by an uncommon early-onset dementia – was shorter in duration and more provincial in scope.

It seemed as though everyone in Alberta had a great “Ralph story” to tell, and as often as not people would refer to him affectionately as Ralph or, reflecting his political style, sometimes King Ralph. A man celebrated for his common touch who on occasion tearfully acknowledged that he drank too much, he was well known at favourite watering holes like the bar at the run-down King Edward Hotel in Calgary. He was a political fixture in Alberta for a quarter century, beginning with his election as the mayor of Calgary in 1980. His illnesses prevented him from experiencing much retirement; they were diagnosed soon after he left office. Klein was 70 years of age.

Klein was not a good planner or a gifted thinker. However, during his term he was endowed with good luck – especially in respect to the oilsands.  Three of Alberta’s 14 premiers have played major roles in oilsands development. The other two were Ernest Manning (1943-68) and Peter Lougheed (1971-1985). On Premier Klein’s watch (1992-2006), however, the industry grew into an economic giant. One reason is that government and the oilsands industry prepared for growth. The other is that during the reign of King Ralph, as he was also known, oil and gas prices tripled.

The early part of the Klein era was just awful for Canada’s petroleum industry in general and the oilsands business in particular. Shortly after Klein took office both the federal and Alberta governments withdrew financial support from the OSLO oil sands plant, which would have relied on loan guarantees and tax and royalty concessions to become profitable. Klein famously described his government as being “out of the business of business” – an early indicator of what the Klein era would look like.

The Surge

When he took over from Premier Don Getty, Klein inherited “a bloated bureaucracy and an angry electorate,” as one commentator put it.. Alberta faced large and growing deficits and was desperate for a more balanced budget. Desperate for more jobs across Canada, Prime Minister Jean Chretien (1993-2003) had just handily won an election in Ottawa. The major plank in his election platform? Economic opportunity. Oil prices were in the tank and the industry was desperate for investment opportunities.

Thus was the stage set for the industry’s great surge forward.

Klein had barely moved into his new office when the Edmonton-based Alberta Chamber of Resources formed a Task Force on National Oil Sands Strategies in 1993. Eighteen months later the multi-stakeholder task force issued a report titled “The Oil Sands: A New Energy Vision for Canada.” In clear and compelling prose, the report outlined eight areas where players in the emerging oil sands industry could help the industry grow – by developing new markets and more, for example, a pipeline system that better served areas where bitumen was being produced.

However, the key to growth was a better fiscal regime. According to the task force, “The Federal and Alberta governments…should develop a generic set of harmonized tax and royalty measures based on economic profits. Such a system will provide a consistent fiscal framework for all oil sands projects and result in a balanced sharing of profits. These common fiscal terms are necessary for the future development of Canada’s oil sands.”

After the release of the task force report, Klein’s government immediately began looking for ways to implement its suggestions, and in September approved a generic oilsands royalty and tax regime that would apply to all new projects. New projects would pay the province a 1% royalty on production until net project revenue had paid out all start-up costs. At that point, the royalty would rise to 25%, although all capital costs, including operating, research and development, were fully deductible in the year they were incurred. This was radical, and the free-market Klein government deserves credit for stepping up to the plate without hesitation.

Historian William Wylie once described how the key players in the oilsands have changed over time. “The federal government was the principal actor between 1875 and 1918,” he said, “at first from a sense of responsibility for regional development, and near the end of the period from strategic considerations.”

In the 1920s, though, “the government of Alberta became the major force, in part in order to assert its claim to control provincial resources. In the 1930s, two private companies showed signs of promise and the two governments pulled back in deference to private development and in order to cut costs. The 1940s were years of increased involvement on the part of both levels of government due partially to strategic considerations, and to the power struggle between them. In the 1950s, the conventional oil boom in the province took attention away from the oil sands and delayed their development until the 60s and 70s when the long run decline of the conventional reserves was finally anticipated. When commercial development occurred, private industry was the major agency, but with considerable governmental backing as well.”

Then, the industry morphed into another phase. In 1992 the industry began to enter a new era of oil sands policy – one that is now two decades in duration. Call it the Klein legacy; it is a period in which financial responsibility for oil sands development lies entirely with the private sector. It has already been the longest-lasting of the major periods of oilsands policy, and in the near future seems unlikely to change.

What has made this new era so solid is that during the Klein era conventional oil prices rose from about $19 when he began his term to $63.43 on the day he retired. Gas prices also more than tripled, from $2 to $7. To a large extent driven by the US-led invasion of Iraq, these surges pulled bitumen prices along.

The outcome was a flood of oilsands spending in the province. Suncor began a series of mining and in situ expansions that made it Canada’s largest petroleum company. Syncrude also announced large expansions. Both companies introduced technologies and operations that led to huge reductions in the cost of production.

In 1999, a Shell-led consortium began its Muskeg River Mine oilsands development – better known as the Athabasca Oil Sands Project. The project went on stream in 2003. Construction of Canadian Natural Resources Limited’s Horizon project began toward the end of Klein’s term, with the first phase completed in 2009.

The Klein Legacy…

Oddly enough, as he completed his term as one of the most popular premiers in Alberta’s history, Klein held a news conference in which he essentially proclaimed himself a failure. On the matter of oilsands development, he was partly responding to general criticism by Peter Lougheed, who had called for more limited oilsands development. “What’s the hurry?” Lougheed had asked. He was concerned about the environmental and social impacts of oilsands development. “Why not build one plant at a time? I hope the new government in Alberta will reassess this and come to the conclusion that the mess, and I call it a mess, that is Fort McMurray and the tar sands will be revisited.”

In his sometimes tearful farewell, Klein said he couldn’t have imagined how forcefully the industry would respond to the royalty and tax changes of the mid-1990s. Thus, his government didn’t have a plan for how to deal with the spectacular growth that followed. Of course, any other premier would have basked in the glow of leaving behind an economic boom.

That Klein didn’t have a plan more or less characterizes the man himself. According to one biographer, his government was anything but ideological. It tended “to act first and think later, impulsively adopting elements of the neo-conservative agenda without having an overall strategy.”

Maybe that’s the best we can say about the man most Albertans still think of as Ralph. He was not a planner, but a pragmatist and an instinctive free-market conservative who happened to be in the right place at the right time – just as the oilsands sector reached maturity.   

Productivity Alberta

This article appears in the April 2009 issue of Oilsands Review

By Peter McKenzie-Brown

“It’s really tough to be less productive (than other companies) when times get bad,” according to Jim Rakiewich. “You and your competitors are both scrambling for sales, but prices become compressed. So the companies that aren’t really productive and have too much cost built into their products – they really get killed.” The president and CEO of Edmonton-based McCoy Corporation, Rakiewich was discussing Alberta’s productivity growth – or, more to the point, the lack thereof.

In economics, the definition of “productivity” is bloodless. It is a ratio comparing what is produced to what is required to produce it – usually an average expressing the total output of some category of goods divided by the total input of, say, labour or raw materials. Bloodless the definition may be, but the reality of Alberta’s productivity ranking is downright bloody: Dead last in labour productivity growth among Canadian provinces during the period 1997-2005. Growth was 1 per cent a year – below the national average of 1.4%, and well below growth rates for U.S. and European countries.

The Alberta government is concerned about this problem, and in March launched an agency – Productivity Alberta – to help improve provincial productivity. Rakiewich is one of a group of private sector CEOs who have agreed to serve as advisors to the agency. “If you want to stimulate productivity in Alberta,” he says, “it’s important to have those who are passionate about it on the governing board. That’s why I’m on the board.”

Alberta’s go-to person is Lori Schmidt, a senior director in the Finance and Enterprise bureaucracy. “When this process started,” she said, “companies were working flat out, didn’t have enough people, but despite working at capacity were finding their bottom line continually shrinking. That’s why we started to look at the importance of increasing our productivity. Today, with the economic conditions changing, there’s probably even more need for firms to look at their efficiencies. This doesn’t mean getting rid of people, but utilizing our people to their best ability. Are we utilizing all the inputs and resources and processes that we have so that we can continue to compete?”

Schmidt describes the new agency sees itself as a “path-finding service” which will offer two levels of service to any business that asks for it. “For free, we will offer a preliminary assessment to help them with their operational efficiencies, perhaps by directing clients to online tools. Right now, people may know they have problems but don’t know where to begin. That’s the free part.” Adds the ever-enthusiastic Jim Rakiewich, “You don’t really pay for someone to help you analyse your processes and offer advice. In effect you are getting free consultants, and these are really sharp guys. Where your costs come in is in implementing those ideas.”

“The second part,” continued Lori Schmidt, “is to connect (our clients) to tools and programs and services that are already out there in the marketplace. We want to be the connection point” between organizations that need to become more efficient and resources they can use to achieve that aim. “This is available to any business, but we are really focusing on value-adding businesses – anyone who produces a good. Manufacturers and their supply chains, for example, but also small and medium enterprises. In Alberta, that means businesses with 100 employees or less. Those companies have been doing a lot of work in the oilsands.”

According to the new agency’s slick new brochure, “Productivity Alberta brings together the talents and efforts of people and organizations across the province to tackle productivity challenges and to provide a direct point of access to productivity enhancement offerings. This industry-guided, not-for-profit corporation works in concert with government, industry, academia, associations and communities throughout Alberta to address productivity challenges.”

Jim Rakiewich has bold opinions about the importance of higher productivity and about the reasons why Alberta’s recent record has been so dismal. “Those who are more productive have lower input costs. If you are not really connected (to the importance of increased productivity), you have a lot of waste in your system.”

Alberta’s low productivity growth has had a number of causes – most importantly the tight labour market. There is also a geographical component to Alberta’s poor recent performance. According to Rakievich, “North America is not very competitive compared to the rest of the world, and Canada generally performs worse than the U.S. Alberta just hasn’t been very focused on becoming more competitive” – to a big extent because of the tight labour market. “Rather than finding the right skill sets for jobs on offer, (companies in Alberta) have been hiring warm bodies and trying to bring them up to standard.” He adds that, because manufacturing is such a small part of the provincial economy, there is less experience to draw from than in, say, southern Ontario.

Rakievich’s final comment pertains to the threat of global markets to Alberta business. “Markets are really global in nature, now, and outsiders are coming in to steal market share. This is forcing us to realize someone is going to eat our lunch if we don’t smarten up.” Heed this.

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.”