Navigating uncertainty in the global oil market

Energy Visions spotlight

Episode 1

In this podcast episode, we bring together several energy experts to discuss current uncertainties in the global oil market—and what they might mean for the future of Canadian oil and gas.

Navigating uncertainty in the global oil market

In the last month, we’ve seen some drastic changes to the global oil market. In this episode, we shed some light on what’s really going on and discuss some of the most difficult questions energy organizations are grappling with today. Can the world reach some form of consensus to help stabilize markets and create a floor? And what does this all mean for the Canadian oil and gas industry? Join us and learn more.

Adam: Welcome to PwC's Energy Visions spotlight podcast. Today we're going to talk about navigating uncertainty in the global oil market. My name is Adam Crutchfield and I am PwC Canada's national energy leader. We're recording on Friday, April 3rd, 2020 and instead of doing this in a studio, we're leveraging technology to record remotely with all of us currently working from home.

Joining me today, we have Robert Johnston, Managing Director of Global Energy and Resources from Eurasia Group who many of our Energy Visions attendees will know and recognize from his work with us over the past 10 years. I'm also happy to welcome PwC's Alberta regional leader, Reynold Tetzlaff, who many of you will recognize from his prior role as PwC Canada's energy leader. We were also hoping to welcome McKayla McQuade from the Eurasia Group this morning, but unfortunately she's unable to join us due to a last minute scheduling conflict. RJ, Reynold, welcome to our first Energy Visions podcast.

So let's start with a macro view and then we'll head into the impacts for Canada. The global oil market has been in free fall following the collapse of the OPEC plus agreement in early March, which resulted in Saudi Arabia and Russia walking away from production caps, with both signaling their intent to flood the world's oil market. During the same week, the true scale and impact of the COVID-19 disruption became a reality as the World Health Organization declared the outbreak of pandemic and countries across the globe began to limit travel and movement of their populations.

These two events have had a dramatic impact on the oil market with demand collapsing just as production is set to expand. What does this mean for the future? What does this look like when it's all over? Can the world reach some form of consensus to help stabilize markets and create a floor? And finally, what does this mean for Canada and our domestic oil and gas industry if the future is one of low growth or no growth? So RJ, opening statement to you here. You speak with a lot of different energy companies around the world and here in Canada. What are you discussing with leadership teams and what are people wondering?

RJ: Hi Adam. Hi Reynold and it's great to be working with our longstanding partner, PwC Canada on this podcast. And there's no shortage of topics today. It's been a crazy month since the meeting in Vienna where the OPEC plus talks fell apart. And at that point Russia and Saudi Arabia clearly had fatigue in terms of arguing over the distribution of production cuts within the OPEC plus agreement. And they decided to swing to a kind of free-for-all strategy where they would maximize production and try to put pressure on the markets and see who would blink first.

Well in doing so I think they really underestimated as did many of us this COVID-19 situation, how big the demand shock would be in the global economy, what structural shifts we'd see in terms of jet fuel demand, gasoline demand with shelter in place and curtailing global travel.

So the result has been a demand shock where we think demand for the second quarter will be 25 to 30 million barrels a day below what it was this time last year. And as a result of that, the price war and this dispute between Russia and Saudi Arabia over who should bear the balance of the role of swing producer has really become secondary. So, right now I think everyone in the markets are trying to assess whether even a return to OPEC plus production restraints even with other countries like the US and Canada participating, whether that would really be enough. So that's what we're all on pins and needles to hear here as, as we did this podcast recording.

Adam: Thanks RJ. So I mean there's a theme here around demand and maybe Reynold, if you want to comment on maybe how we've looked at demand historically and how we might have to look at demand in the future that's a little bit different.

Reynold: It's different for sure, Adam. I would say in the past one a lot of the demand discussion and even in past Energy Visions discussions. It was really focused on demand internationally. Initially a large focus was on China, then it came to India where there seemed to be a lot of upside and then others as well. We look at China, demand is definitely down in Q1, especially when it comes to fuel consumption. India with some of the recent moves to a three week lockdown, this is going affect India demand going forward and it's probably not as optimistic as it may be once seemed. But that said, there's now a second demand situation that we need to consider and it relates to local North American demand when it comes to the refineries. With consumption of gasoline and diesel being reduced by some projections around 50 to 70%, these refineries, they're all slowing their production and therefore demanding less crude input. That's not ideal for these refineries as they're pretty complex grids and they're meant to run smoothly. It's not just global demand anymore that's affecting the local market. A lot of it is demand regarding these refineries and how that's changed.

Adam: RJ, any thoughts there? Because, the North American refinery complex is interesting in the type of crude that it actually uses.

RJ: That's right. And I think first of all we've got a refinery complex that is decimated in terms of gasoline and jet fuel demand. So they're struggling to run a refinery where your gasoline jet fuel demand is collapsing, and yet you still have pretty strong pull for diesel and for bunker fuel at least relative to the other products. So that's not easy for an operational perspective. And then how do you scale it down to adjust for this lower demand?

You mentioned North America, Adam, and of course North America is very integrated and the connection between the Western Canadian crude supply and the refiners in the US and Midwest and Gulf coast is very close. I think when they catch a cold in the Gulf coast, we get a sneeze in Canada as we know all too well with the differential. And right now we're in obviously pretty extreme territory with the differentials for the inland crudes like Canadian barrels and North Dakota barrels, even Cushing barrels. And I think that when the refiners ramp down, that's just putting incredible pressure on the storage and pipeline capacity and ultimately will be forcing production shut. And so as Reynold said, there's one layer of demand adjustment globally as the economy slows down, and then that manifests itself at a very local level, refiner by refiner as they adjust for the demand shock as well.

Adam: Let's pivot a bit now into a North American focus. Let's talk about Canada and the U.S. and our respective domestic oil and gas industries. How do they stack up globally, and at the macro level, what does all this disruption mean for Canada? Reynold, I'm going to start with you. Obviously, a lot of conversations over the past number of weeks. What are the biggest issues that you're hearing from Canadian energy companies as they're starting to navigate the world that we're in today?

Reynold: I could probably give you the top 10 or 20 issues, because there's lots of them, obviously, in the market we have. I keep reminding people, if it was one of these two events that would cause a lot of concern for the market, but you put the two together, and it's the oil price war in addition to the COVID-19, If I put it to at least two or three, the first would be they're just in survival mode. They're assessing how to save cash in the short term on basically all areas and all costs, and while maintaining their optionality in the event that, when this is going to bounce back, they want to be able to be stable enough that they can bounce back with it.

The second is they're all very focused on their people and their employees as much as possible, and what kind of government programs can they use and how can they use them effectively to sort of help their people. We've been working with a lot of these companies on that to really manage through that navigate through these programs. The last one would be that a lot of them are working very closely with their lenders and really looking for any kind of credit or relief that they can get from their lenders on all fronts.

Adam: And RJ, how about you? When you step back and you look at the Canadian oil and gas industry and the U.S. oil and gas industry, there's a lot of similarities, but there's a lot of differences. Obviously, the Canadian industry has had a challenge around the debt and equity markets for the past number of years. This is a recent phenomenon in the U.S., so when you look at these two industries, despite the fact they're connected by a lot of infrastructure, how do you look at them and gauge them against one another?

RJ: Well, a few things come to mind. First of all, I think the U.S. producers have fared relatively better compared to Canada and last three or four years. They haven't had the extreme pressure on the differential like Canada has. They've also said those short cycle economics where producers have been able to ramp up production, manage inventories, build up drilled but uncompleted Wells, and just sort of run a less capital intensive model. The problem now I think is that that model is being disrupted because of COVID-19, and I think there's a search in the U.S. for a new model, kind of like what Canada's been trying to do the last few years. Trying to live within cash flow, reduce debt, focus more on value over volume as the saying goes.

I think Canada's further down that road than the many of the U.S. shale producers are, and I do think that you would see some pretty significant consolidation happening in the U.S. shale over the next six to 12 months. Perhaps OPEC plus production cuts will help provide a little bit of a floor in the market, a little bit more stability, a little bit more time to have a kind of consolidation in the U.S. and in Canada, because I think there's certainly a lot of consolidations that can take place in the U.S. That will not be free from political complexity for sure in an election year, but I think that's definitely what needs to happen in the U.S.

Adam: Looking at longterm for Canadian oil and gas players, what does this do to our position in the market, especially when we think about where we've been over the past number of years? Coming back to this theme we started with and as we were talking about as we prepared for this podcast, but the low growth or no growth environment. When you wrap that around the current situation, RJ, how do you look at the Canadian industry and look at where we are today and where we're going to go. At the same time, and maybe, RJ, we'll start with you and then go to Reynold. Where are the opportunities that emerge in that low growth, no growth world?

RJ: I think the opportunities are still considerable for Canada, and I think in the long term, and you have to be careful saying that in Canada energy, because it feels like we're always talking about the long term admittedly. But I think coming out of this, moving from low growth to no growth for the oil sands, and that sounds disappointing in many ways, but I do think that the focus should really be on determining what path forward we have for the oil sands base load production, which is almost four million barrels a day, which will continue to play a critical role well in North American energy security over the medium to long term. 

Then I think the growth will come much more in terms of natural gas, particularly the LNG export play. Then thinking even more about innovating around the clean energy economy with things like hydrogen from natural gas, advanced biofuels, leveraging Western Canada's significant advantages of lands and agriculture. Things like nuclear, small modular reactors. There's going to be a big opportunity for CCS as well, so I'll be interested to see whether governments, particularly the provincial government and federal government, can align on a strategy that that focuses first and foremost on consolidating and locking in the liquidity and functionality of the base load oil sands production, but then really doubles down on the new energy economy, because I think coming out of COVID-19, it's going to be slower growth for oil globally.

Reynold: Adam, I would agree. What I see in the Canadian companies, they're taking such a granular look when it comes to cost and future projects and what's accretive and which operations have been subsidized in the past. It really comes down to what's their optimal size, stay focused on profit, stay focused on growing only if they can grow profitably. I think if we do all that then, we can give a reasonable return back to the investors. 

Adam: Yeah. Maybe let's just stay on that investor theme for a second here. RJ, I'm interested in your take here because you talk to a lot of investors around the world. Institutional investors. As we move forward and we establish whatever the new normal is going to be, what kind of investor do we see coming back into the Canadian oil and gas market?

Is it an investor who is value-focused and the ESG mandate is there but it's table stakes? Or will that change at all? What do you see by way of investors coming back in?

RJ: Well, I think what's frustrating is that we were very much on the cusp of a really healthy and productive federal provincial private sector effort on net-zero emissions. You saw several of the oil sands players announcing various forms of convenance towards net-zero or carbon neutrality. I think there were interesting debates in Ottawa and Edmonton about what that should look like.

What we saw was that there are investors out there, the big global banks and asset management firms, pensions and insurance companies that maybe didn't want to fund traditional GHG-intensive oil sands, were actually moving from divestment discussion towards really focus on helping Alberta decarbonize. Helping find projects that would actually lead to measurable GHG reductions, including in traditional oil and gas production.

I think that's kind of on hold for now. I think coming out of this, that will come back with great interest, because there's a very large amount of sustainable finance capital out there that will be looking to both reward and promote the firms that are already at the top quartile of ESG performance and GHG intensity.

But also the changes working with those that are further down the curve to actually provide financial support for decarbonization. So stay tuned because we're involved in that personally at Eurasia Group and I think there will be a lot more to come over the next couple years. The question would be what kind of policy frameworks will make the most sense. We know that in Ottawa, the idea of agreeing to a stimulus package to help with economic recovery is well underway. There's been discussion about orphan wells for example. Orphan well remediation. But there's other areas of green stimulus that could well support this trend as well.

Adam: It's going to be fascinating to see what happens with the whole stimulus as we come out of this. I do want to come back for a second RJ, and you made a mention of natural gas. I know when we were preparing for this, it's not all that you cover, you focus more on the oil side, but there's an interesting story developing here around natural gas. 

As production starts to be shut in, especially in the oil side, the associated gas goes away. We've also seen some interesting moves in global LNG spot prices with them coming way down. But then just over the last week cargo is going out back into Asia. Maybe just more of a macro view again on the natural gas picture and what do you think it looks like globally and then what does it do in North America?

RJ: I think in the next six to 12 months there will be a tension in North American market between on the bullish side a curtailment of associated gas production, but that being offset by lower industrial activity and lower commercial heating demand and things like that, and cooling demand, as the economy struggles.

I think they'll be maybe slightly supportive but mostly neutral. Globally though, I think some big changes happening at LNG market. I think we could see with oil heading into a more structurally bearish outlook for the next three to five years, if that's indeed what plays out here, we will have a opportunity for that oil-linked LNG contract to be very, very competitive with coal and with crude oil as well.

That's something where I think there could be a positive bounce here for LNG. Then we'll go back to the debate over, is gas in Asia going to be part of the energy transition, the low carbon transition? And I think the answer is yes. Not just in the electric power sector displacing coal, but also in areas like transportation and cooking fuel as well. I'm still more optimistic on gas overall.

Adam: That's good to hear. I think we have to start talking about what happens as we come out of this and that's going to be one of the interesting stories to follow as we go.

As we start to wrap up the conversation here, back to a question around Canada and what's going on with both federal and provincial programs. I guess RJ to start with, given that you cover a lot of what's happened at the feds. Thoughts on programs to date. You alluded to a program that might be implemented to spur the economy coming out of this. Maybe talk about the programs that are already in place for energy companies and what you think might be coming or how they might pivot into a different kind of program that energy companies can take advantage of.

RJ: Here's the political analysis. I think that as you guys know, I'm based here in Washington, DC and I'm speaking to you from Washington, so of course we follow the Trump administration quite closely.

The US stimulus was very different than what we saw in Canada. I think in Canada there was a very strong effort from the Trudeau government to focus on households and individuals versus companies and shareholders. I think that was partially about the massive unemployment numbers that were filed, that gave, certainly, political and economic shock to the Trudeau government. But also their orientation towards maybe that was the lower hanging fruit.

What we're seeing unfortunately is that the sector level liquidity efforts and policy interventions are just more complicated. The debate over which sectors get bailed in and which ones get bailed out. What's the right mechanism for each sector? Then trying to handle, not just oil and gas, but transportation and retail and consumer real estate, financial institutions, non-profits, everything at the same time is a bit overwhelming.

I would say that Ottawa has gotten a bit behind the curve here. I can sense based on our client interactions, I wouldn't say panic, but certainly concern mounting in industry that there isn't enough sector level response yet. That said, I think we'll be seeing some next week. But as you guys know, next week meaning the week of April 6th. But I think many people are surprised we haven't seen more already.

What we have seen on the corporate side is the Bank of Canada liquidity window being opened, which has been important in terms of the commercial paper market and the basic funding mechanisms a lot of companies use. Certainly  steps have been taken. But now the heavy lifting has to be done for oil and gas, airlines, transportation and others.

Reynold: If I can jump in just quick. I would echo that the job sharing, wage subsidy, and other programs, they're definitely welcome from industry for sure, but there seems to be a lack of some clear guidelines around these programs and also the time it takes to get some of these programs out, I think there’s some frustration brewing, especially in the energy industry. Also, the other area that I'm hearing a little bit around is the government probably needs better data when they are putting these programs out so that when they do bring the programs that they're actually programs that will matter and make a real difference to the industry for both service and the E&P companies

Adam: It's a great point. So I guess we see what happens next week as you say RJ. That's the week of April 6th. Last question here, and this is something that always interests me because there's so many different variables at play in the world right now that can have either a positive or a negative impact on the price of oil in this case, from a simple tweet by an individual in the US to other more structural changes. So maybe we'll start with you, RJ. What are you watching in terms of indicators that could really swing things globally and thus impact us here locally?

RJ: Well, certainly on the Covid virus, that's not our focus here but, but the second and third wave of that would be concerning. I think we would also look for, on the oil market, whether or not we're going to see timely supply cuts. Now, does that happen through the so-called OPEC Plus Plus Plus, OPEC plus Russia plus the US and Canada, or is it more market led, meaning that you really need to fill up storage globally to enforce prices lower to get really massive supply destruction? Those two things get you to the same place but in very different pathways.

I think the OPEC Plus Plus deal provides a little bit more of an orderly shutdown, whereas something that's market led would run into all kinds of, I think, volatility in the market and lead to a lot of unintended consequences and a lot more uncertainty that would reverberate not just in the oil sector but in oil dependent regions like Alberta, Texas, and the countries you mentioned that are national as well. So I think that the major global leaders on the oil side, the Saudis, Russia, US, et cetera, recognize that there's some urgency here to act. Now, whether or not they can actually pull off a coordinated production or if it ends up being left in the market remains to be seen, but they're certainly at least trying to get something more orderly in place.

Adam: Reynold, any thoughts there or comments?

Reynold: The only other thing I would add to that is in the past, I would say few Energy Visions, there was discussion around the fact that there was probably historically low exploration spending going on globally, and that's continued. So as a result of everything going on, if there's fewer and fewer exploration dollars being spent, more CapEx cuts, fewer suppliers that sort of emerge out of this or more consolidation that happens. Long term what's going to happen with future supply? For some of these long-term assets that we have locally, is there actually an upside there in the fact that there is going to be an overall lower supply coming into the market years to come and does that put our assets eventually in a reasonably good position.

Adam: Yeah. I mean, unprecedented times to say the least. Well look, RJ, Reynold, thanks so much for taking the time today. We're right at the end of our allowed time, so we do have to sign off, but I wanted to thank you for taking the time to share your insights with our Energy Visions audience and look forward to doing this again soon.

RJ: Thank you, Adam. Always a pleasure.

Reynold: Thanks, Adam, and hopefully Mikaela can make it to the next one.

Adam: For all of our listeners. Thank you for tuning into our first Energy Visions Spotlight podcast. Our goal is to provide valuable insight and into the global indicators that you should be watching as you lead your organization and teams to the next evolution of our industry, which I think we can all agree is upon us. Finally, I need to mention this podcast has been produced by PricewaterhouseCoopers, LLP and is for informational purposes only. Contents discussed are for general guidance on matters of interest and should not be taken as professional, legal, business, or investment advice. Thank you for listening.

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Adam Crutchfield, National Energy Leader, PwC Canada
Tel: +1 403 509 7397
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Robert Johnston, Managing Director of Global Energy and Resources, Eurasia Group

Reynold Tetzlaff, Calgary Managing Partner, PwC Canada
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Adam Crutchfield

Partner, National Energy and Alberta Consulting Leader, Calgary, PwC Canada

+1 403 509 7397

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Reynold Tetzlaff

CA, Alberta Region Managing Partner, Calgary, PwC Canada

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