Finance Committee on March 10th, 2015

[Tim McMillan]

I think Canada has a great opportunity to be a world supplier. The effects of us reaching that potential will be felt and the benefits will be felt, not just across Canada but in the countries that are seeing their middle classes grow. People today who are cooking over an open fire may have access to natural gas from Canada a decade from now if we do things right. The types of decisions that you're talking about, as the policy leaders you are, will have great effects not just in our country but far beyond us.

[The Chair, Conservative, James Rajotte]

Thank you, and thank you, Mr. Adler.

There are a couple of minutes left. I have a number of questions, but I don't have time for all of them. I'll try to get one on the table.

I do agree that we should not overact both at the federal and provincial levels.

Mr. Reynish, you said Suncor was scheduled to pay $2.7 billion in taxes to the Canadian government and now it's done to $800 million. That is a sizeable impact. Another concern...Mr. Dunn, you raised the new normal. You've certainly faced a new normal in terms of natural gas prices. People talk about markets going up and down, but the concern here is that we have a fundamentally changed geopolitical situation, and a fundamentally changed crude production market, with the U.S. coming on in such a large way as being one of the top three crude oil producers in the world. You have the reaction by OPEC and by Saudi Arabia, presumably to distort the market and drive the price down, to preserve or increase their market share. That seems to me to be the big elephant in the room that we haven't yet addressed today, and I'm doing it with two minutes left in the panel. Is there someone who wants to take that on?

Canada is a price-taker in this whole thing. The concern is that if OPEC or Saudi Arabia keeps that up as a market strategy, how long can we in this country sustain that?

I'll look to Mr. Reynish. I probably only have time for one or two of you to comment on that.

[Steve Reynish]

Let me say I think yours was a very good summary of where we're at. We are planning at Suncor for a two-year horizon for these much lower prices. I think we do see that volatility is back in the market, and I think we'll see some big swings both up and down going forward.

[The Chair, Conservative, James Rajotte]

Mr. Dunn, do you want to comment on that?

[Richard Dunn]

Yes. I agree with your comments, Mr. Chair, around the new normal and getting to the new normal. We shouldn't overreact, nor should we ignore that there will be a new normal. Competitiveness will be critical in terms of how Canada fares in the new normal. There is an urgency to continued action on all of our parts.

[The Chair, Conservative, James Rajotte]

Thank you. I appreciate that. I'd like to get into that more. Maybe Professor Leach can address that in the next panel.

I do want to thank all of you so much for being with us. If there's anything further you want the committee to refer to, please submit it to me. I'll ensure that all members get it.

I want to thank all of our witnesses here in Ottawa.

Mr. McGowan, thank you so much for getting up two hours earlier in Edmonton to be with us from there.

Colleagues, we'll suspend for a couple of minutes and come back with our next panel.

[The Chair, Conservative, James Rajotte]

Colleagues, please find your seats for the second panel. We will begin right away. Thank you.

We're resuming our discussion here, continuing with our study of the impact of low oil prices on the Canadian economy. This is our second panel here this morning. We have four witnesses to hear from for this panel.

First of all, from the University of Alberta, we have Professor Andrew Leach from the Alberta School of Business. Welcome, Professor Leach. We have from the Canadian Renewable Fuels Association, the president, Ms. Andrea Kent. Welcome to the committee. From Packers Plus Energy Services, we have Mr. David McLellan, senior economist and business strategist. Finally, from TransAlta Corporation, we have Mr. Rob Schaefer, executive vice-president, trading and marketing.

We will begin with Professor Leach. You each have five minutes for your opening statements and then we'll have questions from members.

[Dr. Andrew Leach, Associate Professor, Alberta School of Business, University of Alberta, As an Individual]

Good morning. Thank you very much. It's a pleasure to be here with you today.

I'd like to deliver remarks on three aspects of the oil price crash for you today. First, I'll look at how the changes of the market have affected the outlook for oil sands projects. Second, I'll talk briefly about greenhouse gas policies and oil sands projects in light of the oil price crash. Then, if time allows, I'll add something on refining and upgrading as well.

As you know and as we discussed in the first panel, oil prices have declined considerably over the past nine months. Early on we had a little bit of an advantage in Canada, in particular for oil sands, with a weaker Canadian dollar, lower discounts, and cheaper diluent, which led to Canadian oil sands projects probably faring better than projects did on average globally. That's actually reversed now, so things have gotten a lot worse in the last little while for oil sands. It seems every time I write that they're okay, they get worse.

To understand the impacts of these prices on oil sands projects, I will go quickly through three aspects.

When you look at CAPP's oil sands production forecast, we think that's a reasonable benchmark for what industry has planned. You see about two million barrels a day of current production, about another one million barrels a day of production that we're expecting to come online, which is currently in construction, and then another two million barrels per day of forecasted growth projects. These would be projects that don't have significant capital already invested in them.

If you divide the existing operations into those three groups, you're at very little risk of seeing any of those shut down. To take a couple of simple examples, for a project like CNRL's Horizon, you're looking at a cost of production of about $38 per barrel today for a product that sells for about $60 a barrel. So you still have a healthy operating margin.

Suncor, from whom you heard earlier this morning, has pretty similar statistics. Their production costs—and they're in the high end of the oil sands producers, because they have a large integrated project—per barrel are about $35, and that barrel sells for about $60 to $70. If you go down through their existing in situ projects, they're at very little risk of actually shutting any of them down unless the oil prices get a lot worse.

New projects are a little bit of a different story. Like economists, we always have two hands, so I'll talk about two types. On the one hand, we have the projects for which significant capital has already been invested, and on the other hand we have the projects for which it hasn't been.

If you look at the ones with significant capital investment—and we saw a good example of this recently, again from Suncor, with the Fort Hills project—even though that's a relatively expensive project, it was worthwhile for them to continue that because the forward-looking view, even with lower oil prices, is still for a positive rate of return on investment.

This is also an area in which you can plainly see the impact of the Canadian dollar. We used to think of new mines as being projects for which you needed $85 to $100 WTI to make work. With today's Canadian dollar, you can probably make a new mine work somewhere between $65 and $70 WTI, if the Canadian dollar holds where it is right now. For a new in situ project, those numbers get even lower, down into the $50 to $65 a barrel range. If we're looking at the projects that are currently under development in which significant capital has been invested, those numbers get even lower still.

So what does that mean in terms of what you should expect? It means you should basically expect what you heard Mr. McMillan from CAPP talk about this morning—a pullback in future capital investment on new projects leading to a decrease in the rate of increase in oil production, if you can follow that double negative. So there will be less production than what you expected but more production than you have today.

Second, could a GHG policy disrupt this trend? Would it be crazy to introduce new policies on oil sands emissions?

I don't think so. If you look at the types of policies that have been proposed, whether for something like a 30-30 or 40-40 approach in Alberta or at the federal level, or even something like B.C.'s carbon tax, the margin you're talking about is, for a 30-30 approach, maybe 10¢ to 25¢ a barrel. If you take a B.C. carbon tax approach, it's maybe $1 per barrel at most.

I don' t know about you in this room, but I actually find it far less comforting to think of the fact that our oil sands industry is 25¢ a barrel away from disaster than I do to think of the prospects of a greenhouse gas policy. I think we're much better off if we have a credible greenhouse gas policy in the oil sands than we are if we have none at all.

Lastly, on refining—and you heard some thoughts on refining from Mr. McGowan this morning—it is true that refining margins hold up better, because they tend to reflect the cost of refining, and they don't tend to reflect the cost of crude. We're finding that margins have been more stable, but according to recent analysis that I've just pulled together over the last couple of weeks, the total return to shareholders, to governments, and to royalties would be higher by a factor of about 40% for extraction alone versus extraction plus refining per dollar invested.

Thank you very much for your attention. I look forward to your questions.

[The Chair, Conservative, James Rajotte]

Thank you very much, Mr. Leach.

Ms. Kent, please.

[Andrea Kent, President, Canadian Renewable Fuels Association]

Good morning. Thank you very much.

It's a privilege to be here today on behalf of the Canadian Renewable Fuels Association and our membership.

Just by way of a quick background, our domestic biofuels industry is now generating $3.5 billion yearly in economic activity. We've created over 14,000 quality Canadian jobs to date. We return over $3.7 billion in investments back to the government every year. We've had significant growth since 2006.

Notably, 26 renewable fuel plants are operating across Canada. They make more than just biofuel. We make clean technology. We're making new products, and we're expanding our renewable fuels supply.

CRFA represents the full spectrum of Canada's domestic biofuels industry. Our members are biofuel producers, petroleum distributors, retailers, and farmers. Over our 30-year history, we've seen many challenges and we've risen to them. Declines like this and these low prices that we're seeing in this environment certainly are not uncharted territory. Of course, this is not to minimize the impact that lower oil prices have on our industry or our membership, but it is not uncharted territory. We've been here before.

After all, renewable fuels and petroleum industries are very closely linked and tied. Earlier in this hour, we heard from CAPP and from CFA. I want you to know that those two groups really encompass our customers. They are our members as well—you heard from Suncor. We work together, we play direct roles in one another's successes, and by that token, what affects one impacts the other.

With the committee's questions in mind, I will give you an overview of what we're seeing in our industry as a result of lower prices.

By way of context, we have federal mandates. There is a 5% requirement for ethanol in the gasoline pool and 2% for biodiesel or renewable diesel in the distillate pool. It really is important to note that those mandates and that stable policy is helping us offset a lot of the disturbances that a low price environment can create.

While we are a domestic industry here, a lot of our business actually operates on a north-south trade axis. American ethanol imports have been slashed. Their exports to Canada are significantly lower than last year's projections. With those U.S. exports drying up, the product does back up into the American market. It has caused depreciation in the U.S. market.

It's reducing the amount of overblending in the Canadian market compared with what we have seen in previous years. It's significant because with overblending and over-compliance largely due to the price advantage of ethanol, Canada overblends and exceeds the national mandate requirement by about 130% a year. This is going to dry up now because that price advantage for ethanol is shrinking.

On average, the wholesale price of ethanol has been roughly 20¢ cheaper than gasoline. Falling gasoline prices weaken that price advantage and essentially remove a lot of the financial incentives for higher blends and for overblending that we've seen in the past.

The resulting glut of product in the U.S. also shrinks the market for Canadian biofuels, so it reduces demand and it puts downward pressure on profit margins. At the same time, we see input costs that are a bit higher, purchases that are down, investors who see their portfolios shrinking, and access to capital tightening. In one way or another, we all feel the effects.

Even more concerning than price fluctuations in the short term is policy instability in the medium and long term, and that's true in any market. The long-term need for Canada to diversify its fuel mix really does remain strong. That's kind of the point here for us and our members today and that is in the face of anything, including declining oil prices.

The good news, and there is good news, is that Canada benefits from stable national mandates that have helped build resiliency. However, if we are to continue to grow and progress, government policies need to keep pace by: specifically, renewing and expanding renewable diesel mandates, which is important, moving from 2% to 5%; and supporting innovation and developing broader market access for producers. That's going to echo a lot of the comments that you heard in the first hour.

Thank you very much for the invitation. I look forward to your questions.

[The Chair, Conservative, James Rajotte]

Thank you very much, Ms. Kent.

We'll go to Mr. Schaefer and then to Mr. McLellan.

[Rob Schaefer, Executive Vice-President, Trading and Marketing, TransAlta Corporation]

Thank you and good morning. My name's Rob Schaefer and I'm the executive vice-president of trading and marketing at TransAlta.

Thanks for having me here today. I really appreciate the opportunity to speak here about the impact on the electricity sector of declining oil prices.

Before I get started just let me introduce TransAlta for those of you who aren't familiar with us. We are Canada's largest, publicly traded power generator and marketer. We've been in business, headquartered in Calgary, for over 100 years. We are a well-diversified company. We have operations across Canada, in the United States, and in Western Australia. We have 64 generation facilities and we span pretty much all fuel types, from hydro to wind to coal to gas, with a total fleet capacity of over 8,500 megawatts across all those jurisdictions. We're Canada's largest wind generator and we're among the largest publicly traded renewables companies in Canada.

We're in your communities. We have small hydro facilities in British Columbia. We have efficient coal plants in Alberta. We have wind farms in Quebec. In fact, we have a gas cogeneration plant right here in Ottawa serving the children's health centre just north of here. We've been serving that facility for a number of years and we're very proud to have just worked out a new deal with the Ontario Power Authority to continue the operation of that plant.

We're very involved in the oil and gas sector. Of course, we supply power to the grid in Alberta. We supply all oil and gas producers that way. We also have cogeneration facilities right on site with Suncor, for example. We just heard from Suncor earlier. In fact, we've been in business, in partnership, with Suncor at Fort McMurray for 14 years, with a cogeneration plant there. We serve their refinery in Sarnia, Ontario, as well. Clearly the oil and gas sector is important to our business.

What I would like to do here today is to speak to the impact of oil prices on the power sector, and I'm going to cover both the short-term impacts as well as the long-term impacts.

Thinking about the short term, what we're seeing today are the lowest power prices we've seen in years in Alberta, and actually across North America. There are a couple of things going on here.

Number one, we've had a significant amount of new power supply come in during the last couple of years, brought on by having relatively higher prices that brought on new supply. Now we're seeing the impact of that with quite low prices.

The second thing, though, is that we have very low natural gas prices. I think you heard about that and you've certainly been aware of that. So what's happening is that we're seeing a trend of increased competition between gas and coal in Alberta and in other markets as well. In fact, in 2014 coal ran about 12% less than what it was capable of, and our analysts are linking that to low gas prices. Basically in any jurisdiction where you have a reasonable amount of gas-fired generation you're seeing the impact of that on the markets. Those are the short-term impacts.

The longer term impact is this. As difficult as low oil prices are on the oil sector, it's also difficult on the power sector. If we see a protracted period of low prices, it's going to be difficult to make the investments we require to renew the generation fleet across Canada. Clearly in the short term consumers are better off with low power prices. The challenge is that, longer term, we could see a knock-on impact in the form of higher prices later, and even potentially supply shortfalls. You know that in western Canada, in particular, an oil and gas industry that's not investing in growing means a flat load growth for the power sector.

As we look to the 2020 timeframe to renew our fleet, if we have a protracted period of low prices it's going to be challenging to do that, no matter what fuel technology you want to talk about because all new generation comes with large price tags. There is a long lead time to make those investments, much longer than the oil and gas sectors themselves, so you get into a timing crunch.

That's the bottom line. Just to wrap up, at TransAlta we're certainly up for the challenge. We've adapted to the effectively low mining revenues in Western Australia, the manufacturing sector in Ontario. We've been dealing with the growth we've had in western Canada. We can certainly deal with a softer market. It's not the first time we've seen it; it won't be the last. We're certainly up for the challenge.

Thank you very much, and I welcome your questions.

[The Chair, Conservative, James Rajotte]

Thank you for your presentation.

We'll go to Mr. McLellan, please.

[David McLellan, Senior Economist and Business Strategist, Packers Plus Energy Services]

Thank you.

Packers Plus Energy Services is an excellent case study on innovation and success originating in the Canadian oil patch. I'm honoured to have been afforded the opportunity to participate in today's panel discussion on the impact of the decline of global oil prices on the energy sector and the Canadian economy.

Our company was founded in Calgary at the turn of the millennium by three partners. They developed a system that allowed for the efficient extraction of hydrocarbons from tight formations through hydraulic fracturing. Its introduction was a catalyst for radical change in the industry as it combined with advances in horizontal drilling such that North American hydrocarbon production has grown considerably faster than North American demand. The consequences of this are not unrelated to why we are convening today.

Today Packers Plus has almost 1,000 employees with 32 locations around the world. Our company designs, manufactures, sells, and installs the highest-quality completion systems in the industry. We've now become the fourth largest completion company in the world after behemoths such as Schlumberger, the new Haliburton-Baker Hughes merged company, and Weatherford.

Ours is an example of how Canadian innovation and oil field expertise is sought and exported around the world.

If we discuss impact on prices, first I would like to point out that the members should consider that a barrel of oil is not necessarily homogeneous. There are varying crude qualities coming from different locations to a number of destinations. Canadians will be most impacted by the price of West Texas Intermediate and the Western Canadian Select blends.

Standard pricing is in U.S. dollars and it facilitates easier comparison and international trade. This means there is an inverse correlation between oil prices, particularly WTI, and the U.S. dollar. The current strength in the U.S. dollar is one aspect hampering a recovery in oil prices. Note that many OPEC and other oil-exporting nations have increased demand for U.S. dollars because they need to fund their budget shortfalls with their sovereign wealth funds and foreign currency holdings, and by holding U.S. dollars it protects them against currency losses.

Of course, Canadian producers have benefited by that in that the Canadian exchange rate has dropped from about $1.07 per U.S. dollar to close to $1.21 today.

Brent crude is the international blend and it's what sales are frequently based on. Over the last 25 years West Texas Intermediate has averaged a slight premium of about 2.6% over Brent, but since 2009 and the introduction of new hydraulic fracturing technologies, WTI has traded primarily at a discount. The discount has been relatively volatile but has more recently averaged over 20%. This premium represents lost opportunity for the Canadian economy and should be part of recognizing the motivation to increase our market access to tidewater so that we can sell into that market.

Despite the contention of my colleagues on the previous panel, oil is not necessarily the global commodity it's made out to be. The United States right now has a law banning export, so we have a North American market. Shale oil in the U.S. has increased production by four million barrels a day at a time U.S. demand has fallen from a 2006 peak of 22 million barrels a day to about 19 million barrels a day today.

With respect to the reduction in E and P capital expenditures and reduced oil field activities that was talked about, we are seeing sharp drops in North American rig counts. According to the CAODC website, each rig represents about 20 direct jobs and 135 indirect jobs. The rig count has dropped from over 1,800 in November to about 1,500 now, and it is expected to bottom later this year at perhaps as low as 1,250. A price recovery above $70 U.S. for West Texas would provide the signal to start adding rigs and subsequently increase production.

In the service industry that we are part of we've seen the reduced capex budgets and drilling activity felt across our industry. Competitors such as TriCan have experienced layoffs and have asked their staff to take pay cuts. Operators have been asking for and receiving price cuts but there are limits to how much of the price burden the service industry can or is willing to take.

This new reality will renew focus on efficiencies and provide incentives for companies to adopt more innovative approaches. A $90 West Texas Intermediate environment produced a pattern of drill, complete, put on production, and repeat among many shale operators. They became so busy ramping up their production they really didn't focus on efficiencies. This reduced activity level has now given them an opportunity to pause and review data.

Subsequently, we at Packers Plus expect first to see a lot of high-quality research papers produced, and then to gain some significant market share for us.

I am based in Houston, Texas, after 16 years in Calgary. Half of our business comes from Canada. We are looking to grow significantly in the United States. Open hole completions are the dominant completion method for unconventional ex-oil sands in Canada but in the U.S. it's cemented liner plug-and-perf.

[The Chair, Conservative, James Rajotte]

Could we get you to conclude, please?

[David McLellan]

Wrap it up?

[The Chair, Conservative, James Rajotte]

Yes, wrap it up very quickly.

[David McLellan]

Sure.

How about this? I look forward to your questions.

[The Chair, Conservative, James Rajotte]

I will have questions for you. Thank you very much for your presentation.

Colleagues, I think we're going to try six-minute rounds to be fair to all the members.

We will start with Mr. Dionne Labelle. You have six minutes.

[Pierre Dionne Labelle, NDP, Rivière-du-Nord, QC]

Thank you, Mr. Chair.

My first question is for Dr. Leach.

You said that the equilibrium cost of past projects was $75 a barrel and that the equilibrium cost of new projects was $50 a barrel. Say the barrel price remains at $50 for the next five years. In fact, from a global geopolitical perspective, the trend is that there is an oversupply. What would be the impact of sustaining this price on Canada's oil industry, specifically on projects with an equilibrium cost of $75 a barrel?

[Dr. Andrew Leach]

That's a good question.

If you did see a sustained oil price world in today's price.... All the numbers that I gave you were based on holding today's prices as predicted by the futures market right now. If you did see that hold, what you are going to see is that most projects under construction will go to completion. Most if not all existing projects will stay in operation on the oil sands side. Probably some of the top-tier new projects and expansions will go forward, but you'll probably see a larger share of the expected two million barrels a day delayed or cancelled.

On the light oil side, it's a little bit of a different ball game in that those are very quick to ramp up and ramp down so you'll likely see more. My colleague, Mr. McLellan, could probably comment more on that, but you'll see much more variability in those spaces. They do make money at a lower oil price often but they're also more easily brought online or off-line. So you may see more rapid delays in those sectors.

[Pierre Dionne Labelle, NDP, Rivière-du-Nord, QC]

Today, we heard from an economist with the Alberta Federation of Labour. Several people have spoken about the need to export oil to international markets. The economist in question said that if we export oil to international markets, given the current oversupply, we would increase the supply, would help keep prices low and would encourage the non-profitability of oil sands development.

Do you see the logic in that?

[Dr. Andrew Leach]

Again, we need to keep in mind the following.

What we need to keep in mind is that, yes, there is an excess of supply in the world markets. That's what's pushing the price down, but that factor is even more prevalent in the North American market, as Mr. McLellan also mentioned. We have a landlocked market in North America, which is leading to prices here being lower than they are on world markets.

So, no, by exporting Alberta bitumen to world markets, you're not going to see us getting a Brent price for Alberta bitumen. But you also would be talking about a relatively small quantity in the global scheme of things, if we're talking about increasing exports off the Canadian shores by, let's say, a million barrels a day.

[Pierre Dionne Labelle, NDP, Rivière-du-Nord, QC]

This won't make the barrels that are produced more profitable.

[Dr. Andrew Leach]

It will make them marginally better relative to what they would be otherwise. You're not going to get back to a hundred-dollar-a-barrel world or anything magically, but you're also not going to have a big impact on global markets. We're just not big enough to move them.