Subcommittee on Oil and Gas and Other Energy Prices Committee on Aug. 27th, 2008

[Michael Masters]

Yes. Recently a CFTC vice-chairman, Bart Chilton, said that he felt the study may have reflected a foregone conclusion. More important, in the last few weeks the CFTC themselves reclassified one very large trader, Vitol Corporation. I believe it was in The Washington Post. They had classified them as commercial and then reclassified them as a—

[Bruce Stanton, Conservative, Simcoe North, ON]

Mr. Masters, I don't want to cut you off, but I only have six minutes. I have one little follow-up question along the same lines, if you don't mind, which I will direct to Ms. Russell.

In our context, we're faced with the same issue. You have contradictory reports on this phenomenon, if I can call it that. From a public policy point of view, it's in our interest to do what we can to make sure we have prices for oil that are reflective of supply and demand. If we assume that there are some issues, what is one to do, Ms. Russell, to bring some effective public policy to bear on them?

[The Chair, Conservative, James Rajotte]

Ms. Russell, and then Mr. Sprott.

[Dr. Ellen Russell]

I've used your time. Why don't you go?

[Eric Sprott]

Mr. Stanton, it is my belief that the commodity markets are not well regulated. I would not believe that report. We have seen so many examples. All of us have seen them. We saw Amaranth. We saw the SemGroup recently blow up and lose $3 billion. How much did you have invested to lose $3 billion? Maybe you had $12 billion. All the regulators who say they are regulating things, particularly in the U.S., are not regulating. People say they're regulating the banking business. They have no idea what's happening in the banking business. The derivatives market is totally out of control. There are six hundred trillion derivatives out there that have nothing to do with the commodity market.

But the one thing I want to say about the commodity market is that it's a paper market. It's paper. Anyone with a lot of paper, a bank or hedge fund, can trade paper, but do you know what? They don't take delivery of the oil. You have a real oil market and a paper market. They're two different things.

[The Chair, Conservative, James Rajotte]

Thank you.

Ms. Nash.

[Peggy Nash, NDP, Parkdale—High Park, ON]

Thank you.

Welcome to the witnesses this afternoon.

Ms. Russell, I'd like to start with you. I hear you saying that there may be factors like supply and demand involved in the prices, but the deregulation of the market, specifically the Enron loophole, has led to dramatically greater speculation investment that wouldn't otherwise be there. We can all think of the dot-com investment and the sub-prime mortgages, which hurt a lot of average people, made a few people rich, and then created real havoc in the aftermath. You talked about how it drives up prices. You said it was a misallocation of investment that could leave a legacy far into the future.

Can you tell us what such a misallocation of investment could mean for Canada? What should we be trying to do to prevent that misallocation?

[Dr. Ellen Russell]

When the price of oil is relatively high, this encourages investment. Investment in oil is a long-term proposition. You can't suddenly reverse investment made in enhancing the supply of oil. These are big, lumpy investments that will extend far into the future. In response to the 1970s oil difficulties, there was a lot of investment made to increase supply, which ended up casting a shadow over the market for some time to come.

The issue I'm flagging for you is that we might be overheating investment in oil in response to these price signals, which have been partly inflated by speculation. Once we've committed to those investment decisions, we're going to have to build facilities intended to serve the market far into the future--this is oil that doesn't come today, it's oil that will come in the future--and perhaps that's not justified with the underlying economic fundamentals. So when you consider the landscape of the economy in general, it's a concern to be putting all of this emphasis on the oil sector, to the detriment of other sectors that might merit investment if this price signal mechanism weren't so distorted.

[Peggy Nash, NDP, Parkdale—High Park, ON]

Just to pursue that, the main industry committee did a study of the impact of the dollar on the manufacturing sector, and certainly we heard concern there from manufacturers and anybody who exports or is particularly price-sensitive, I would argue—tourism as well, the cultural sector. Is there similar concern about the high price of oil, especially if it is an artificially high price, that it could permanently damage key sectors of the Canadian economy, like tourism, like manufacturing, that may afterwards have difficulty recovering? Are we putting too many of our eggs in one basket?

[Dr. Ellen Russell]

Certainly the concern is that these are decisions that have repercussions far into the future. So if, for example, you over-invested in oil today, let's say, and under-invested in manufacturing, and you did that for as long as an oil bubble lasts—I don't know how long that is—then once you've misallocated that investment, you can't reverse it instantly. So a manufacturing plant that gets closed today because it's a casualty of this difficulty doesn't just open up the minute the price signals return to something like fundamentals. That may be gone. That window of opportunity is closed, because it's shuttered by the--

[Peggy Nash, NDP, Parkdale—High Park, ON]

Mr. Masters, are we facing an oil bubble?

[Michael Masters]

I don't know if I'd call it a bubble or not. I think you have definitely seen the amplification of price, of a fundamental supply and demand situation, by investors. Now there's debate over what that amplification is.

My view of the world is that $170 billion going into anything is going to have pretty significant distortions on the price, especially when the markets are much smaller than the typical capital markets that capital market investors usually invest in. So I think it's had a fairly significant impact on the price, and if that's the case, then it does call into question the level of investment that's appropriate. To a certain extent, what you may be getting is more investment than you would otherwise get today, front-end loading it. The problem with that is that what you don't want to see for true energy security is that investment to suddenly go away if prices come down significantly, because they shouldn't have been up as much as they were. That's the issue with bubbles.

You go back to the housing market; you go back to the Internet situation. A lot of supply that was planned to come on ended up not coming on, and so the demand that was anticipated in fact didn't actually materialize, but the plans and the financing and so forth that were anticipated came into being and they were left sort of holding the bag, if you will.

[The Chair, Conservative, James Rajotte]

Ms. Nash, Mr. Sprott wanted to comment as well.

And I think, Mr. Diwan, you wanted to comment? Okay.

Mr. Sprott.

[Eric Sprott]

I'd like to make two points.

As you realize, I believe we have an oil problem in the world. It's because of something called depletion. When you start production, a well automatically depletes because the pressure depletes. Your production goes down. You're on a treadmill here, where you have to spend a lot of money just to keep production up. I would venture to say that the industry in the world spends 15% more a year and it gets nothing for it. There's no extra production. So we have a problem.

Exxon, I believe—and I wish I knew the exact number—spent something like $50 million a day and the reserves went down last year. It is not easy to find oil; it's not easy to find gas. Everything gets more expensive all the time. So that's the point I'd make.

[The Chair, Conservative, James Rajotte]

Just briefly, Mr. Diwan.

[Roger Diwan]

I want to make the same point.

We have a tremendous increase in oil prices, but we haven't seen supply increasing. So we are not in a situation right now where we are misallocating in a big way. What high prices have done is reduce demand, and it's painful for consumers. But from the point of view of public policy in the United States in particular, it's probably a good thing.

But the fact is that the increase in prices has not given us more supply, for a number of reasons. One is that we don't have the capabilities in the service sector to increase production; the second is that we are not finding any more very large new provinces. We're finding some of them: Brazil is an interesting one; the deep water off the Gulf of Mexico is a good one; Canada, the oil sands, is a good one. But what you see is a big depletion across the world. So what you have here is that as new fields are coming online, they're just not replacing the declining older large fields, and supply is not rising.

[The Chair, Conservative, James Rajotte]

Thank you.

Thank you, Ms. Nash.

We'll go to Mr. Alghabra, please.

[Omar Alghabra, Liberal, Mississauga—Erindale, ON]

Thank you, Mr. Chair.

Mr. Diwan, I want to follow up on that point because initially, in your earlier testimony, you said that you were not necessarily accepting the narrative of the oil industry that there is a shortage of reserves or oil production, but now you have just said that they're having a hard time finding oil.

So could you reconcile that, please, for me?

[Roger Diwan]

Yes, it's fairly simply.

The world is divided in two, if you want. You have what I would call the OPEC and non-OPEC countries. Inside the non-OPEC countries is where production has really not been increasing over the last five years—or you had an increase in Russia and a decline pretty much everywhere else. When you think about the non-OPEC world, basically the countries outside the cartel, they represent something less than 15% of global reserves—and that includes Russia. All the rest of the reserves are in areas that are not open to investment and/or exploration by the international oil companies.

So if you take 100% of the reserves in the world, if you want, 77% reside in countries or among companies that do not allow third-party access. The exception to the rule is places such as the United States, Canada, Australia, and Great Britain. The rule is that it's not open. It's in Saudi Arabia, it's in Iran, it's in Iraq, it's in Mexico, etc., where you do not have access.

So in the portion of the world that is open—and really, the truly open commercial oil represents only 6% of world reserves, that is, in the U.S., Canada, Australia, and Great Britain—yes, you are reaching levels where you're producing a lot and it's very difficult to replenish your reserves and continue producing at these levels. In the rest of the world, where we do not have access, the problem doesn't seem to be oil under the ground or the reserves of molecules, but access and the capacity for production.

And if you take all of these countries together, which represent something like 35 to 40 million barrels per day of production, there's only one country that's really investing, and that's Saudi Arabia. The rest are not.

[Omar Alghabra, Liberal, Mississauga—Erindale, ON]

Thank you, Mr. Diwan.

There appears to be a very powerful scientifically based narrative that speculators are over-speculating or increasing the price of oil not based on fundamentals. One would think that in an informed, intelligent market there would be a correction soon if one were worried about one's investments, but we also know that there are a lot of emotional factors and peer pressure and wanting to participate in the money-making now, taking risks and hoping that it will last until you pull your money out.

From our perspective, what can a government do? We know that in the U.S. now there is a movement that is rightly asking the government why they didn't act to protect against the sub-prime crisis. What can we do, as legislators, as a government, to ensure that we manage this crisis before it occurs?

[The Chair, Conservative, James Rajotte]

We'll go back to Mr. Diwan.

[Roger Diwan]

I'll go back to what Mrs. Russell said, that we removed the speed bumps; we removed the speed bumps in the United States. And the question is—and there has been a lot of discussion on this in the United States, where Mr. Masters and I have been quite involved—how do you put back the speed bumps to make sure that you basically look at these markets and understand what is going on? There is a movement here, and the CFTC has to look a lot more into the data and reclassify them, and I think in September we're going to see a much larger reclassification of the data to better understand the dynamic of these markets. They're complicated. But at the same time, I think it's also a political battle, as you have certain lobbies; and the financial industry, which has not been doing particularly well, doesn't want to see that loophole closed, because it's the only place where they're making money right now.

So you have different interests at play in the United States, and at the end of the day, it's a U.S. issue of how you put back the speed bumps and make sure you regulate your markets.

[The Chair, Conservative, James Rajotte]

Okay, we'll go to Mr. Sprott.

[Eric Sprott]

I want to reiterate that there are paper markets and there are real markets, and the commodity exchanges are a paper market.

[Roger Diwan]

It's the same thing.