By Peter
McKenzie-Brown
It’s hard to forget
the 2008 financial crisis, when the economies of North America and Europe went
into freefall. The world seemed to be teetering on the brink of a collapse like
the one that followed Black Tuesday – the day in 1929 when a stock market crash
triggered what became the Great Depression. By contrast, the Great Recession
that followed the 2008 event was a period in which, in Alberta, imaginative
companies were able to find opportunity.
Take the case of four
small private companies. Starting in October 2008, during periods when the
petroleum industry as a whole was nervous about the future, they were seemingly
the only bidders on many parcels, at many Crown land sales – the bi-weekly
auctions at which Alberta sells mineral rights to the highest bidders. The
informal consortium reached an agreement by handshake.
One of the partners
explained the outcome of their acquisitions, but for “competitive reasons” insisted
on anonymity. “For a collective payment of less than $1.4 million (including
initial rentals and fees), we acquired mineral rights of different sizes, in a
variety of geological horizons and in many parts of Alberta,” he said. “Excluding
lands in which others hold minor royalty interests, we acquired more than 60,000
hectares of mineral rights.” That was a small fraction of the mineral rights
sold at auction, but he and his partners bought those lands at “a very small
fraction of the average cost of lands sold within that time frame.”
The four companies
were already moderately successful; their proprietors had been in business for
25 years or so each. But this deal – agreed during a period of great
uncertainty – took each player to another level. In the years following, they entered
into deals where they sold or farmed out these lands and the plays they
developed to a variety of other players, retaining residual interests when they
cut the deals. By drilling and installing production equipment, “larger entities”
successfully transformed that land into producing operations. The partners
received production royalties and cash payments, and they have since gone on to
other deals – sometimes together, sometimes solo. Of
course, those partners were operators, whose ultimate goal was to develop their
own companies. Other companies see asset sales in a different light.
Liquid
Assets: For decades Calgary has been home to the largest number of
major head offices in Canada outside the Toronto area, which has five times the
population. Calgary is a corporate city, which arranges finance and makes
business decisions. It is a technical centre, with an amazing array of
scientific and technical skills. It is a management city, and its seasoned
executives continually make high-stakes decisions.
A unique mix of
characteristics have set Calgary up for growth and increasing strategic
importance in the energy world. Within the city’s ten blocks – the business
part of downtown – is an extraordinary concentration of expertise – the largest
concentration of geological talent in the world, for example. Alberta’s
petroleum industry has traditionally produced from conventional oil and gas
formations that on a world scale are relatively modest. The industry developed
strong drilling, engineering and technical skills at least partly in response.
Other areas of
expertise include management, legal and accounting skills; finance and
economics; technological development and environmental innovation. These skills
developed in an entrepreneurial climate which takes a competitive delight in
financing, exploring, developing and overseeing production from the geologically
complex Western Canada Basin.
“What makes Alberta
special is its great investment environment,” according to Malcolm Adams, a
senior VP at Annapolis Capital. “There’s a fantastic
entrepreneurial spirit in Western Canada, and good royalty structures. In the
Western Canada Sedimentary Basin there are opportunities for all kinds and
sizes of companies.”
Annapolis, which invests exclusively
in Canadian energy, has a pragmatic approach to asset
liquidity. “We don’t invest in service companies or the midstream,
where we don’t have a lot of expertise, or in the capital-intensive oil sands.
We do put investment money into companies that are doing unconventional tight
oil and shale gas, the Bakken – that kind of thing.”
“The best investments
you can find are companies capitalized in the $50 million-$150 million range,
according to Adams. “As an investor we can help those companies grow, and might
have somewhere in the range of $150-$400 million in value some years down the
road.” There’s a big market for the “de-risked assets” that result. “To achieve
an annual 20% rate of return for our investors, we take a bit more risk at the
front end than those bigger organizations are willing to take.”
As the eight to 12
companies in a portfolio grow, Annapolis sells interests to bigger entities. Of
course, the market for assets within Alberta “ebbs and flows,” according to
Adams. “We had six realizations last summer. It was maybe 18 months since our previous
realization.”
Waste
to Wealth: In one investment area, Alberta is unique in the world.
That is its approach to greenhouse gases – an inevitable by-product of oil and
gas production.
By no means are the 105
largest CO2 emitters in the province all oil sands operations. As North
America’s main energy producer, Alberta’s largest emitters include, for
example, petrochemical plants at Joffre and Fort Saskatchewan, and large
coal-fired power generating facilities. The quasi-independent Climate Change
and Emissions Corporation (CCEMC) – established by the Alberta government but
funded by imposing a $15 per tonne charge on the 105 largest CO2 emitters in
the province – came up with the idea of having a global competition to see who
could come up with the best ideas for turning emissions into products that
benefit society. It doesn’t take long to recognize that as a transformative
investment idea.
This extraordinary
competition – nothing like it has ever been tried – has as its aim to develop
businesses in Alberta which control CO2 emissions by using them as a feedstock.
In a competition one-third through its five-year cycle, CCEMC created a global
challenge to turn greenhouse gas emissions (mostly CO2) into a profitable
resource.
To find ways to
commercially use carbon dioxide as a resource, the agency is funding a global
competition to look for answers. A not-for-profit with a mandate to reduce
greenhouse gas emissions, the agency provided financial incentives for
competitors – they ranged from university professors to multi-national corporations
– to come up with “bright ideas” that, if initiated in Alberta, could help the
province turn carbon dioxide into a useful resource – for example, methanol,
which can be used directly as a fuel, or as a petrochemical feedstock.
According to CCEMC’s
managing director, Kirk Andries, “Alberta isn’t the only jurisdiction with this
kind of technology fund, but we are the only technology fund supported with
these types of regulations.” Emitters have a number of compliance options. They
can reduce greenhouse gases by continuous improvement, they can buy offsets or
emission performance credits from other emitters, or they can pay into the
fund. “Or they can do all of these things; it is up to them to decide how they
want to pay the bill.” Such a funding arrangement is possible because the large
emitters are responsible for 70% of the Alberta’s emissions.
A “virtual
organization” without offices, CCEMC has 90 projects on the books. “We have
invested about $230 million in those 90 projects, yet their total value is
about $1.6 billion. Our money is leveraged; on average for every dollar we
spend we get $5-$6 of return. Ours is risk capital, and it is mostly put into
projects that would not occur without our funding,” Andries continues. “We
support transformative technologies that can deliver meaningful greenhouse gas
reductions.”
“From the GHG
perspective, the reduction potential from all the projects we have funded is
more than 20 million tonnes by the year 2020,” he adds – a number he says is
generated at the project level. “When the technology itself is commercialized
and then broadly deployed in Alberta and anywhere else, we expect a much
greater reduction.”
Oil
Price Collapse? As this article went to press, global
oil prices had just gone through what the business press frequently called a
“price collapse.” These price declines followed half a dozen years in which
international oil prices averaged nearly $100 per barrel. In real terms, that’s
one of the longest periods of higher oil prices on record. Of particular
interest, Brent crude – an international standard, based on oil production from
Europe’s North Sea – was higher-priced than West Texas Intermediate, the most
important North American benchmark.
These prices made
heavy oil and oil sands projects quite profitable, but they also made tight oil
production – a relatively new technology – profitable and competitive. Fracking
projects were releasing natural gas and condensate in large volumes,
profitably, and the oil sands sector was providing the market with more complex
hydrocarbons – resources with uses for both fuel and petrochemicals.
For the first time in
many decades, North America needed to find ways to export petroleum and its
products, and did so. This led to a rapid decline in oil prices, beginning in
October. How significant was that?
According to Ziff
Energy’s Bill Gwozd, “The current price is irrelevant. What is really important
is the price over the next several decades.” His company, which is active in
most of the world’s petroleum basins, helps E&P firms by forecasting energy
prices to the year 2050. “Construction on the projects that we are working on
won’t even start until 2019, say. They won’t be going on production until 2023,
and then they’ll produce for maybe 40 years. What you care about is the median
price, maybe three decades forward.”
Not so, said an
executive from Cenovus, who wished to remain anonymous. “We’re almost halfway
through our Foster Creek project’s lifecycle, for example. Our steam/oil ratios
aren’t quite as good as they were, and the price drop does have an impact on
our ability to invest.”
According to executive
VP Dan Allan of the Canadian Society of Unconventional Resources, the resources
in the province are such that, although these price declines will not seriously
affect long-term development, they will affect capital markets. “Rates of
return dictate the business; if margins start to thin out, capital goes
elsewhere. That is reality in the financial sector.” he says. “Certain projects
being considered for mezzanine financing, for example, are now going to be
marginal or at least less attractive.”
Then his infectious
optimism kicks in. “I have been around long enough to know that we always find
a way,” he says. “We go somewhere else with a different product. It might be
light tight oil; it might be liquids-rich gas. We go to the products that
provide the highest rates of return, while we let other assets sit idle for a
while until circumstances change. When it becomes difficult to attract capital
on one side of the equation, an opportunity opens up on the other side. That is
how markets correct themselves.”
As Allan observes, “it is the nature of
markets to change.” For example, at the beginning of 2013, it was difficult for
some companies to raise money. As the year progressed, however, that changed. “The
right assets with the right management teams got in favour again, because
people were feeling more comfortable about the prospects for success in some of
these projects, capital started to flow back in. Capital flows are robust, and that
is a good thing.”
Many service
companies are headquartered in Alberta. Operational services are generally in
Edmonton, Red Deer, Fort McMurray and Lloydminster. Corporate headquarters are
mostly in Calgary, and many of those companies do international work.
To cite one example, Ziff
Energy – the company Bill Gwozd works for – does “two things for a living. We
have an E&P services group, and we have a natural gas group. Our E&P
services group has national oil companies as clients, intermediate oil
companies, private companies, public companies, small producers, big producers,
onshore producers, offshore producers” in 70 countries around the world.
“The most important
thing we do is to benchmark operating costs,” he says. “For example, when you
are drilling an offshore well you need materials, and unique services. You may
need chemicals such as glycol.
For similar operations – the Gulf of Mexico
versus Indonesia, for example – your annual glycol costs in may represent $1
million in one area and $10 million in the other.” Because his firm has so many
clients, its database enables it to quickly benchmark minute operating costs. “We
help our customers understand that in some areas they are very efficient, while
in others there is room for improvement. By benchmarking you get best
practices, and you drive your operating costs down.” That’s one part of Ziff’s
business.
The other is its forecasting
group, which uses sophisticated forecasting tools to forecast energy prices to the
year 2050 – a 35-year timeframe. “We forecast gas supply, gas demand, gas
transportation, gas pricing, cost of gas. We forecast the decline rate of new
shale gas plays in the Marcellus in the year 2029. We are interested in at
least a 30-year spectrum – say, the price of oil from 2017 to 2047; 2032 is the
midpoint. The same with LNG projects: the relevant time period is 2020-2050.
That is how you build your economics.” He returns to the question of recent
price declines. “Today’s price has no relevance for big, mammoth projects.”
What Malcolm Adams
called Alberta’s “fantastic entrepreneurial spirit” is a spirit that runs deep.
