What are we going to do about oil and gas?

Delwin Graham - May 08, 2018
Optimism seems to be returning to the energy sector.  In fact, there is even talk of US$100 crude returning within the next three months.

Optimism seems to be returning to the energy sector.  In fact, there is even talk of US$100 crude returning within the next three months. (Cf., Ambrose Evans-Prichard, “The World Risks a Full-Blown Oil Shock Within Months,” www.financialpost.com).  Evans-Prichard argues that three geostrategic crises could come to bear and send commodity hedge funds into a speculative scramble.  First, it is now likely that Trump will reinstate oil sanctions against Iran in mid-May and Japan, South Korea and most European firms will probably join the American because it is dangerous to defy the US. Treasury.  Second, oil supplies will be further restricted when the Venezuelan oil industry goes into total collapse.  Currently, drilling parts are running out and staff at the Venezuelan state energy group PDVSA are walking of the job in protest over pay arrears. Third, the OPEC- Russia cartel has finally succeeded in reducing OECD inventories to their five-year average and cleared most of the global glut, with the Saudis cutting production even deeper than agreed upon in order to lift oil prices above US$80 before selling off shares of Aramco.


Maybe world geopolitical events will lift oil above US$100. Maybe not. Obviously, the possibility that these events will come to pass, and that they will have a significant effect on the oil price, is speculative and not under the control of the energy sector.  In fact, the crude oil price is simply presented to any individual oil company and their responsibility is to establish a sustainable and profitable business on that basis.  The use of technology is crucial because it increases efficiency, i.e., profitability, at any given price of crude oil. In Canada, the development of the Athabasca Oil Sands is an example of technology being brought to bear on established reserves.  Similarly, the Cardium formation, which is the largest accumulation of light oil in the Western Canadian Sedimentary Basin, is continually being rejuvenated; directional drilling and multi-stage fracing are only the most recent technologies being applied.  As a result, the industry is moving away from a discovery model to a technological innovation model where established reserves are re-worked to improve efficiencies. They like to go where they know the oil is.


Of course, these technological developments can be revolutionary.  In fact, the production cuts that the OPEC-Russia cartel have instituted were in reaction to the recent surge in US shale oil production that was afforded by directional drilling and multi-stage fracing.  The directional fracing of formations looks to hold even more promise for increased efficiencies.   The OPEC-Russia cartel can continue to cut production in response, but I am sceptical about its ability to control the innovation that is afforded by the rule of law and free-market capitalism.


Given that the efficient development of reserves seems to be the rule of the day, “oil farming” is becoming more attractive to energy investors. In the case of the traditional discovery model, junior exploration companies take on debt, acquire a land package, hire a hot-shot team and then run like heck to build reserves and pay for their overpriced staff.  An alternative is to use mostly equity and minimize debt. Drill your field.  Pay out most of the proceeds to the shareholders and re-invest the balance back into the ground when there is the potential to produce oil at a profit. Rather than using unlimited capex to build reserves to sell at a big multiple, like the wheat farmer you are looking for sustainable and profitable production at the current commodity price and if you get an extra few dollars per bushel or barrel, that’s a bonus. You drive your tractor straight to the bank.


Please contact me (Delwin.Graham@canaccord.com; 780-408-1518) for more details and a few actionable ideas.