(Liam Mogan)
Barry Munro pulled up to a Costco gas station in Calgary on a bitterly cold Sunday in early January to fill up. As the Canadian oil and gas leader at Ernst & Young, Munro knew he’d be returning to work after the Christmas holidays to awful oil prices; he also knew some in the energy industry would be worrying about whether they’d have jobs to return to at all. Prices were then at their lowest in five years, having tumbled 53% from a June 2014 high-water mark of $107 to hover around $50 a barrel. Then he looked at how much the gas cost per litre: 71¢.
“If we didn’t live in Calgary and didn’t make our living in the energy business, we’d think we had died and went to heaven,” says Munro.
Just how bad low oil prices are—if they’re bad at all—kind of depends on your perspective, he says. Low oil prices in the United States are a strong economic stimulant; the massive consumer base has more cash in their pockets, and they spend it. Meanwhile, the American oil and gas sector is a fairly small proportion of the country’s overall economy.
The A to Z of the oil crash
The Canadian economy, however, is significantly more dependent on the industry. The price dive could put pressure on the federal government to the tune of $2.5 billion annually for the next four years, according to a fall economic update from Ottawa, and oil-producing provinces such as Alberta, Saskatchewan and Newfoundland are staring down revenue and royalty losses worth billions. Oil companies are tightening their belts for a period of low prices. On Jan. 12, Goldman Sachs slashed its six-month forecasts for West Texas Intermediate from US$75 to US$39 a barrel and from US$85 to US$43 for Brent. But there are opportunities amid the rock-bottom prices. Canadian Business spoke to more than a dozen leading experts to gather their advice for surviving—perhaps even thriving—in a world of cheap oil.
1. Don’t panic
This is not the first time oil prices have taken a plunge. “The first piece of advice is just don’t panic,” says John Chambers, chief executive officer of FirstEnergy Capital Corp., a Calgary-based investment banking service provider that focuses on energy. “We’ve seen many, many of these downturns in the past, and in every instance, they seem long and dark and ominous while they’re occurring. But in hindsight, they never seem quite as bad.”
Generally, downturns tend to bottom out within about four months, says Chambers. “It will go up again,” he says. “It’s really a function of remaining calm and riding out the storm.”
Todd Hirsch, ATB Financial chief economist, says a year from now prices likely won’t be back in the US$100 range, but they will be recovering. These wild price swings are just par for the course. “We see this so many times in Alberta—not a single person should be surprised by this,” says Hirsch.
2. Look south for sales
The weaker loonie that comes with low oil prices means a boon for some. A Royal Bank of Canada report released in early January even suggested that the benefit of a low dollar for exporters, coupled with an upswing in the U.S. economy and increased consumer spending in Canada, could offset the economic hit of low oil prices. Royal Bank economist Paul Ferley says now is the time for Canadian exporters to aggressively pursue opportunities to sell in the U.S. “[Where] they may have found they were getting outbid earlier on…they may find now that they’re more competitive, given the weakening of the Canadian dollar,” he says. “They may find that doors that were shut half a year ago now open up.”
That’s the case for safety shoe manufacturer Mellow Walk, which employs about 50 people at its Toronto-based factory. “What we’ve found in the past is that a lot of American safety footwear retailers loved our shoes, but they found them a little bit expensive,” says company president Andrew Violi. “Now with the drop in the Canadian dollar, we’re able to make up some of that difference. We’re seeing our U.S. business grow.” The downside, of course, is that most of Mellow Walk’s raw materials come from overseas and are priced in U.S. dollars.
In the decade he’s been at the company, Violi has seen the Canadian dollar go from around 75¢ to over a dollar and back to its current perch around 84¢. “So we don’t base our business on currency, but we are definitely aware of it, and some years are better than others.”
3. Rethink, reset, reposition
The industry has seen a “frenzy of activity” over the past five years. Prices were so high that companies scrambled after volume and growth, sometimes failing to consider whether they were getting good value and higher productivity for their investments. “The Canadian industry has been plagued by productivity issues,” says Mary Hemmingsen, KPMG partner and national sector leader. “[The drop in prices] forces you, it’s the impetus, to refocus on how productive you are and go after value as opposed to volume.”
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Companies will need to review their portfolios, reassess competitive core strengths and potentially look at divestment of assets. It’s also an opportunity to address labour issues. “There’s been a lot of labour challenges, some presenting scarcity issues that have caused wage escalation and cost escalation,” says Hemmingsen. “In some measures, this is helpful in resetting the expectations for resources and labour.”
Munro says companies should prepare for a fundamental structural shift. The era of scarcity is over; it’s a world of abundant oil, at least for the time being. “The business model of an oil and gas company in the future is going to have to be built around the abundance model, where your returns are not going to be made by commodity price increases,” says Munro. “They’re going to be made by earning strong margins on your activities.”
4. Make the most of cheap oil
For those fuel-reliant businesses that are saving big with current oil prices, now is the time to win some love from your customers. Hirsch suggests that airlines could gain some competitive advantage by, for example, cancelling fuel surcharges for 2015 or lowering prices. “Obviously that cuts into their profit, but it does afford them the chance to pick up some more market share,” says Hirsch.
Companies with high-energy inputs, like airlines, railways and miners, should also be trying to lock in long-term fuel contracts at current low rates, says Janice Plumstead, senior economist at the Canada West Foundation. “If they’re doing forward contracts, they want to be thinking about getting a good price for their fuel, looking into the future, to really take advantage of these lower costs, so they’ll be able to take advantage for quite a while,” she says.
There could also be opportunities for manufacturers, for whom transportation is often a major cost, says Derek Burleton, deputy chief economist at TD Bank Group. “They may be able to look at some of their distribution structure to see if they can take advantage of lower transportation costs,” he says. “If you’re a supplier of goods, maybe there’s an opportunity there to diversify your market base.”
5. Invest when there’s blood in the streets
Investors have this old market expression, says Ryan Lewenza, private client strategist and portfolio manager at Raymond James Ltd: Buy when there’s blood in the streets. “That’s what’s happy with oil right now,” he says. “People are so worried about tomorrow and next month and next quarter, but they’re not seeing the forest for the trees here, which is that the solution to low oil prices is low oil prices.”
Prices were driven down by increased production; they will be driven back up when companies reduce production as a result of lower profitability, says Lewenza, whose firm predicts prices will be up to US$60 or US$70 a barrel by the second half of the year. Lewenza recommends buying stocks in integrated companies—those that both produce and refine oil, so that one part of the business is essentially benefiting from the misfortune of the other—as well as in oil transportation, such as pipeline companies. “Right now, you’ve just got to be very patient. Stick with these quality stocks, and we’ll get out of this just fine,” he says.
It’s also a good time to think about the consumer discretionary sector, says Lewenza, as lower prices at the pumps mean consumers have more cash to spend. And transportation companies, such as airlines, are likely to benefit this year, as low oil costs shave a significant amount off their operating expenses.
6. Tighten your belt
When oil prices last took a precipitous dive in 2009, David Yager was CEO of a medium-size oilfield services company. In the space of a year, it went from revenues of $114 million to $82 million, and from 900 employees to about 625. “We used a very, very sophisticated management strategy: You throw shit over the side till the boat floats,” says Yager, now national leader of oilfield services at MNP, a chartered accountancy and business consulting firm. “You really have to look at every single expenditure in the company.”
Managers pored over vendor and input costs, and delayed discretionary capital expenditures and maintenance. Yager advises keeping bankers in the loop and letting them know well in advance whether you may run into difficulty. And tell staff what’s going on. “Sit down with your team, and have a conversation on the state of the industry and what your objective is. Say ‘our objective is to cut through the slump intact, preserving as many of our skills as a high-trained workforce as possible, and we’re going to need a little help,’” says Yager.
As a result of its work during the downturn, he says, the company came out stronger than ever. “We found permanent ways to be more efficient that we probably didn’t know existed until we had to look for them.”
7. Keep your people
If prices dropped a few decades ago, people were the first to go, says Mark Salkeld, president of the Petroleum Services Association of Canada. That’s not the case anymore. “The technology involved and the knowledge required, from an administrative aspect in the office to the field, it’s changed,” says Salkeld, whose association represents nearly 250 companies that employ more than 75,000 people. “You can’t just hire somebody off the street and put them to work anymore.”
The top thing companies need to focus on now, says Salkeld, is keeping their employees on the job. Layoffs should be a last resort, he says, not a knee-jerk reaction. “We all know that the oil prices are going to come back around again and we’re going to need those people,” he says. This is the time to get employees into training to upgrade skills, to catch up on yardwork or maintenance—activities that are difficult to undertake when things are ramping up.
8. Grab ex-oil workers for your sector
There will be smaller companies that will be forced to let people go, says Hirsch. That’s an ideal opportunity for those with deeper pockets to nab qualified applicants that are hard to find when times are good. “It seems a bit counterintuitive: Our commodity price is half what it was. Let’s add staff, or let’s spend some money training staff or getting them updated skills—all of those things which are really difficult to do when you are in a busy environment,” he says. “Well, the next six months might not be. So this is your golden opportunity to invest in your workforce.”
Sectors that compete directly with the oil and gas industry for their labour force will have an easier time filling their payrolls if widespread layoffs occur, says Hirsch. That’s a good thing for industries like forestry that can’t compete with the sky-high wages on the oilpatch. “They’re going to have a very good year, because they often struggle to find workers,” he says. “When oil is at $100 a barrel and oil companies can back up the money truck with wages, it’s really difficult for forest producers to keep pace. Now I think we’re going to see some nice resumés coming through the door of those forest producers.” That, combined with good prices for lumber and panel board, and the low Canadian dollar, should make 2015 a stellar year for Alberta’s forest industry.
9. Cut the CEOs per barrel
When times are tough, companies need to “reduce the CEOs per barrel,” says Yager with a laugh. That means consolidation. In a high market, small companies can survive. But in a low market, it’s much tougher to make it without the economy of scale, he says. “Consolidation is a strategy that works, but to do that, you’ve got to put your ego on the shelf,” he says. “This is a strategy I don’t think enough people consider.”
It’s also a time to pick up some tremendous deals. “If you have been financially conservative during the high cycle, and you’ve got a strong balance sheet, and available cash, there’s no question that the evaluations of everything in the business will be plummeting,” says Yager. “So there may be some opportunities to pick up some real quality assets…at distressed prices.”
Peter Tertzakian, chief energy economist and managing director at ARC Financial Corp., says it’s a bit early to see much acquiring or consolidating, but it’s likely coming. “The people with cash are not yet feeling confident enough to be opportunistic; the whole other camp is in denial that anything is going on, in denial that they’re in distress,” he says. “But if the pain lingers…you’re going to see opportunism really take root.”
10. Innovate, innovate, innovate
There’s a new buzzword in the oil and gas industry these days, says Bob Schulz, a business strategy professor at the University of Calgary’s Haskayne School of Business. Innovation.
“If prices are high and you’re making money, you say, ‘Oh, well, we don’t really need to be too innovative,’” says Schulz. “But when the price is $50 a barrel instead of $100, well, we’ve got to go figure out how were going to make things work.”
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The time is ripe for anyone with new ideas on some facet of oil and gas exploration, drilling or production that could cut costs, says Yager. “Necessity is the mother of invention, so the doors could be opened,” he says. “Clients could be more responsive to cost-saving technologies, services and initiatives than they would be when things are very good. The mindset to consider and possibly adopt change is greater.”
Canadian companies are no strangers to innovation, says Hemmingsen of KPMG. The expense and difficulty of extracting bitumen from the oilsands forced great strides in technology and operational practices to make it a lucrative enterprise. “The opportunity that is presented by this is to continue to innovate, to continue to look at rationalization and also more sustainable practices, which are also another basis to reduce cost and create a more sustainable platform for future development.”
11. Woo U.S. tourists & international students
When gas prices are high, Americans don’t travel as much—no one does, says Hirsch. But cheap gas should mean more people taking road trips, and a low Canadian dollar makes travelling north of the 49th parallel an attractive option for Americans. “We might see more people loading up those motorhomes and Winnebagos,” he says.
Canadians are also more likely to take vacations within the country, as the exchange rate will make travel to typical winter holiday spots more expensive, says economist Roslyn Kunin of Roslyn Kunin and Associates, an economics, business and human resources consulting firm.“Suddenly Canada is a great big bargain to people all over the world, but particularly from the United States,” she says. “Definitely, this is a good time to be advertising, marketing both within and outside Canada, because we are going to be good value for tourists from abroad, and they should know about the opportunities we have here. And market to Canadians who may not have thought of taking holidays in Canada. Now the cost advantage is such that they just may.”
Another group that’s often overlooked is international students. A 2011 study conducted by Kunin showed students from abroad brought more money into this country than the entire softwood lumber business. And they’re a savvy lot: Most pay careful attention to the exchange rates of the countries they’re considering. “This would be a very good time to remind educational institutions abroad that if their students are looking to go to other countries to study, this is an excellent time to come to Canada,” says Kunin.
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