This is a post from Alex Carrick's blog that covers the Canadian construction industry.

Since 1985, Mr. Carrick has held the position of Canadian Chief Economist with Reed Construction Data's CanaData, the leading supplier of statistics and forecasting information for the Canadian construction industry.

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Notes from Alex Carrick - Aug 26, 2011

Alex Carrick
The roles of oil and natural gas in the economic outlook

How does the world become extricated from its current funk? As in all things economic, there are self-correcting mechanisms that come into play.

Take energy for example. The slowing in world economic growth takes some of the pressure off energy prices.

One of the factors that caused the U.S. recovery to stop short in the spring was a large jump in gasoline prices.

The Arab Spring has been a historic leap forward for human rights in many Muslim countries, but it has played havoc with oil prices. 

This was most clearly demonstrated when the armed insurrection in Libya led to oil supplies from that nation being cut off entirely.

Now that Moammar Gaddafi is on the run, a call has gone out from rebel leaders for oil field workers to return to their posts and help restore the flow of Libyan oil once again.

While Libya usually supplies only 2% of the world’s oil, a return to production would be a symbolic victory. On a practical level, it would also offer relief to one of Europe’s more heavily debt-burdened nations, Italy. Italy receives most of its oil from Libya and is the latter’s biggest customer.

There is the danger that a further domino effect among MENA (Middle East and North Africa) nations will cause more turmoil in world oil markets. The problems in Syria appear set to boil over next.

Perhaps luckily for the world, that nation doesn’t have much oil and isn’t part of OPEC. But if significant civil unrest makes its way to Saudi Arabia, then all bets about future oil prices are off.

In the meantime, the price of world oil has dropped from $110-$120 U.S. per barrel during its most recent peak period back into the low- to mid-$80 region. Oil’s all-time high price was $144 per barrel in July 2008.

The easing in the price of oil will gradually translate into lower prices at the gas pump in the U.S. and Canada, providing considerable relief to consumers.

Uncertainty about oil supplies continues to be a huge issue in the U.S., however. At the same time, environmentalists are strongly opposing some proposals that would provide answers.

For example, there is strong opposition to TransCanada Corp.’s proposed Keystone XL pipeline that would take Oil Sands product from Alberta all the way south to refineries in Texas and along the Gulf Coast.

The objection is grounded in the potential damage to water systems from leaks and spills – especially the Ogallala Aquifer in Nebraska – and carbon emissions from oil sands extraction north of the border.

Canadian producers have embraced the challenge of acting responsibly. Producers in other countries from which the U.S. draws its oil are not always required to meet the same worthy standards.

Besides, what are the alternatives? The U.S. is counting on: 1) renewable energy (solar, wind, etc), which is costly and provides only limited capacity increments: 2) “clean” coal, which is still technically hard to achieve; and 3) natural gas.

Interest in the latter is particularly focused on shale gas. The traditional pricing relationship between oil and natural gas is based on energy equivalency.

Oil is typically priced per barrel, which generates 6 million BTUs of energy. Gas is priced per million cubic feet of volume, which generates one million BTUs of energy.

Therefore, theoretically, the common measure for gas should be priced at one-sixth what is charged for oil. That relationship has broken down in recent years.

The price of gas has been much lower and hasn’t moved far off its base.

That’s because it’s in abundant supply. Part of the reason has been a shift towards international shipments of liquefied natural gas (LNG), which is supplied by more countries than just OPEC.

Plus there is another major cause. North American supplies have been augmented by new technology that is allowing gas trapped in rock (shale gas) to be extracted using horizontal drilling and hydraulic fracturing (“fracking”).

The latter pumps liquids laced with chemicals deep into the ground to break up shale rock and release the gas. Drilling horizontally opens up hard-to-reach places and expands the zone to be tapped. 

There are many deposits of shale gas in the U.S., even in unlikely places such as Ohio, Pennsylvania and New York (e.g., Marcellus and Utica fields) and Michigan (Antrim). There are also abundant supplies in highly regarded fields such as Barnett in north-central Texas.

Again, however, development of these fields has come under a cloud due to environmental challenges. Drilling companies insist their extraction methods are safe.

They drill well below water-table levels and everything is contained within formidable barriers. 

However, the experience with BP’s Macondo well disaster in the Gulf of Mexico has put everyone – government watchdogs, oil companies themselves and the general public – on alert.

In Canada, the energy future is particularly important not only due to the traditional tie-in between output growth and the fuel needed to support it, but also because of the impact oil prices have on the value of the Canadian dollar and equity prices on the Toronto Stock Exchange.

Oil is often the trendsetter for TSX shares. Furthermore, the Canadian dollar has become a petro-currency.

When oil climbed above $100 U.S. per barrel earlier this year, the “loonie” reached $1.05 U.S. with every indication it would keep on soaring.

Fiscal problems in Europe, the debt downgrade in the U.S., more restrictive monetary policy in China and higher gasoline prices have all acted to slow growth. One consequence has been a lower world price of oil.

At the same time, the Canadian dollar has retreated to almost parity with the U.S. dollar. 

In the recession, the global price of oil dropped down into the $30 US range. Oil Sands projects were shelved and cancelled with abandon.

Now that oil is at least twice as pricey, investment dollars have returned to the oil patch.

Furthermore, the latest round of investing has a larger foreign element than previously.

China’s presence in resource projects around the world has greatly increased. That nation is determined to assure its place in the world economy by lining up sources of supply. Raw materials are at the top of the list.

Access to an inventory of assured oil is a must. And hence Chinese partnerships with other firms in major Alberta Oil Sands projects.

Nor is Canadian energy investment limited to Alberta. Expansions of offshore drilling sites in the province of Newfoundland and Labrador are planned. Hibernia South and Hebron are two mega projects in the planning stage.

We also have our own shale-rock projects, both gas and oil, with tremendous potential in the Peace River region of northeastern B.C. (gas) and the Bakken field in southern Saskatchewn.

Bakken also stretches into North Dakota and Montana and even includes a small corner of Manitoba.

For Canada, one major issue will be the problem in getting product to market.

For example, a Mackenzie Valley gas pipeline has finally received regulatory and governmental approval. But those may have come too late. The project was first proposed a decade or more ago when circumstances were quite different.

The cost of such a pipeline, with $13 billion as a starting point, may have rendered it uneconomic given the new sources in more accessible regions that now have potential.

Canada will continue to supply the U.S. with output from the Oil Sands. But if the Keystone XL pipeline is rejected or delayed, there will be even greater impetus to seek customers in other parts of the world.

That means the need for a delivery system to the West Coast.

There are four competing proposals that involve shipping crude to nations in Southeast Asia, such as Vietnam and South Korea, if not China itself.

Two of them are pipelines – backed by Enbridge (Northern Gateway) and Kidder Morgan Canada - and two involve the use of railroad lines and tanker cars.

Again, environmental issues may be an inhibiting factor.

The election of the Conservatives in Ottawa does mean there is a greater likelihood of ocean-going ships being allowed to move oil out of ports along B.C.’s Pacific coast.

Proposals for major liquefied natural gas facilities in B.C. are also on the table.

And skipping across the country, Encana’s Deep Panuke gas field in Nova Scotia is about to begin pumping money into that province’s economy.

The gas will come ashore by means of undersea pipeline at Goldboro, then be shipped through the Maritime and Northeast Pipeline to other parts of Atlantic Canada and down into New England.

Beyond the immediate plans for energy investments in Canada and the U.S., the future of oil-well drilling internationally will concentrate on the deep waters off the coast of Brazil and West Africa, as well as in the seas of the High Arctic.

Canada must be prepared to firmly assert its rights in the Far North.

Wherever the new oil is to be found in the next five to ten years, it is likely to be expensive, not only from a cost perspective but also as a result of market conditions. There seems little doubt that emerging nations will be greatly increasing their demand.

Many of the implications for Canada, at least from a construction standpoint, are positive.

Alex Carrick

Find Canadian construction-related economic articles in Canadian Construction Market News and in the Economic Outlook section of Daily Commercial News. Mr. Carrick also has a lifestyle blog that can be reached by clicking here.


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