Crying Wolf in the Oil Patch

December 2, 2016 Craig Maddock

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By Craig Maddock CFP, FCSI, CIM, FICB, CFA, MBA
Vice President, Investment Management

It’s been an eventful week for the energy industry. First, the Canadian government approved two major oil pipeline projects that could mean a million more barrels of oil a day from Alberta to global markets.

And second, the Organization of Petroleum Exporting Countries (OPEC) announced that it had agreed to limit output for the first time since 2008. If finalized, the deal would mean a reduction in OPEC’s output of about 1.2 million barrels a day. However, the deal is dependent on persuading non-OPEC producers like Russia to cut output as well.

OPEC, essentially an oil cartel, is not a true supply and demand arrangement, and this announcement should be taken with a grain of salt. Key OPEC members know that their long-term profitability is in jeopardy thanks to alternative energy sources.

While major oil producers all want to sell crude at a high enough level to be profitable, no one wants to give up market share. And as they have in the past, I fear that OPEC will drive the price of oil up as global investment in oil projects ramps up, and then flood the market with cheap oil once again.

Talk is cheap (even if oil isn’t)

I’m skeptical as to whether or not all parties will deliver on their commitments. OPEC has a long history of playing on emotion to support oil prices; and then not sticking to its promises.  

Like the boy who cried “wolf” in Aesop’s fable, there are only so many times OPEC can cry “cut” without the market losing confidence.

Higher oil prices a double-edged sword

Are rising oil prices good for the economy? I have mixed feelings about this question. Rising oil prices mean higher costs for industries that rely on energy, like transportation and farming. And I don’t like oil price increases because of the impact at the gas pump, rising heating costs over the winter and higher food prices to feed my family of five.

But when the oil price goes up, it’s good news for the Canadian economy. Because Canada is an oil-exporting nation, it means more revenue to the government, stronger employment and a more robust energy sector.

Higher oil prices together with the new pipelines approval are undoubtedly positive for Western Canadian oil producers, such as our investment in Enbridge.   Additional pipeline capacity alleviates constraints faced by growing production, and gives producers the ability to access markets for better pricing. However, the level of investment in these projects will be dictated to a large degree by the price of oil itself.

The economics of moving Canadian oil is dependent on a reasonably high price for oil, and there is still more supply than demand. While many Canadian oil companies can make a profit at $50 US a barrel, they will need more sustainable prices closer to $55-60 a barrel to make a big difference in productivity.

At MD, we will be keeping an eye on the price of oil over the next few months. And I’ll be watching whether or not OPEC keeps its promises this time, without crying “wolf” yet again. 

 

About the Author

Craig Maddock

CRAIG MADDOCK, CFP, CFA, CIM, MBA, is Vice President with the Investment Management team at MD Financial Management. He leads the team of portfolio managers and investment analysts responsible for managing the firm’s mutual funds and investment pools.

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