Steadily falling oil prices and flat production will start eating into the bottom lines of Canadian oil and gas companies, although returns will stay healthy, the Conference Board of Canada has predicted.
The Ottawa-based economic forecasting group is counting on oil prices averaging US$38-$39 a barrel this year, before embarking on a three-year slide to well below $30 as supply worries dissipate and production goes on the upswing.
But the board expects natural gas prices will remain in the $5-$6 per gigajoule range, reflecting the North American industry’s inability to keep pace with growing demand that will see production resume its slide this year.
“As a result, the market for natural gas has become extremely tight and gas is now trading in a new equilibrium price range,” the board said in its report entitled Canadian Industrial Outlook: Canada’s Oil and Gas Industry.
“Natural gas prices will fall somewhat in the near term in response to falling oil prices, but will begin to rise steadily in the medium term, averaging $5.78 per gigajoule in 2008.”
Profits projected to drop to C$15.1 billion in 2005
The combination of dropping oil prices and declining gas production should see the profits of Canadian E&P companies drop from the record heights of C$22.1 billion in 2004 to C$15.1 billion this year and just over C$9 billion in 2008.
However, commodity issues are not the only contributors to lower profits, the board said.
As Canada swings more to heavier crude oil and liquids, revenues will drop over the forecast period.
The board forecasts that revenues on a net basis will decline by 12.7 percent this year and 3.7 percent a year over the medium term.
It said conventional crude revenues were up 22 percent last year because of a 21.7 percent hike in Canadian par crude prices, but it expects 2004 will be the industry’s historic high. The report points to a fall of 15 percent in revenues this year and an average annual drop of 10.9 percent between 2006 and 2008.
For 2004, conventional crude profit margins hit a peak of 16.8 percent, generating overall profits for the sector of C$2.7 billion.
But the industry is told to prepare itself for a slump in profits to C$747 million by 2008, with the profit margin at a modest 8 percent.
Conventional and non-conventional heavier crudes will absorb the biggest blow over the forecast period, despite strong revenue growth for synthetic crude and bitumen producers.
The board predicts conventional heavy oil producers will see their profits plummet from C$2.1 billion last year to C$257 million in 2008.
Non-conventional prices will drop, production increase
Non-conventional producers will experience a drop in prices in line with the rest of the industry, but overall output will grow steadily as a host of new projects comes on stream over the next decade.
“As a result, the decline in revenues after the surge in 2004 will be much more modest and revenues will actually begin increasing again by 2008,” the board said, adding that the non-conventional crude sector will be the only one to post positive revenue growth over the next four years.
The study raises a warning flag that, despite technological gains, heavy oil operating costs will rise, which means profitability will slump in line with the other sectors.
From C$4.7 billion in 2004, net earnings will slide, averaging 28 percent a year over the 2005-2008 period.
The board said key price differentials “will be a major factor in determining the profitability of the industry,” noting that the spread between diluent prices and heavy oil prices will be a deciding factor in the profit margins for synthetic crude producers.
Because natural gas fuels both the extraction of bitumen and its upgrading into synthetic crude what happens to gas prices will play a vital role in how much profit non-conventional producers will pocket.
The board said that with oil prices likely to fall and gas prices headed for a modest correction, the spread between the two commodities will “narrow further.”
Analysts and industry spokesman, most of whom anticipate oil prices will remain above $40 this year, rated the board’s near term forecasts as slightly pessimistic.
