EDITOR: | April 11th, 2016 | 1 Comment

Drilling for Dollars in Calgary’s Oil Patch

| April 11, 2016 | 1 Comment
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Calgary, the pumping heart of Canada’s oil and gas industry, has suffered through a vicious couple of years after oil prices began their precipitous slide in early 2014, with the expected decrease in value for any company related to petroleum production. Real estate prices are down, unemployment is up, laid-off employees are leaving causing “shrinking city syndrome”, O&G shares are getting battered, and overall the provincial economy has been in decline. “For Lease” signs are springing up like wild roses.

Here are some data points demonstrating the economic decline:

From December 2014 to December 2015, retail sales in Alberta were down, from $6.48 billion to $6.12 billion (5.5 per cent).

The construction price index for Calgary for 2015 was off by 0.9% year over year to January, 2016.

The unemployment rate in Calgary skyrocketed from 4.9% in Feb of 2015 to 8.5% in Feb, 2016.

Finally, ZeroHedge outlined a catastrophic series of statistics showing an increase in suicides, food bank use and home invasions.

Historically, changes in the price of oil are correlated to Calgary’s health: see the four charts below that track oil against Calgary’s GDP, employment, population (to April of 2015) and unemployment rate (to July, 2014). (courtesy of Calgary Economic)2016_4_11_Clausi1

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The chart tracking GDP is a bit odd. It shows local GDP increasing in 2014 and 2015, in the face of wells being shut in, logistics companies laying off staff, environmental firms having much less work, and activity in the oil patch decreasing. I suspect that some of the input data might not be reliable. GDP is a malleable economic measurement at the best of times involving some judgment for, “what to leave in, what to leave out” (thank you, Bob Seger). A good statistician can make GDP dance or stagger, depending on the assumptions.

The other three charts though clearly show the correlation.

Based on a multitude of global economic and lifestyle indicators, Calgary Economic Development takes the view that Calgary still offers one of the world’s best qualities of life. The lifestyle rankings are here and current economic indicators can be found here.

Is the CED right? What’s in store for Calgary’s future?

Human context is needed to flesh out the data above. I was in Calgary last week at the Canadian Corporate Counsel Association’s annual event, for two days of education, networking and listening. This gave me casual access to top lawyers from across Canada, and the host city’s economic well-being almost always came up in conversation.

The economic uncertainty was noted and almost everyone had a personal anecdote about the shrinking economy. No one had hard answers. But, the overall sentiment was best summarized by Janet Fuhrer of Ottawa’s Ridout & Maybee, LLP., who is also the well-travelled President of the Canadian Bar Association. Her interactions with the profession and the public give her a unique cross-Canada perspective.

Her view, echoed by the majority of people I spoke with, was that while Calgary would have some work ahead of it, Calgary would recover from its current sluggish economic state, with the recovery driven by an eventual recovery in oil and by Calgary’s efforts to diversify away from oil.

Giving an infrastructure perspective, the lawyer placement firm ZSA Recruitment ran a booth at the conference. They said they had been placing more litigation and bankruptcy lawyers than usual.

I also had a great chat before the show with a friend who is a long time entrepreneur in the patch. This isn’t his first down market. He’s worked in Alberta for the past thirty years in petroleum and has on-the-ground experience as the CEO of oilfield service companies. In this industry, his opinion carries a lot of weight with me.

He is extremely enthusiastic about the state of Calgary’s economic decline, because he sees a “Golden Opportunity” to consolidate hurting companies, right-size them, keep them alive, and ride the inevitable  increase in oil to sell them at peak prices. (His use of “Golden Opportunity” is a mixed metaphor but you get the point.) His short term plan is to source investment USD and buy significant positions in weak but viable Canadian companies. He is in the USA as this is being written, sourcing that capital.

Then we have input from Silver Mountain Mines Inc., a Calgary-based junior miner. Last week the shareholders of SMM approved a resolution authorizing management to expand the company, “from an Exploration Mining Issuer to a Diversified Company engaged in investing in and acquiring privately held and publicly traded companies, or the securities or assets of such companies…”. The CEO of SMM, Steve Konopelky, said this was in response to deteriorating local and global conditions, including in the oil patch, and that the shareholders wanted the opportunity to become a cash-flowing company outside of the resource sector.

Calgary’s current situation was probably best summarized by our taxi driver. He’s been driving for 14 years, an immigrant to Canada who was part of Calgary’s last boom phase. “This is all still very shaky,” he said, paused, and then added, “but at least I have a job.”

Calgary certainly has a better outlook than the poster child for boom towns, Fort McMurray, who is seeing the size of the town shrink as employees leave town. The New York Times ran a piece on FortMac called “Oil Sands Boom Dries Up in Alberta, Taking Thousands of Jobs With It” – it’s not a good time to start a new career as a real estate agent in that part of the world.

One more input comes from Barron’s, who recently published an article entitled “It’s Time to Pump Up Your Oil Exposure“. The article’s thesis can be summarized by Warren Buffet’s famous quotation:  Be greedy when others are fearful.

And finally we have the eternally optimistic Investment Executive magazine, who published an article in the April, 2016 edition (p.41) arguing for upward movements in the price of oil in the latter half of 2016.

So how to profit from this state of affairs?

1 Research. Find companies that can make their debt payments from current cash flow without having to borrow further and without large capital expenditures. The cutting of dividends is an acceptable temporary measure to protect that cash flow.

2 Diversify. Invest in producing O&G companies but to risk mitigate also take positions in the oilfield service industry.

3 Diversify further. The oilfield service industry contains many subsectors such as trucking, environmental remediation, housing and drill rig equipment. Spread your risk out among them.

4 Avoid a company that also has revenue from US operations. Currency movements are unpredictable and create extra risk. Keep companies that have their expenses in CDN but record revenue in USD.

5. Be patient. This won’t play out overnight so don’t put all your eggs in the oily basket.


Peter Clausi

Editor:

Mr. Clausi is an experienced investment banker, executive and director. A graduate of Osgoode Hall Law School called to Ontario's bar in 1990, Mr. Clausi ... <Read more about Peter Clausi>


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Comments

  • dave r.

    A great article and 5 points to profit are very appropriate & necessary. Do you have any recommendations of companies that may fit most of these criteria as a starting point for DD?
    Thank you. dr

    April 12, 2016 - 11:00 AM

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