How low can oil go, and who gets hurt?

The fallout from the steep drop in oil prices on pipelines, refineries and the LNG industry in B.C. depends on how long they stay low

The biggest fear for B.C. over sustained low oil prices is the impact they could have on the liquefied natural gas industry.

Of all the provinces with oil and gas, B.C. may be the best insulated from oil prices that still appear to be searching for a bottom, at least for the short term.

Should oil prices recover by mid-2015, as some economists predict, B.C. may generally benefit from the sector’s current doldrums.

But if some analysts are right, a “new normal” could be years of comparatively cheap oil, thanks to cutthroat competition between low-cost conventional producers in places such as Saudi Arabia and high-cost unconventional producers in North America that have brought new supplies of oil onto the market.

Other observers believe that competition will simply drive high-cost producers out of business (just last week the first casualty was the bankruptcy of WBH Energy, a small shale-oil producer in Texas), ultimately shrinking oil supplies and sending prices back up.

In the meantime, though, there are growing concerns that B.C.’s liquefied natural gas industry could suffer collateral damage in the oil price war.

“The whole thing about this is, ‘How low for how long?’” said Ken Peacock, chief economist and vice-president of the Business Council of British Columbia.

“It’s generally good for B.C., but there is this new little wrinkle in the B.C. context, and that’s if it results in [LNG] projects being delayed or maybe even not going ahead.

“If oil prices hit $50, and then turn around and start to climb and this is a short-term thing, that’s a very, very different world than if oil prices stay low for two years.”

West Texas Intermediate (WTI) oil fell below US$50 per barrel the first week in January – a 50% drop since mid-2014. It was the first time oil prices had sunk that low since 2009.

Western Canadian Select heavy oil – which has historically traded at about US$20 per barrel less than WTI – was down to US$35 per barrel in early January.

At those prices, many oil and gas companies operate at a loss, so the higher-cost producers will have no choice but to suspend new drilling or oilsands mining projects.

One sector in B.C. that is likely to be hit hard by low oil prices is B.C. manufacturers that make equipment and parts for the oil industry in Alberta – from mobile work camps to special heavy equipment and parts used in the oilfields and oilsands.

“They’re staring to feel the pinch,” said Marcus Ewert-Johns, B.C. vice-president of the Canadian Manufacturers & Exporters. “For a small, medium-sized enterprise, if you don’t get that $100,000 order, that half-million-dollar order, you’re kind of screwed.”

B.C. produces little oil compared with Alberta or Saskatchewan, but it does have multibillion-dollar oil pipeline and refinery proposals.

David Black said low oil prices won’t hurt his $22 billion Kitimat Clean oil refinery project proposed for Kitimat.

“As long as there’s demand for our oil and it has to be refined, then the refinery’s viable,” he said.

Enbridge Inc. (TSX:ENB) spokesman Ivan Giesbrecht likewise said oil prices will have no effect on the company’s $6 billion Northern Gateway pipeline project.

Peter Tertzakian, chief energy economist at ARC Financial Corp., recently calculated that the revenue loss to Canadian oil producers in 2015 could be $45 billion, based on an average oil price of US$60 per barrel. Alberta, Saskatchewan and Newfoundland would be hit hardest.

In the short term, low oil prices would generally be a net benefit to B.C. But that could change if oil prices stay low for the long haul, since the “wet” gas (natural gas liquids) that make dry gas more economically viable to extract are affected by oil prices.

“On the surface, least affected should be natural-gas-prone British Columbia,” Tertzakian wrote in a mid-December opinion piece. “However, gas prices aren’t exactly booming and natural gas is often a byproduct of higher-value liquids that trade off the price of oil. The impact of this major global economic event will be felt across Canada.”

Scotiabank economist Patricia Mohr said oil prices may already have had an effect in B.C.

Petronas has delayed a final investment decision on its $36 billion Pacific NorthWest LNG project in Prince Rupert. Mohr believes falling oil prices had something to do with that decision.

“Because of the lower crude oil prices, I do think that the proponents of that project just felt that they were a bit unsure about the outlook, so they would delay,” she said.

Barry Munro, oil and gas leader for EY, has no doubt that low oil prices will have a negative effect on LNG. LNG contracts in Asia have historically been linked to oil prices, so falling oil prices could shrink the difference between North American gas prices and Asian LNG prices.

But that’s not the biggest problem.

“The LNG projects are massive capital expenditures and each of the proponents are energy companies that have both oil and natural gas exposure, who have watched the price of their oil reduced by 50% in the last six months,” Munro said.

“So their balance sheets are stressed. Board members would be struggling about whether they should be committing to billions of dollars worth of capital expenditures in a commodity price environment that might mean they’ll have no free cash flow.”