Oil sands must adapt to drier financing climate

By Geoff Hill 

“We can only realize our ambitions as a country if we have foreign direct investment.”

So said former federal industry minister Jim Prentice last October, a day before addressing the annual Oil & Money Conference in London. It was there that he would go on to reveal how much Canada’s ambitions could be thwarted by a stunning drop in foreign investment in the domestic energy sector: down 92% to $2 billion in 2013, compared to $27 billion a year earlier.

Prentice was talking about changes made earlier in the year to the Investment Canada Act. The changes now demand greater scrutiny of state-owned enterprises (SOEs) looking to invest in Canada’s oil sands.

Consider how one Chinese official responded to the changes: “We don’t want to be where we’re not wanted.”

According to a report from the Canadian Energy Research Institute (CERI) last year, foreign companies, including the United States, had invested $30.3 billion in the sands between 2004 and 2012. Each of the United States and China accounted for 33% of that total.

I believe the changes to the Act were well-intentioned, aiming to prevent an SOE’s potential control of an oil sands business unless it is deemed to be of “net benefit” to Canada, and then only in “exceptional” circumstances.

But the impact of the new rules goes beyond a single year’s reduced investment.

Rite of passage
In our fourth annual Gaining ground in the sands report, we examine not only why those changes make it harder for SOEs to exert their influence over our economy, but also how the rules will make it difficult for existing producers to invest in the future of their companies—not to mention Canada’s.

Business is a lot like personal finance: the easiest time to borrow is when you don’t need to. But this is a luxury many of the start-up juniors and intermediates in the oil patch simply don’t have today. Major capital is required up front in the oil sands. It’s not like conventional oil and gas production, where a would-be producer can bootstrap to success one well at a time.

Unfortunately, the revised Investment Canada Act is ambiguous on key points. For example:

• Is there “acquisition of control” if an SOE finances more than 50% of a project, or more than 50% of a corporation’s total debt? What if the financing is split among several SOEs or a combination of SOEs and private (even from the same country) investment firms?
• Is it of “net benefit” to Canada if the project would go ahead with SOE financing but would fail, or even bring the company to bankruptcy, without it?
• Is it an “exceptional circumstance” if Canadian technology gets to be applied worldwide as a result of an SOE investment?

The ambiguity means a company could spend millions before the government even begins to consider whether it will give the project the green light.

The ground’s the limit
Consider how one Chinese official responded to the changes: “We don’t want to be where we’re not wanted.” Or how one producer did: “Do we think it is fatal? No. Do we think it is helpful? Absolutely not.”

The fact is, North American sources of financing, focused on shareholder returns rather than government-mandated objectives, must take a view that is not only shorter-term than most SOEs but also absent much genuine certainty. For instance, producers are never certain what the quality of their reservoirs and production will be until after they’ve started. As of today, with the fates of new pipelines still up in the air, market access is anything but assured, while the price differential between global crude benchmarks and what oil sands producers can fetch is constantly changing, almost never in producers’ favour.

Meanwhile, intensifying environmental scrutiny has started to affect not just public image but access to capital. Last March, Standard & Poor’s suggested that rising carbon constraints are affecting financial models “based on past performance and creditworthiness” such that the relevance of those models is waning. The effect will be greatest on smaller companies and could lead to negative outlooks and downgrades.

Those smaller companies, of course, are the same ones the revised Investment Canada Act will also affect the most.

Ultimately, all producers must find ways to do more with less. Companies must look at increasing investment in environmentally friendly solutions like the following:

• Energy efficiency technologies;
• Waterless processes;
• Co-generation.

These solutions can go a long way both toward saving costs and improving prospects for attracting future funding. Companies should also be investing in tools to improve their asset management and programs to ensure that knowledge is reliably transferred to the next generation of leaders.

Growth at some costs
The oil sands are at a critical juncture — somewhere at the tail-end of initial, rapid growth, not yet mature, but clearly showing they have nearly come of age. But they risk missing maturity altogether if investment and other planning remains focused only on the most immediate concerns. If the sector can get that right, the sands will come of age as a leaner, more flexible, globally attuned industry that remains profitable in an increasingly carbon-constrained world.