The View from Up North: The Collapse of Commodity Prices and the...

The oil boom is over. This is not an earth-shattering statement, given that we are now nearly a year into the precipitous price collapse of oil, which began in November 2014, with the price for a barrel of WTI crude oil falling from the $100 region to the $40-$50 range recently. With lots of supply, sketchy demand, and only small and slow cut backs in production, it is unclear (read: unlikely) whether oil prices will rise any time soon. While low oil prices are good for the consumer in terms of lower gas prices and cheaper transportation costs for goods purchased, for regions where oil and gas are the mainstays of the local economy, persistently low prices are not good news.

Western Canada, where the economy is based largely on the extraction sector, is feeling the pinch, not only because of collapse in oil prices but also because of the decline in precious and base metals prices over the past few years. The result has been a perfect storm of bad news for Western Canada.

When oil prices first declined, O&G companies did what any company does in the face of economic headwinds: They tightened their purses a little bit and issued press releases stating that their companies were well funded and will weather the storm. But as prices continued to drop into early 2015, O&G companies began to cut back on capital spending, in particular involving exploration and in the building of new well fields. This resulted in the first wave of job cuts, with the oil field services companies, the main beneficiaries of cap-ex spending, feeling the biggest hit. As prices continued to decline, further cutbacks and reductions or outright cancellation of dividends occurred. And as we approach the first anniversary of low oil prices, companies are selling assets in order to maintain cash reserves and pay down debt.

The impact on the Western Canadian economy cannot be understated. Up until the summer of 2014, Western Canada was the engine of the Canadian economy. The O&G sector was booming, manufacturing in Central Canada was on the decline, the dollar was strong against the Greenback, and people and money were flocking to the west. The promise of high-paying jobs and opportunities lured many from Eastern Canada, and all sectors of the Western economy benefited: Construction of residential and commercial properties skyrocketed, and new retail and other consumer service providers were everywhere. As well, government coffers were never so full, resulting in increased spending on infrastructure, social services and the promises of more spending.

With the collapse in prices, all of this has reversed. With thousands of jobs being cut and more at risk, the flow of human capital is now outbound, especially with respect to seasonal workers. Newfoundland, the biggest exporter of rig and exploration workers to Alberta and the biggest beneficiary of the boom in Alberta (with money flowing back into the Newfoundland economy as workers came home to rest and spend), has seen not only a return of now-unemployed residents, but also an increase in employment insurance claims and personal bankruptcies. The biggest hit, though, has been in the frontier towns and the major urban centres of Alberta. With the cutbacks, those business that serviced the O&G sector and its workers are also suffering: Vacancy rates are rising, and restaurants and hotels have seen a significant decline in revenues. Moreover, the recently elected left-of-centre provincial government that had banked its many promises on higher revenues, which can now not be realistically expected, has also had to rethink how it governs.

For the local insolvency practitioner, it has become a very busy time. Bankruptcies and in-court restructurings have soured, not only with respect to exploration and production companies, but also regarding oil field services providers. This has more recently spread into more small business bankruptcies, with construction company bankruptcies in particular increasing as the demand for new housing and commercial properties declines. And of course, personal bankruptcies are also on the rise.

For the insolvency practitioner, this represents both risk-management concerns and opportunities. Clients that are currently invested in the O&G sector and in Western Canada may generally find that their investments are at risk. Since the local economy as a whole is feeling the impact of low oil prices, clients must be vigilant in monitoring their investments in the region. One thing we have done with clients when reviewing their investment is to go beyond simply looking at the financial statements of the investment and looking more closely at the key customers and suppliers of the investment in order to identify where there may be a risk of a domino effect — where a key customer of the investment goes bankrupt and as a result puts the investment at risk because the investment relied heavily (maybe too heavily) on that one particular customer’s business. This is a particular concern for oil field services companies, which generally carry only a few large contracts at a time, any one of which has a huge impact on the provider’s bottom line.

Of course, every problem is also an opportunity. Valuations for everything in the region are dropping, which means that companies with cash to spend and a long enough time frame can go bargain-hunting. Stock prices are down, as are valuations for equipment, oil fields and their reserves. And since not all fields in the region are prohibitively expensive to exploit, astute distressed investors may be able to profit from this downturn by buying low, holding, and then, if and when prices recover, profit. For U.S.-based investors, this downturn has another plus: The collapse of the Canadian dollar against the U.S. dollar means that anything that is denominated or valued in Canadian dollars is that much cheaper.

In short, Western Canada, with its Calgary Stampede, hockey and real football (there is no fair catch rule in the CFL), but with a struggling economy, should be on the radar of all investors, distressed or otherwise, and their advisors, not only for the risks posed but also for its potential opportunities.

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