“Canada’s oil patch feels the pain from sliding prices”
(Financial Times, 2015)
(Financial Times, 2015)
Economics at Royal Bank of
Canada conclude that there will be cutbacks in oil investments into Canada
following the decrease in oil prices (Financial Times, 2015). This resulted in
the announcement by Timothy Lane (2015) -deputy governor of the bank- that:
“Lower prices are likely,
on the whole, to be bad for Canada.”
The primary reason for
this is due to the large decrease in oil price- depicted in Figure 1- leading
to a decrease in the value created, with investments in the region perhaps now
unable to obtain a sufficient rate of return required for the risk class of
investment (Arnold, 2014). Even before the decrease in oil prices major
oil firms were struggling to obtain sufficient value creation to satisfy
shareholders. This was stressed by Chazan (2013) who stated despite strong oil
prices, ExxonMobil, Chevron, Royal Dutch Shell and BP increases in capital spending
was only resulting in decreases within their earnings, and even oil and gas
outputs.
Explanation of such poor performance was partly attributed to the firm’s
investments decisions, which saw large investment into the development of more
expensive oil fields such as Canadian tar sands, instead of the more
conventional fields in part of the Middle East (Chazan,
2013). Almost all of Canada’s reserves (and production) are in the
form of oil sands, which are among the most expensive types of crude to produce
(Bloomberg, 2014).Throughout this blog I will use value based management
theories to critically analyse why investment into extracting oil from Canada
is likely to be so effected by the decrease in oil price.
Figure 1: Oil Prices
Source: Nasdaq, 2015
To analyse the effect of
oil prices will have on investments into extracting oil in Canada I have used
Arnold's theoretical framework to display value creation of strategic
business units, to create Figure 2 , as it is believed it can assist
managers in the allocation of resources, including knowledge of potential
good-growth and bad-growth investments, which will be further analysed later
(Arnold, 2014). I have used the major oil company Shell to depict some of
investment options available to global oil firms, who operate business units
such as Shell in the United Arab Emirates (Shell UAE) and Shell Canada (Shell
CA) (Shell, 2015).
Figure 2: Shell Investment Options Before and After Oil Prices Decrease
Source: Self- elaboration for this blog
I have predicted that even
before the large decrease in oil price; the value created in investments into
Shell CA was perhaps minimal in relation to other fields due to the high costs
of extracting oil from Canadian tar sands, as depicted in Figure 2. Investment
into Shell UAE would be seemed to add much more value to shareholders, although
I have recognized that this unit probably receives much more external risk
in relation to government reform, which places high constraints on investment
options, (IFC, 2011). Thus before the decrease in oil prices, I believe Shell
could have viewed investment into Shell CA as a safer and more obtainable
choice which would create a lower, but more sustainable value creation option,
likely to last for long after the planning horizon (Philips, 2014).
With oil prices decreasing I believe the value creation of
all investments of extracting oil to Shell will decrease. After such large oil
price decrease it is noticed by Bloomberg (2014) that investments into
extracting oil in Canada may find it difficult to gain a return, I
have recognized this by my placement of the business unit Shell
CA in Figure 2 'after the oil price decrease', by depicting the unit in
the negative performance spread. This means investments into this option would
now be deemed to in fact be ‘value destruction’ instead of ‘value creation’
when using the framework of Figure 3. This is also described as ‘bad growth’
which occurs when managers invest in strategies that produce negative return
spreads (Arnold, 2014).
In fact even if investment into Shell UAE is unobtainable,
simply minimizing the use of resources in Shell CA would be
deemed value adding according to the academic framework. This doesn’t bode well
for future investment into Canadian oil, with co-portfolio manager at Investec
Asset Management, Charles Whall (2013) stating the investment strategies of
major oil firm “are all moving away
from the idea of growth at all costs towards better value management."
Figure 3: Investment
Decisions
Arnold (2010)
In conclusion I believe the high costs of extracting oil have
perhaps stopped global oil firm’s ability of achieving value creation in the
region. With recognition from Phillips that these firms are trying
to achieve better value management, I believe investment in the region is
likely to decrease as they seek the creation of value ahead of expansion. Use
of academic framework in relation to current news in this area has helped
me recognize how value creation in some industry investments is susceptible to
external conditions.
References
Arnold, G.
(2013). Essentials of corporate
financial management. 2nd ed. Harlow: Financial Times Prentice Hall,
p.330.
Arnold, G. (2013). Essentials of corporate financial management.
2nd ed. Harlow: Financial Times Prentice Hall, P.334
Arnold, G. (2010). Handbook of corporate finance. Harlow
[u.a.]: Financial Times Prentice Hall.
Chazan, G (2013). Oil majors spending more to find less. Available
at: http://www.nexis.com/
Financial Times (2015). Canada’s oil patch feels the pain from
sliding prices. Avalable at: https://www.nexis.com/
IFC, (2015). Sustainable Investment in the Middle East
and North Africa. Retrieved from http://www.ifc.org/
Lane, T (2015). Canada’s oil patch feels the pain from
sliding prices. Retrieved from:
https://www.nexis.com/
NASDAQ.com,
(2015). Commodities: Latest Crude
Oil Price & Chart. Retrieved from: http://www.nasdaq.com/
Philips, M.
(2014). Can Canadian Oil Sands Survive Falling Prices?. Bloomberg. Retrieved
from http://www.bloomberg.com/
Shell (2015). Shell
Canada. Received from http://www.shell.ca/
Shell
(2015). Shell in the United Arab Emirates. Received from http://www.shell.com/are.html
