MARKET ACTIVITY/TRADING NOTES FOR DAY ENDING TUES., JANUARY 13, 1998 (3)
FEATURE STORY
ROLL OUT THE RECORD
Syncrude Canada Ltd. -- well on its way to producing its billionth barrel of oil later this year -- said yesterday it set a production record for 1997.
The massive synthetic oil producer, located north of Fort McMurray, said it turned out a record 75.7 million barrels of oil last year -- the equivalent of more than 207,000 barrels per day.
In doing so, the Syncrude facility, which is in the midst of a multi-billion- dollar expansion, set its 16th annual production record over the past 19 years.
The plant accounts for roughly one- tenth of all of Canada's crude oil production.
In 1996, the plant -- one of two synthetic oil plants in the Fort McMurray area -- produced about 73.5-million barrels, the equivalent of 201,000 barrels per day.
A Syncrude production record was also set during the final three months of last year when the company, owned by a group of oil and gas firms, shipped 21.6 million barrels of oil, which averages out to a staggering 232,000 barrels a day.
When Syncrude was laun-ched almost 20 years ago, many analysts and observers scoffed at the project as being too expensive, too complicated and too remote.
Both Syncrude and neighbor Suncor Energy Inc. mine massive amounts of oil-laden bitumen from the Athabasca oil sands, which are then refined into crude oil. It takes about two tonnes of bitumen to produce a barrel of crude.
Syncrude said even with expanded production last year, it reduced the total level of several pollutants, including sulphur dioxide and carbon dioxide.
"This record-setting production is the result of steady, safe and very reliable plant operations," said Syncrude president Jim Carter, adding the increased output was due, in part, to some improvements at the facility.
Syncrude is also planning a $3-billion expansion of the company's operations.
Kerm's added notes:
For 1998, the company's production goal is 80 million barrels or about 219,000 barrels per day. That's up from 1997's production goal of 76 million barrels. Syncrude is a joint venture of AEC Oil Sands L.P., AEC Oil Sands Ltd. Partnership, Athabasca Oil Sands Investments; Canadian Occidental Petroleum; Canadian Oil Sands Investments; Gulf Canada Resources ; Imperial Oil Resources; Mocal Energy; Murphy Oil Company and Petro-Canada.
Syncrude's 1997 production records toppled previous company records but the new year isn't getting off on the same good foot. One of the plant's two cokers is experiencing a performance problem. "It is running right now but it's not performing to its full potential," said Syncrude spokesperson Peter Marshall this morning. A decision whether to continue running the coker or begin an unscheduled maintenance turnaround on the vessel is expected within days. In side the coker vessel bitumen is cracked intofractions and coke is withdrawn to start the conversion process of bitumen to upgraded crude oil. A turnaround had been scheduled for March. During the company's 41-day turnaround last March, daily production was cut to 160,000 barrels from about 200,000.
FEATURE STORY
Welcome to 1998: Take Cover!
Woodside Research
Publication Date: Jan 13, 1998
As we move into 1998, I am more worried about the prospects for the Canadian economy, equity markets and the oil patch than at any time since the early 1990s. I hope I am wrong, but I see a great deal of instability in the year ahead. Major issues in Asia that have been kept in check for many years emerged during the last six months of 1997 as obvious and serious problems. These have concerned me for some time and 1998 may be the year they collide to make for a difficult year for the oil patch.
Three Worries Cloud 1998
Three items concern me. The collapse of the Asian Tiger economies which was triggered by the currency devaluations across the region, the continuing fallout in the world financial system resulting from the Asian currency meltdown and the December emissions deal reached in Kyoto, Japan.
The Asian economic problem has been growing for years. These economies have been based on export-lead growth of mass produced consumer goods using inexpensive labour, the availability of cheap capital from their domestic banking systems and open access to the North American consumer marketplace. At the same time, all these Asian economies have import barriers to protect the domestic market from competing products from North America and Western Europe and internal rigidities that impose high prices on the local consumers.
In the worst example, the US has conducted a 15-year battle to try to open the Japanese market to American goods and services. The gains have been minor and the non-tariff barriers to foreign goods remain prohibitive.
Crony Capitalism is Not Efficient
The Asian economic model of state-directed capitalism is a modern form of mercantilism (controlled trade to benefit the "mother country") under what have generally been authoritarian governments (until very recent softening in some countries). This has lead to what has been called "crony-capitalism". Family, political and business contacts and kickbacks have been the basis for capital allocation and market forces have not been used as the primary mechanism for making investment decisions.
In some sectors, this has lead to over-capacity and a growing portfolio of non-performing loans. But under the system, the lending institutions have supported the crony capitalists beyond what would be considered prudent lending practices. The real estate sector has been particularly imprudent across the entire region. In Japan, property values have been falling for nearly a decade with a resulting explosion in non-performing loans.
The internal markets of Japan and the Asian Tigers have often provided high-priced domestic goods to the captive market that have yielded large profits for producers in both the domestic and export markets. These artificial high returns have attracted a good deal of offshore capital from both banks and portfolio investors.
Bubble Economies of Asia
As a consequence of the artificially high profits and real estate inflation, most Southeast Asian countries have seen large inflows of foreign capital to take advantage of the high rates of return to equity capital and low rates of taxation. But at the same time, the barriers to protect their domestic markets from foreign imports has also allowed them to run large trade surpluses. Despite the high level of exports, the Asian Tigers have been running current account deficits. The trigger for the meltdown in 1997 was that Thailand's current account deficit had reached nearly 8% of GDP in 1996 (above the level that triggered the Mexican peso devaluation in 1994-95). Once the Thai baht crumbled, the deeper problems with most of the region's economies were revealed and their currencies were also put under pressure.
The Asian banking system has been at the core of the emerging problems for years. Loans have often been made based on relationships with the ruling families rather than collateral. In many cases, there has been an optimistic view of the economic future for an individual project without any assessment of the macro-economic forces required to sustain that across the entire economy. North American banks are not immune to massive domestic credit errors either. Self dealing has been epidemic in Asia for years.
Massive Adjustment
Now there is a period of massive adjustment. Across the region, both the currencies and the local stock markets have fallen by about 50%. In some cases, the decline is much greater (75% for Thailand and Indonesia). Taiwan and Hong Kong are still holding with smaller declines, but that may change.
The Japanese yen and stock market have fallen, but also less seriously. But Japan has been in a near recession for the last six years. The Nikkei index is under 15,000 compared to the high in the late 1980s of about 40,000 and last year, 30-year bonds were issued with yields below 2%. The adjustments have been taking place in slower and more controlled fashion in Japan. But now Japanese banks will have to deal with the billions in loans they have to the devastated economies of the region. One recent report put the total Japanese exposure at over US $250 billion with Hong Kong, Singapore and Thailand accounting for nearly US $190 billion.
These emerging economies had been growing by 6% to 9% annually. The price of imported commodities and goods (usually set in US dollars) has just doubled in the local currencies. Oil now costs twice as much as it did in 1996. The Thai economy grew by 6.4% in 1996 but only an estimated 1.0% for 1997. One estimate calls for -5.0% for 1998. Similar results will ripple through the region. Indonesia is an oil exporting country but imports other raw materials, goods and services. Indonesia may suffer the least but the uncertainty about the future of the aging and ailing President Suharto adds to their problem. The country will also post a decline in GDP for 1998. Japan Not Exempt
Japan will suffer too since about 30% of its exports and 15% of its imports are with Southeast Asia. In addition to its problem loans, this trade could suffer and cause a further contraction in Japan. By contrast, the region accounts for 13% of US exports and 12% of imports, while only 2% of Canadian exports and 3% of imports are with the region.
The fallout from the Asian meltdown for the Canadian economy and the petroleum sector is serious. Canada's lack of economic engagement in Asia does not exempt us from fallout.
Canadian Impact of Asia is Serious
The Asian credit crunch may well spill over into Canada. We have the second highest level of public debt to GDP of the G7 nations (after Italy). It is not unreasonable to see downward pressure on the Canadian dollar and upward pressure on short-term interest rates. Both are already evident and may well have a long way to run their course.
Canada is a commodity-exporting country. The collapse of the Asian Tigers means many of Canada's important exports will decline in value. The demand for lumber, paper, gold, copper, nickel, aluminum, zinc and iron ore should all be lower than expected in 1998 and 1999. That means lower prices for these commodities in all markets and less revenue for Canadian forestry, mining and smelting companies. Demand for wheat and other grains may fall, pushing agricultural prices lower. Finally, the global demand for crude oil is not likely to meet the expected levels for 1998 and 1999. That is only one factor behind the current soft oil prices but producers are already reviewing 1988 spending plans in light of lower expected cash flows.
Oil May Dip to US $15-$12
Oil may well be in the worst shape of these commodities for 1998.
In addition to lower Southeast Asian demand, a downturn in the Japanese and Chinese economies would be a nasty surprise. China has already reported two months of negative economic growth yet published forecasts still call for a 10% gain in Chinese oil use for 1998.
In addition, the United Nations recent deal with Iraq for the sale of US $2 billion over a shortened 5-month period means the addition of nearly 1 million barrels per day into export markets. OPEC has agreed to a higher quota for 1998 that assumed continued 2% annual demand growth. Non-OPEC supplies continue to be added, though not as rapidly as had been forecast.
My personal view, (one that spoiled the conversation at a number of Christmas receptions), is for West Texas Intermediate (WTI) to reach lows of US $12-$15 per barrel in 1998. WTI was in the $18-$20 range when I made that prediction and the present $17 level is only a suggestion of what is to come.
Canadian Dollar Vulnerable
As for the Canadian economy, if we are hit with a sustained attack on the Canadian dollar, that could easily push its value down to 65› or lower without strong intervention. That might soften the effects of lower US$ commodity prices.
If the Bank of Canada opts to support the dollar with higher interest rates, then short-term rates could easily double (they have been artificially low compared to US short-term rates for over a year). That would push open mortgages and blue chip corporate lines of credit up past 10%. The impact on the economy is obvious.
If this sort of turmoil is imported to the Canadian economy, that would likely put a pinch on consumer spending for everything from new homes (and all the related requirements) to automobiles and other durables as well as consumer non-durables. Canada could easily dip into recession as a consequence of the Asian turmoil. Our economy is far more exposed and fragile than the US economy (the only adult economy in the world). So is the Canadian dollar.
1998, A Bad Year for Markets ?
The obvious result is a strong possibility of a bear market for Canadian equities and possibly even a bear market for Canadian bonds. The oil and gas producer index suffered a 10.8% decline for 1997. I see a similar or even larger dip for 1998 and the producer index was off another 16% to end of the first full week of January. I would also expect a recovery by late in the year as global production adjusts to lower demand (and low prices).
A recovery would be canceled if Ottawa is obstinate on the issue of reducing so-called "greenhouse gas" emission. Ottawa still has to clarify how it plans to implement the deep cuts in energy use (or massive program to improve efficiency) but that policy could bode badly for the robust plans of the oil sands and heavy oil sectors.
It could be a very unhappy year for the Canadian oil sector.
Natural Gas a Better Bet
The bright spot in the sector is the positive outlook for natural gas.
An additional 1.1 billion cubic feet per day of new export capacity becomes available in November 1998. That will help tie Alberta gas prices more closely to US prices. In my last article I showed the sharp divergence between the two markets due to the lack of take-away pipeline capacity. Higher prices and increased production volumes should mean a good year for the gas industry, starting by summer when analysts start to look forward to the 1999 calendar year. Another 1.2 bcf/day may be added for November 1999 with the Alliance Pipeline (now seeking approval before the National Energy Board).
I am normally an optimist by nature. At the start of a new year, I have always sought to look for the best in the months ahead. For 1998, I see more to worry about than I have in any recent years.
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