Energy shiftClick image to enlargeby Tim Wilson

Manufacturers look to diversify amidst weakening oil and gas market

The sudden drop in oil and gas prices has many analysts arguing we are not in a slump, or a short-cycle, downward adjustment, but instead facing a new era of moderate prices. This has significant implications for those job shops that supply to the industry, with many looking to diversify–either within the sector, or beyond.

“Most producers are now working towards a cost structure whereby they can survive at $50 to $60 a barrel of oil,” says Reynold Tetzlaff, the Calgary-based national energy leader at PwC Canada. “With oil at its current price, the focus is on efficiency, enhanced productivity and taking time to fully assess the situation to minimize cost and maximize economic benefits.”

With less money on the table, some suppliers to the industry are looking to diversify to alternatives such as wind and solar. The problem is that growth in these areas tends to follow the same cycle–if revenue is down in the oil patch, often, so are investments in alternatives. An additional irony is that the oil shock in Western Canada means that economic activity has slowed to such an extent that Alberta could actually meet its greenhouse gas emission goals.

“Usually the alternative energy discussion becomes more prevalent when energy prices get higher as opposed to lower,” says Ken Corner, director of research and operations at Auspice Capital Advisors in Calgary. “When the market is high, there is more interest in alternatives; and when prices are low, it takes some pressure off to explore those things. Having said that, solar and wind have become very popular, with solar both more efficient and more viable.”

Specifically, the National Energy Board expects wind to more than double in the next 20 years, from 4 per cent of total energy supply today, to 9 per cent in 2035. And solar, biomass, and geothermal, while still small, will nonetheless double from 2 per cent to 4 per cent.

With that in mind, for those job shops supplying to the oil and gas sector, addressing the downturn in prices won’t necessarily be sector specific. Instead, a likely approach will be to see where skills fit from a cross-industry perspective.

“Companies have very specific expertise,” says Corner. “Most oil and gas suppliers are not really the ones to move into solar or wind.”

A company with expertise in pipe fitting, for example, may find opportunity in a biomass or nuclear, but wouldn’t have much value to add to wind and solar. It could also diversify into more general infrastructure projects. This shift may prove necessary, given a recent survey by Ernst and Young in which nine out of ten oil and gas companies said they had either minimal or no long-term strategic cost management strategies. This lack of preparation for a longer-term downturn could have major implications for the industry– but so could getting it right.

“The energy companies are attempting to build a cost structure that’s more permanent,” says Tetzlaff from PwC. “When oil is at $100, the key is to get the oil to market, and that may sometimes mean at a more costly, less productive manner.”

The good news is that, should prices rebound, energy companies will be lean and productive; and willing to spend, too. Many observers think the market has moved too far to the downside. As well, with work resuming after the spring breakup, companies will be in a strong position to demand a reduction in operating costs–particularly with regard to wages.

“For now, people are worried about keeping their jobs,” says Corner. “That said, it is important to realize that it is normal for markets to overshoot, either higher or lower.”

And as dire as that sounds, with suppliers competing to match–or beat–their customers’ requirements for reductions in operating costs, there should be downward pressure on both wages as well as the price of materials. This, in turn, could open some breathing space for those job shops looking to explore other markets. SMT

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