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Never mind.
Way back in December, the Saudis were sending very strong signals that they would defend a target price of $60 a barrel for OPEC's oil. As the owner of the most production capacity among the countries that make up the Organization of Petroleum Exporting Countries, the Saudis certainly have the market leverage to do that.
If they want to.
But right now they don't want to. Saudi Arabia's oil minister, Ali al-Naimi, has made it very clear in the last week or so that the Saudis are comfortable with a target of $50 a barrel. Since OPEC's target price is for a basket of oil grades that includes a sizable proportion of less desirable heavy crude, that OPEC target translates into about $55 a barrel for West Texas Intermediate, the most commonly quoted price of oil.
A price of $50 or $55 a barrel isn't by any means low enough to send the oil and oil-service industries into the kind of decade-long funk that ruled the 1980s and 1990s, when oil sold for less than $20 a barrel most years -- and as little as $11.28 a barrel as recently as December 1998. But $50 is low enough to inflict selective pain in the energy industry.
So for investors, it's time to ask the musical question: With oil at $50 a barrel, "who's cryin' now?"
I don't think it's a mystery how something good like $50 oil can hurt so bad. I'd put two energy sectors and three oil-exporting countries on my list of those who'll taste the bittersweet.
Fallout for Canadian oil sands producers
There's trouble ahead for the newcomers to Canada's oil sands.Oil at $50 a barrel is no problem for companies already up and running, turning Alberta's oil sands into oil. These companies make money even at $25 a barrel, according to energy consultants Simmons & Co. But if you're still building your plant, then your costs could be quickly approaching $50 a barrel. The boom in Alberta's oil sands region has driven everything from skilled workers to giant truck tires to pipes and valves to scarcity. And that has raised prices, delayed projects and pushed costs through the roof. Shell Canada (SCUAF, news, msgs), for example, announced last summer that the cost of the planned expansion at its Athabasca project had climbed 75% from earlier estimates to about $13 billion.
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You can understand why fast-rising costs -- or the inability to project costs at all -- might worry oil company executives if you look at what falling oil prices did to revenue and earnings at Suncor Energy (SU, news, msgs), Canada's second-largest oil sands producer, in the last quarter of 2006. Earnings fell by 48%, and the cost of mining bitumen and turning it into a barrel of refinery-ready synthetic crude climbed 23% from the fourth quarter of 2005.
The reaction to the pain has been muted so far, but investors can still see where this is headed: consolidation, as companies with lots of cash acquire companies with more oil sands under lease than they can afford to develop.
The problem is cash flow -- even if you've got it, costs that are rising as fast as these are can put the squeeze on a company quick and hard. Suncor's cash flow from operations, the money available to pay for new projects without borrowing or selling more shares of stock, dropped by almost 40% from the fourth quarter of 2005 to the fourth quarter of 2006, but it still came to $746 million Canadian for the period and to $4.53 billion Canadian for the year. That looks great until you realize that the company, besides spending $2.5 billion on expanding its oil sands operations in 2007, is also looking at investments in oil refining and marketing, ethanol and wind power. In 2006, the company's capital spending came to $3.5 billion Canadian, so you can see that the 2007 plans for oil sands are a huge commitment of cash flow.
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One option, of course, is to cut back on capital spending. Petro-Canada (PCZ, news, msgs), for example, which had a very comfortable $3.7 billion (Canadian) in cash flow for 2006 but $3.5 billion in capital expenditures, is considering scaling back the first phase of its Fort Hills oil sands project. That is risky, given the long lead time on these projects. Scrimp now and a company could see itself lagging the rest of the oil sands industry when big flows start to come on line around 2010.
Another choice is selling out or finding a partner with deep pockets. Rumors that BP plc (BP, news, msgs), the only international major without a position in oil sands, will make a bid for Suncor have intensified recently because of the pending retirement of BP CEO John Browne, a noted skeptic on oil sands. (BP sold its leases in Alberta in the 1990s.) The bid by Royal Dutch Shell (RDS.A, news, msgs) to buy the minority share of Shell Canada it doesn't already own has just added fuel to the fire.
The squeeze on ethanol producers
Expect consolidation among ethanol producers.Like the companies working in Alberta's oil sands, ethanol producers are feeling the squeeze of lower oil prices -- and higher prices for their essential raw material, corn. Last summer, when oil was $77 a barrel and corn was selling for $2.50 a bushel, ethanol makers scored a profit of 86 cents a gallon, according to Credit Suisse. The boom times for ethanol profits led to a boom time for new ethanol companies. A recent count showed 415 ethanol plants either in operation, under construction or planned.
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