The Bank of Canada used its latest quarterly business survey to ask energy companies how they planned to spend the windfall from triple-digit oil prices, and discovered that producers are setting aside only 40% of estimated cash flow for capital expenditures, compared to an average of more than 100% in the years preceding the pandemic.
This is useful information for the Bank of Canada because it suggests that models based on historical relationships between oil prices and investment will be less useful in predicting how rising commodity markets will affect economic growth and inflation in the coming months.
Crude and gas prices skyrocketed as the world economy recovered from the COVID recession, only to skyrocket again after Russia invaded Ukraine. However, Canadian energy companies have not been investing in new projects or sites to the same extent as in previous booms. Instead, cash flows are being used to shore up balance sheets and reward shareholders.
The reduction in capital spending follows a drop in capital spending last year that saw the sector’s capital expenditures fall to 60% of cash flow.
“Financial discipline remains a top priority for firms,” the central bank stated in its July 4 Business Outlook Survey. “After many years of financial stress, the majority of producers are using the current revenue windfall to improve their balance sheets, reduce debt, and pay dividends to shareholders.”
Companies that reported investing in production did so primarily at the margins of existing projects.
“Many conventional oil and natural gas producers are focusing on expanding drilling in areas where supporting infrastructure is readily available,” according to the report, which also mentions that heavy oil producers are improving efficiency and maximizing capacity utilization for existing oilsands projects.
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Each quarter, the central bank interviews 100 business representatives to get a sense of how the economy looks from the ground up. Policymakers also discussed the state of the oil and gas industry with executives from 13 different companies, as well as three energy analysts from chartered banks in Calgary, during the most recent poll, which was conducted in May. According to the group, high commodity prices caused by a global supply shortage have improved profit margins, increased activity in the sector, and contributed to overall positive sentiment.
However, concerns about the transition to low-carbon energy, future pipeline capacity constraints, and infrastructure development continue to weigh on the industry, which expects only modest growth in capital investment in the medium term.
Labor shortages and supply chain issues have also complicated investment, and the industry is facing significant cost increases.
“Drilling and other well-service pricing was reported to be up by 10 to 15% over the 2021-22 winter season,” according to the bank. “Some participants expect additional increases by the end of the year.”
According to experts, the reduction in capital spending can be attributed in part to the fact that the sector is still emerging and rebuilding from a period of sustained low prices.
Lisa Baiton, president of the Canadian Association of Petroleum Producers (CAPP), said at a Calgary conference last week that a decade of low oil prices has made Canadian producers smarter and more efficient.
“An industry that was known for outspending its cash flow is now focused on generating value,” Baiton explained. “At the beginning of the recovery, businesses shifted their focus from survival to rebuilding their businesses after all of those difficult years.” Repairing their balance sheet, compensating shareholders for their patience, and attempting to entice them to return.”