CANADIAN ECONOMY’s RESTORATION: TIME RUNNING OUT, CANADA NEEDS TO ACT FAST

There were some important nuggets to be picked up from Bank of Canada Governor’s address to the Saskatchewan Trade and Export Partnership in the last week of April:

·       One of the most important forces powering Canada’s economy currently is the long-term strength in global prices for resources; and, for Canada, oil stands out. 

·       As people earn more, they spend more and, as this work force grows, they need more of everything - from Tim Hortons to pickup trucks. This leads to more jobs and higher wages in other sectors and other regions of the economy, so everyone benefits.

·       Diversifying Canada’s export markets is important to future growth and resilience.

·       Canada’s is an export-driven economy. Canadian economy needs to shift gears and for exports to lead again.

A new report from the Conference Board around middle of May put Canada's three oil rich provinces on top of the world in terms of economic performance. The report places Alberta, Saskatchewan and Newfoundland -- the three oil producing provinces -- in that order as the top performers with A-plus scores across indicators such as per capita income, economic growth, unemployment and productivity. They are the only jurisdictions rated to have A-plus economies. Alberta is "class leader," says the report with 2013 per capita income that was $10,000 higher than Norway, the top-ranked country in that indicator. For the rest of the country the news was not so stellar.

What the above narrative clearly suggests is that while the 31 subsectors (of Bank of Canada) of the non-energy export sector need to be promoted with suitable strategies, the increase in production and export of the energy resources, i.e., oil and gas is vital from the point of view of Canadian economy’s restoration to good health in near term and sustaining it in the long term.

However, the growth of the aforementioned two energy resources appears to be getting bogged down in an endless loop of consultation, opposition and procrastination. As Leo De Bever, chief executive of Alberta Investment Management Corp., the largest wealth fund in the country with assets under management of $63-billion, says, “We find it easier to pay somebody not to build something rather than actually build it. There has been a shortage of resolve to build projects.”

De Bever was alluding to opposition to various pipeline projects and oil sands projects. To compound issues there is tardiness is formulating policies that the investors need to know urgently to firm up their investment decisions. For example, investors (Petronas, Shell, Chevron et al) are eagerly waiting on British Columbia’s final decision on the tax regime. As well, the investors are concerned about wage inflation, the tax environment and about Canada’s ability to actually deliver in a timely fashion on environmental assessments.

Besides cost-competitiveness of doing business in Canada (e.g. British Columbia) being crucial, time is of the essence as investor companies are mulling similar projects in Australia, East Africa and the United States. Petronas led consortium is hoping to set sail its first shipment of LNG by 2019 before a number of Australia’s brownfield projects start ramping up. Analysts say that some South Korean investors are already gravitating towards U.S. projects.

Then there is the proposed long term multi-billion dollar oil and gas agreement between Russia and China which Russia’s president Putin is going to pursue aggressively. If this agreement gets concluded, it would mean China’s financial capacity and need to import these resources from other countries like Canada would get that much reduced. Which would in turn mean the companies intending to invest in Canada may like to change their minds.

On the flip side, the Ukraine crisis has got the Europeans to clearly articulate their desire to source their long term energy needs from Canada (and US). This is a godsend opportunity for Canada to latch on to and expedite the necessary approvals process associated with oil and gas and pipeline projects.

Just to give an idea on negative impact of ‘endless cycle of consultations’, as oil sands projects stall and crawl, Canadian producers have lost as much as $30-billion annually due to discounts on their blend of crude in the past few years. While spreads have narrowed over the past 12 months there is much more at stake. According to energy consultancy IHS CERA if oil sands production reaches 3.8 million barrels per day in 2025, the bitumen’s contribution to Canadian GDP could nearly double, and a third more jobs could be expected.

“Between 2012 and 2025, oil sands’ contribution to Canadian GDP could grow from $91-billion to $171-billion,” the IHS estimated in a report published this year. “This would be like adding an economy the size of Saskatchewan today to Canada by 2025. Oil sands could also add over one-quarter of a million more jobs, contributing to 753,000 jobs in Canada in 2025.”

To address the concerns around environmental impacts of oil sands development, Alberta already has in place stringent measures and more are expected. This should blunt criticisms brought forth by the environment-activists. As regards carbon emission issue, an independent group of scientists/experts are challenging the White House National Climate Assessment (NCA) issued in early May. In their view, the foundation of the NCA is a "masterpiece of marketing" that crumbles like a "house of cards" under the weight of real-world evidence.

And, in regard to the issue of opposition by the aboriginals to the various oil and gas and pipeline projects, the legal experts say that as for aboriginal communities, they need to recognize that their right to be consulted doesn’t negate the government’s power to make decisions.

Summary: Energy (oil and gas) is a vital component in the context of restoration and sustainability of Canada’s economy and standards of living associated with this first world country. The companies in Canada, who wish to implement the various oil and gas and pipeline projects, and the Federal and the Provincial governments must expedite the approvals’ process. The window of opportunity for Canada is NOT going to be there for ever, therefore, it would be a criminal folly if they fail to capitalize on the opportunities presented to Canada by the global situations.

ALBERTA's EMPLOYMENT FIGURES IN 2014 LIKELY TO BE DRAGGED DOWN DUE TO OUTSOURCING OF ENGINEERING AND FABRICATION WORK

A report released by Conference Board of Canada last week predicts a bright outlook for Alberta’s economy in 2014 but cautions that it may be stunted by pipeline risks. As per the report, Alberta will lead the country in employment growth in 2014 at 2.8 per cent whereas Canadian employment growth is forecast for 1.4 per cent. The report also forecasts Alberta’s economy to grow more quickly than any other province in 2014, but adds that the lack of pipeline development continues to present a significant downside risk to the forecast.

Alberta’s growth is obviously predicated on momentum in oil and gas sector. According to a report by a Calgary investment bank, capital spending in the Alberta oil sands will rise to a record of about $32 billion in 2014 (more than half of which will go to in situ projects). Canadian Association of Petroleum Producers (CAPP) predicted oil sands production will grow to 5.2 million barrels per day by 2030, up from 1.8 million barrels per day in 2012.

All the above should be good news for Alberta, isn’t it? Are the employment figures going to be really that good even if the pipeline constraints (to move the bitumen from oil sands projects to refineries and/or export) get removed? Probably not! Why? What is the problem?

Here is the reason: The greater portion of engineering cost of a project and thus potential for greater employment lies in the detailed engineering phase (of the project). Unfortunately, substantial chunks of detailed engineering (DE) work is being increasingly outsourced to low cost work centres (LCWC) of Engineering, Procurement and Construction (EPC) companies operating in Alberta/Canada. The EPC companies in Alberta are under tremendous pressure from the owner companies to farm out work to their LCWCs (in China, India, Philippines and such). If an EPC company does not have a LCWC, it is scrambling to set up one because it knows it would be thrown out of the bidding race if it did not have one.

Aside from DE phase being the greater source of employment in the EPC companies, fabrication and supply of equipment and construction of modules also constitutes a huge chunk of total project cost and this area too is a major source of employment. Unfortunately, dark clouds are hovering on this area too since significant amounts of work is being parceled out to other countries, e.g., South Korea and China.

Now, the owner companies may argue that the fabrication yards in Alberta are completely loaded up hence they are parceling work to Asia. This may be partly true, but the important question to ask is: Why are the fabrication/modularization yards not being expanded and/or new fabrication/modularization yards being set up in Alberta?

The answer that one gets is: Fabrication/modularization in Alberta is more expensive than Korea and the Asian yards are sometimes faster too (in completing the work). These assertions are open to genuine challenge and may not hold water if one takes in to account the transportation costs (from Asia), owners’ project management costs (at Asian yards), on-site rectifications necessitated by engineering / fabrication lacunae, possibility of expediting the fabrication in Alberta yards with suitable incentives and so on.

One may say the EPC companies in Alberta/Canada are already full to their capacity which is why DE work needs to be outsourced to LCWCs. That was true in 2005, 2006 but NOT now at this point in time. At the present time, the EPC companies in Alberta/Canada have enough slack to absorb most of the work that is likely to be generated in 2014 and beyond.

The fact of the matter is that the mad scramble to farm out work to LCWCs is causing layoffs in Alberta because the current situation of EPC market in Alberta is sluggish and very weak. Almost every day one hears some technical and/or non-technical personnel (estimators, cost controllers, document management folks, planners, schedulers etc) being let go off. This is ironical for Alberta (with so many new projects expected); indeed it is unacceptable and downright reprehensible and condemnable!

So what should be done? Well, the Province MUST step in and put the boot on the owners neck (like US did with BP during the gulf oil spill in 2010). Some actions on the lines mentioned below must be taken ASAP:

·       60-70% of TOTAL engineering work (DBM+FEED+DE) must be carried out in Alberta. Jobs may be outsourced to LCWCs only if there no capacity in Alberta (and Canada).

·       Not only engineering must be done in Alberta, substantial amount of orders for equipment, and fabrication/modularization must be placed in Alberta first (and in Canada).

·       There should be a continual gap analysis on capacity available in Alberta for supply of equipment, modules and how much of it is utilized. Owners must explain to provincial government why they went to an outside country for supply of equipment, modules etc. if there was underutilized capacity available in Alberta and Canada.

·       There should be tax incentives given to the owner companies for engineering and material sourced from within Alberta and Canada.

Just as a background to people regarding engineering costs: As a ball park figure, contractor engineering is generally in the cost range of 8% to 14% of total project costs (TPC) for greenfield projects, 10% to 18% for brownfield projects.

So, let us consider a project of a billion dollar TPC. The LCWCs at best may provide a saving of 30-50 million dollar during the DE phase. However, anecdotally a lot of it tends to get negated due to engineering and procurement re-work, necessitated to rectify errors and omissions of LCWC engineering, during the construction phase. At the end of the day, the net saving hardly amounts to 15-25 million – a piddling saving of 1.5-2.5% of TPC. Therefore, the notion that sending DE work to LCWCs brings about substantial savings is actually grossly misplaced and overblown, this is something the owner companies need to get in to their heads.

Summary: If the tax incentives can cover some of perceived saving – owing to out sourcing work to LCWCs – the owners would feel incentivized to keep maximum amount of work within Alberta and Canada. That being said, the EPC/EPCM companies should also try to effect economies in man-hour costs as far as possible. In any case, the owner companies got to be requested, cajoled, and coaxed to make sure the EPC work is maximized in Alberta. They must remember that they have a CSR (corporate social responsibility) toward the province (Alberta) whose resources they would be exploiting to generate profit for their investors for helluva long time – after all, the oil sands projects have a pretty darn long productive life.