Alberta sans Natural Gas

Those who have spent any time in Alberta know that the province might get all the hype for its conventional oil and oil sands assets, but it is really a natural gas driven province. What would happen if Alberta's natural gas was simply 'priced out' of the market? What would happen to the provincial royalties and the provincial budget that has gotten used to the cushy $7 to $8 prices?
This article in the Globe discusses just that:

Combine that with a technological revolution that has allowed firms to profitably extract shale gas at $4 to $5 per thousand cubic feet, compared with $7 or $8 for new Canadian conventional supplies, and Alberta gas may find itself simply priced out of the market.

...“Canadian plays in general have some challenges because of the higher cost structure and greater distance to market,” EnCana chief executive officer Randy Eresman said this month.

Could Encana's forthcoming splitting might have anything to do with this changed game?

In the article there are a few other critical insights:

“There may well be a ceiling on North American gas prices,” Gary Leach said. “We may be range-bound – at the top end, around $6, $6.50 – and a lot of Alberta natural gas needs prices higher than that.”

“Either they bring down the costs and there will be a larger industry, or the costs remain the same and it will be a much smaller industry,” he said.

But wage deflation in the oil and gas sector is simply impossible? After all, don't Albertans have to pay well over $300k just to get a little shoe box in the middle of prairies?
Too bad, those signing up for 35 year mortgages based on the very recent prosperity of the province might wake up to numerous economic surprises during the different stages of their mortgaged lives.

Entitlement and Delusions

The welfare queens and kings of Wall Street have already decided to start partying like it were 2007, never mind the trillions of dollars that have been forced upon taxpayers to keep these toxic dumps afloat. But, the underlying chutzpah at these places is enormous, along with the natural sense of entitlement that accompanies it. So what if we screwed up, so what if our products were garbage, so what if our products add negative value; we are entitled to the compensation, because we need to have the 'best and the brightest.' If this is the cesspool you get by hiring the best and the brightest, I wonder what would mere mediocres have done?

The OPEC ministers sing the same tune saying that a fairly high price of $50 is not good enough and is 'undermining economy.'
The wizards of the government economy in Alberta are not too different either as they are borrowing in the hope that the recession will go away if they wait for long enough. It's the same sense of entitlement- higher commodity prices- irrespective of the the macro economic situation. Well, here's a question. If $50 oil and $3.5 natural gas ain't going to cut it in Alberta, what happens if the prices again halve from here on? Can someone say the definite collapse in the mid east asset markets and Klein style cuts in not too distant future. Natural gas btw, is now down to around $3.2 and likely to fall further. We have been tracking natural gas since January and its slow but steady decline from $5 or more to the present levels. What this is doing to the drilling levels in the province and corporate profits will be discussed in another post.

At a more local level, thousands of 'landlords' are wishing that the recession goes away. They can't/won't/don't reduce the prices that reflect the current market conditions and hope that the prices will bounce back to a level higher than the current values. Again, it's a strong hope and delusion, built on the underlying entitlement of 'higher prices' for 'my real estate holding'.
The economy has changed since 2007. Many companies are talking about a permanent and new 'baseline' for sales, production and consequent growth.
The economy of last few years was a mirage. It ain't coming back, neither are the prices of assets that were used to foment this mirage.
A lot of people, currently on EI and the governments willing to take on more debt will recognize that despite the loads of apparent green shoots that appeared in last few weeks, nothing fundamentally has changed. The economy still stinks, no matter how much perfume is applied to it to make the stench go away. It simply can't be fixed by a culture of entitlement, and believing in the ideas of unfounded hope.
Debt deflation is here and it can't be wished away.

Calgary Deflationary Scenario

I've been really busy with work and haven't had opportunity to post. This post from RJT deserves more attention as it presents a hypothetical scenario which is now becoming more realistic to a lot of people in Alberta. Before this is all over, expectations of a lot of people will change- annual raises, retention bonuses, competing offers, wage inflation will have become a distant memory. Keep an eye on the natural gas price, if it goes below $3, it will get ugly here.

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For fun, I would like to give a hypothetical example of deflation in action:

Let's take your typical youngish, Calgary engineer. He's been out of school about 4 or 5 years, and so has only ever seen good times, and doesn't have a concept of what "normal" or "recession" is. Let's call him "Radley", just for fun.

Radley, has done very well for a young man. Graduating during good times, he made 65K right out of school. Within 5 years, he got some good raises and perhaps a promotion or two, and is soon earning 120K. Radley thinks this progression is "normal" in a city like Calgary, which is basically immune to the booms and busts of the rest of the world.

Problem is, the bust comes unexpectedly, and everyone around Radley, including his engineering bosses, comfort him by assuring him it is simply a 6 or 12 month lull, before the perma-boom resumes. His boss even gives him a nice big "retention bonus" around Christmas.

But then something happens. The company that Radley works for starts losing contracts, and those that continue to hire the company, are asking for a reduction in price. Company starts with a "hiring freeze". After a few months, the company realizes that the next few years, probably won't look like the past few, and they need to reduce costs to stay in business. The best way to reduce costs is to either lay off engineers. If they need to hire again in a year or two, it is much cheaper to hire a young one for 60K, than one for 120K.

Some engineers get laid off, and look for other work. They can get it, but the problem is it pays them only 80K, instead of the 120K they were used to.

This is deflation in action. It is happening all around.

This actual wage deflation, memory of wage deflation, and fear of wage deflation is what takes all of the heat out of the local RE market. People don't want to over-leverage anymore, even with interest rates at rock bottom. Better to be safe. Better to have savings (not tied up in illiquid assets). Better to live in a smaller house.

It is a fundamental change in the way people act, spend, and behave.

Recession, Oil Prices and Incogurence

Let's start with the headline of today-the Canadian recession. It's here and is gathering steam. The annualized quarterly number isn't so bad as compared to numbers of other countries, but let's not forget the lag effect. And if you recall, right until the end of October, most people were talking about recession as a 'US problem and not Canadian one.'
But if we were to annualize the December numbers, then our GDP shrank by a whopping 12 per cent. The GDP for November declined by 0.7 per cent. So for the last two months of 2008, the GDP declined by an astounding 10.2 per cent, a pretty bad showing indeed.
But this is a headline you are unlikely to find anywhere in the mainstream media as most people want to believe in the 'We are different', 'we are decoupled', 'our banks are solid' stuff.

M0ving on to oil...
There's something about oil that probably used to be the case with gold. I think several gold bugs are oil bugs now. Garth Turner for example. I like what he writes, at least most of the time, but I'm surprised how he can hold two incongruous viewpoints at the same time. He subscribes to the Peter Schiff hyperinflationary school perhaps.
On one hand he talks about falling economy, a potential depression, falling demand, job losses, massive unemployment and yet in face of that he also talks of $100 oil and a rising stock market. How is that possible? Unless he expects the recession to be short and mild, profits are not rising. And unless job recovery quickly takes hold, there will be a severe demand destruction for oil. The Chindia story is pretty much on hold, if not entirely dead, with Indian economy growing at barely 5 per cent or so in the last quarter. So what will cause a sudden spike in the oil prices? And if oil does indeed rise to $100, then at least one part of Canadian economy will continue to function nicely and that is Alberta. The oilsands investments will resume, the Canadian government and Alberta government's revenue projections won't be so bad and maritimers will flock to Alberta again. Happy days will return to Alberta and the speculators will rejoice once again. But in the face of grimmest economic news in the generation, is it likely to happen? I don't think so.

In similar vein, the oracle of Omaha who seems to be losing his way, says in his annual report that oil prices in $40 or $50 range are too low. Is he just trying to rationalize his purchae of ConocoPhilips? Or is there anything deeper in that statement.
If you recall Mr Buffett visited Albertan Oil Sands in August/September last year. At that time he had remarked (paraphrasing)"You could be the best mining engineer in the world but if you are not sure that oil prices will stay high, then oil sands investments may not be worthwhile."
Again, if thinks $40-$50 oil is not a good price, then why didn't he invest in oil sands? I find that Mr Buffett is now singing the same songs as the mainstream media about inflation, 'cash is trash', 'buy and hold forever', 'stocks are for long run' and so forth. Which is quite a departure from his old days of value investing that was clearly visible during the dot com days.

In other news, the Feburary Calgary Real Estate numbers don't stink too much. Sales, prices, days on market and pretty much all metrics are down with respect to last year.

$50 Oil is here....

and is very likely to overshoot on the downside. Is $40 or even $30 possible. Why not? If 3 months ago anyone questioned that oil could go below $60, he or she was termed fool, like several posters here. Too bad people have such short memories. Even the champions of doom and gloom such as Garth Turner buys into 'higher long term energy costs' while we are in an ocean of deflation. But just yesterday, the DOT reported that the number of miles driven has fallen by around 5 per cent in the US in September. People are now saying, "anytime you drive your vehicle and it's not for work, you are wasting money." Ouch. With the prospect of a multi year bust and double digit unemployment, where is the demand for oil going to come from? The Chindia bull is dead for the moment, but who knows.
In the mean time, our province faces more fundamental problems- What will Alberta do once the oil sands engine is cold? Not much. All the diversification attempts have come to a naught with a merciless exodus given to all non oil and gas companies. Intutit, Dell, TD Call Center and many more have left the province(or even Canada).
Now that the bubble inflated by artificial supply of credit and fake demand for worldwide commodities has burst, are we going to revert to our core competency of selling cheap manufactured goods to the US, attracting US tourists based on a 70 cent loonie and handing out film tax credits? It should not be outside the realm of possiblitiy. It was after all only 4 short years ago that Dell when opening its Edmonton location even refused to pay for training its new recruits. Such was the state of desperation for new jobs in Edmonton. Any big corporation will now be extremely reluctant to take advantage of massive unemployment and cheap loonie anywhere in Alberta after our success in driving out most non-energy companies out of here. And for that, the primary reason was wage inflation driven by high cost of living created primarily by the high cost of housing. Perhaps Alberta government should do something about reining in the speculation in Real estate based on subsidized mortgage products.

Welcome to the New World

We are back after spending a week in the US. The US has changed quite a bit since our last visit almost a year ago. From waitresses in Manchester, New Hampshire who offered suggestions on getting special combo deals for breakfast as ‘every cent counts’, to the sales clerks in Wrentham, MA who hugged me to buy lots of things on the Veteran days sales, it seems like the deflation reflected only in the asset prices so far has finally found its way into consumer items as well. Hotels have become a lot cheaper as well. We stayed in decent Holiday Inn and Mariott rooms for less than $70. Of course, unlike most Canadian hotels, these were large, nicely furnished rooms with flat screen TVs and included breakfast. In booming West though, you only get a roof over your head for this much price, that is if you are lucky.

A retail sales associate in Nashua mall checked on me at least three times to make sure I found what I was looking for. Obviously, with low sales volumes, everybody is scared of losing their job. And what better way to ensure job security than actually doing what you are paid for! What a novel concept. I don’t really recall sales reps being this good in the last ten years. Of course, Albertans are still living in their fantasy land and the nonchalance of sales reps is still very conspicuous in almost every place where I shop. While taking the delivery of my Accord I casually asked the sales manager if their sales were declining and she remarked, “Yeah, there’s a little slow down, as some people see all this gloom in the US and get worried. But it’s their economy and not Canadian economy!”
Of course, she will be learning some painful lessons in economics and firmly grasp that ‘we are all dependent on the US economy’ the coming months as oil prices drop below $50 in the coming weeks and months.
A friend of mine who has family in India says things are getting gloomier there by the day. Perusal of the economic press there talks about major reduction in workforce, fall in real estate, stocks and pretty much every other asset class.
Remember the decoupling theory? Nobody wants to talk about it anymore. It is in graveyard along with the titans of Wall street. It was the ray of hope for the world after the US housing bust, even though the entire world’s growth was piggybacked on the insatiable US (and perhaps other first world) consumers. Remember India was going to save Alberta. And China too. Now that these countries are looking for their own saviors, who is going to save Alberta? Yes, the OPEC production cuts. But didn't we have the second largest reserves in the world? Can't we do something about it? I guess almost every oil company is going to do something about it and the answer won't be to the liking of anyone whose fortunes are tied to high oil prices.

When I look back at things, I could never have imagined they would get this bad. I thought the biggest swindlers and crooks on Wall Street still had everything in control. But I guess with TARP firmly showing up on their balance sheets, they couldn’t care less for the fate of the main street or the rest of the world.

In the coming months and years(hope not), those who possess cash will be in a lot better shape than those who don't. The inflationary period characterized by too much money chasing too few goods (houses, stocks, oil, cars, labour, art work, RVs, boats, carry trade currencies) is definitely over. In the new world, cold cash will rein supreme and those who possess it will have the upper hand over those who have no cash but possess too much of stuff (stocks, cars, houses, debt, art work, RVs, boats etc). The latter group unfortunately represents bulk of world’s population today (exceptions in some parts of Europe, Asia etc).
Too bad nobody in Canada will wake anyone up on what’s about to be unleashed on everyone pretty soon-government hiring cuts, tax hikes (GST going back to 7%, when?), budget deficits, falling loonie, house prices cut in half, high unemployment….
After all, it's only today that the economists in the US have managed to agree that the US is in a recession. So much for the foresight and wisdom of the dismal scientists.
The list is long and painful. Only those who were characterized as the doom and gloomers (including yours truly) who have had nothing but cash in their account for the last several years have been proven right. Not that I’m happy about it.

The Falling Loonie

is making new multi-year lows today....can't help but mention my call again to move the cash to USD. Canadians overall are going to feel really bad about the fall in loonie as pretty much all their assets have taken a significant beating on the world stage. The only saving grace is that we are doing better than the Australian dollar whose dollar has fallen more precipitously than ours.

To put things into perspective, from the days of parity:

those in cash are down about 17 per cent in USD terms.
those in TSX are down by about 35 per cent in CAD leading to a total USD decline of (.83*.65) around 46 per cent.
Those in Alberta real estate are down by about 20 per cent in CAD leading to a total decline of (.83*.8) around 33.5 per cent.

What will this do the Canadian consumer confidence? Not a whole lot of good. People will begin to feel poorer as months go by. The Canadian retailers can resume the blatant gouging without having to do any token service of bringing down the prices.

Most export businesses will be happy with this in as much as their revenue side will be intact(of course the slowdown in the US is the other impact, along with demand destruction for the oil patch) but their cost base just plummetted by a whopping 20 per cent or so. One of the big challenges of Canadian economic policy was just cured by markets in 15 days.

Where do you think the loonie is headed?

Deflationary Week

The WSJ has a very interesting graphic on how various investments did in the last week. It was massive wealth destruction across various asset classes.



We can safely add the TSX and Canadian dollars to the asset classes that were mauled quite badly.



The most common opinion out there is that the bail out package is inflationary. But a few people, including those from the Austrian school say that the bailout package is of very small scope as compared to the massive deflationary spiral that has been unleashed by the global credit contraction.

And while those who called for oil prices to fall below $80 or so were called lunatics just a few months ago, Merrill Lynch has now released a forecast for $50 oil if the global recession materializes.

Alberta Real Estate bulls and 'Fundamentals are strong in Canada' proponents had better be prepared to handle the destruction of their favorite underlying factors(commodity boom).

Inflation or Deflation

The steep fall in commodity prices in last few days, especially for gold and oil was not entirely expected. At least by the inflationists. Is it possible that this is the beginning of the unwinding of the ‘great commodity bubble?’

The simple scenario could play out this way- If we get deflation instead of inflation, commodities are going to fall. It may take a while for them to unwind, but they will fall. How fast and how hard is difficult to say.

On the other hand, commodities will be a good play if inflation or inflation expectations remain high. This has been the primary reason for recent run up in gold, oil and other commodities.

Should the US enter a severe recession, the demand for oil is likely to fall quite a bit (the 3.2 per cent YOY fall is an example). The BRIC economies have been around for a long time and still consume less than the US.

What will happen to the real estate prices here if the only support Alberta prices have got disappears? The answer may not be pretty for some people. Especially those who are leveraged and have huge debts. We are in uncertain times, and no body really knows how things are going to unfold in the coming weeks and months.

What do you think is the oil price above which ‘nothing terrible’ will happen here? What is the threshold below which we could be in the same territory as the last bust?