Canadian Energy's "Exit Stage Right" Plan

Written By Keith Kohl

Posted November 29, 2006

Time to Save the Oil . . . Not the Whales

With prices approaching $1,500 per barrel, what would ever make investors like Charles Morgan want to sell their stake in the oil industry?

Well, Morgan had noticed that the price of recovering the oil was increasing every year, and foresaw even further rises in the cost of his operations.

The world knew that oil wouldn’t last forever, and people like Morgan thought that at the current rate of production the source would soon run dry. Fortunately for him, he recognized this trend and was able to get out of the industry at peak prices, generating a healthy profit for himself.

This may sound like a headline from the future when the earth’s oil reserves will have reached dangerously low levels, but it actually happened over one hundred years ago, in 1847. The source of oil back then, however, was whales.

In the 18th century whale oil was a booming business, supplying fuel for nearly all lighting sources (like torches and candles) as well as lubrication for a growing industrial revolution in the U.S. and elsewhere.

Whaling magnates like Morgan saw that their ships’ expeditions were taking longer, making the trips costlier. The decimation of the whale population caused the price to peak.

A bell-shaped curve in whale-oil production was seen over a certain period of time.

Sound familiar?

Luckily for the whales, technology was moving at an extraordinary rate, with alternative fuel options like kerosene and coal-oil becoming so cheap to produce compared to whale oil that the whaling industry all but died out in the 19th century.

The effectiveness of these new industries took a large burden off the whale population.

The comparisons are staggering, though, when you look at the data suggesting the plateau that global oil production has reached.

Even the simplest minds can see the direct correlation when this is put next to the bell chart for whale oil production in the 19th century.




Just as whale-oil production became too expensive, today’s oil producers are experiencing the exact same thing.

The question that remains: Will we be able to do something about it?

When I was younger and slightly less tactful than I am today, I posed this rather arrogant question to my history teacher: “So why should we even bother learning history?”

His reply, which I will give him credit for having ready at a moment’s notice, was, “If nothing else, it’s to learn from our mistakes and make sure we don’t repeat them.”

Fortunately for some of today’s oil companies, that advice isn’t coming too late.

Abandon All Hope Ye Who Drill

I know the hellfire and brimstone speeches about your personal everlasting doom in a fiery pit that you can’t avoid without repentance.

But if you are in the oil business, either by investing or operating a drilling rig, you can’t help but wonder if your fiery hell isn’t located right here on earth in the near future.

Everyone knows that there is a finite amount of oil in the veins of the earth. Like we’ve been saying for years, the problem of Peak Oil isn’t that we’re going to run out of the stuff. Rather, we’re coming to the end of cheap oil.

We’re like those whalers spending months or years at sea each trip who saw that the oil was getting harder to find (perhaps whales had more sense than we thought) and that the cost of those trips was not even covered by the oil they brought home.

Now look at our near future, when companies will have to drill deeper than ever before merely to sustain their current production rates, let alone increase production. Chevron’s recent experience with its “Jack” oil well in the Gulf of Mexico is a perfect example.

Yet companies need to increase production in the near future.

Just look at the forecasted rise in global oil demand over the next 25 years. According to the EIA, global demand for oil is going to rise by 38 million barrels per day in 2030, to a total of 118 mbpd!

With this demand knocking at the door, maybe paying $200 per gallon is not so hard to imagine, after all.

Now here’s the main issue at hand.

Even assuming peak oil is nothing more than hubbub, isn’t the logical course of action to spend as much money as possible on oil exploration, thereby assuring that future demand is met?

Common sense would dictate that, wouldn’t it?

That’s not the case, however, for many Canadian energy companies that are reorganizing themselves into large Canadian Energy Trusts.

So, how does that affect you?

Good question.

Every Relationship Comes Down to Trust

As early as 1984, Canadian companies began merging into much larger trusts, taking advantage of trust-friendly Canadian regulations.

In a Canadian Energy Trust, operating companies are acquired by the trust, usually through equity offerings, using third-party debt and funds in exchange for grants of royalties, debt and shares. The operating company’s cash flow from sales (from oil, natural gas, etc.) is transferred to the Trust as distributable cash flow.

This means that the majority of the revenue is able to be paid out as monthly dividends to the Trust’s shareholders.

But there’s a catch there, if you look hard enough.

The characteristics of the companies these trusts acquire are pretty interesting. Due to the need to provide their investors with a constant cash flow, Canadian Energy Trusts purchase only assets that are mature, low-exploration-risk properties and toll-based energy infrastructure with predictable operational profiles and minimal or at least low capital expenditures.

This assures the trust of a higher drilling success rate than is typical of exploration and production companies.

So companies find themselves in a predicament.

They can either continue to actively spend their incoming money on exploring for new oil or organize into these Canadian Energy Trusts, thereby giving their shareholders bigger dividends.

In light of the argument by some that there is no easy and cheap oil left to find, it’s interesting to note that many of these companies have chosen the latter option.

Perhaps they know something about the reality of Peak Oil that we don’t.

An Absent Savior

Just as the whales were saved by technological advances like coal-oil and kerosene, we will soon be looking for something to take on the energy burden now carried by oil. But oil’s knight in shining armor-alternative energy sources like solar, wind, hydro and even nuclear-haven’t developed nearly enough to rescue us from the grim future of rising oil costs.

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