Hillary Clinton is not President of the US, and Amazon did not choose Edmonton for it’s first western Canadian fulfillment centre. While we struck out on those two guesses, we also predicted back in November that oil would hit $70 / barrel sometime this year (which it did this week, marking a 70% increase since 2017). While we were wrong 2 out of 3 times, that kind of batting average would put us in the baseball hall of fame (and we prefer to be the glass half full type).
We made our prediction on the premise that you just need to follow the money. With Saudi Arabia planning an IPO on the state-owned Saudi Aramco (which would make it the largest IPO in history), we suggested they would want oil prices to be at a level that maximizes the IPO value, while still being conscientious of increased global production that would come with increased prices. There are also reports that suggest Saudi Arabia needs oil in the mid $70’s to balance it’s budget.
We looked at the biggest IPO in history being led by a country that needed oil above $70 to balance it’s budget. So while oil prices had to climb a further 30% frm the time we made our prediction, we didn’t think it was much of a leap.
As it unfolded, OPEC (read: Saudi Arabia) agreed to (further) collude with Russia in clawing back production. We also saw that the US hasn’t been able to get it’s oil to market as quickly as expected. While they have numerous pipelines under way (which coincidentally do not appear to have any of the objections we’re facing in Canada), those pipelines won’t come on stream until 2019. To fully push prices over $70, there needed to be a catalyst event, which in this case was the US pulling out of the Iran nuclear deal (officially known as the Joint Comprehensive Plan of Action). Iran is the world’s 5th largest oil producer, and some of that production will now be curtailed. Oil prices have been traditionally hypersensitive to small changes in supply, which is why we saw oil prices crumble in late 2014 and while we’re seeing a resurgence in 2018.
What’s interesting to note though, is that this big increase in oil prices has not translated into an equally large uptick in the economy. The oil industry is a big machine, and while it takes time for it to fully mobilize, there are external pressures that appear to be putting a dampener on activity. Here are a few reasons we think are contributing to this:
- Investors are worried about Canada’s ability to have a unified front (a proper Federation, as it were). If one province (BC) is able to restrict development of a pipeline that has been determined to be in the national interest of the county, it is understandable if capital were to avoid the political instability;
- Property taxes are rising 4x faster than the rate of inflation. We might see companies grow in surrounding areas like Acheson, Leduc and Nisku simply to avoid the egregiously high property taxes in Edmonton;
- Minimum wage is increasing rapidly. While we do not argue the merits of a living wage, the increase in labour costs reduces corporate profitability;
- The provincial carbon tax. The carbon levy, according to the Province of Alberta, is applied to diesel, gasoline, natural gas and propane at the gas station and on heating bills. While it’s certainly not empirical evidence, we can anecdotally report that many of the companies we have spoken with believe the carbon tax will have dramatic effects on their businesses.
- Heavy crude discount. While West Texas Intermediate (WTI) and Brent Crude are the two most commonly quoted oil prices, the bench mark price for heavy crude in Alberta is Western Canadian Select. Generally speaking, Western Canadian Select is more expensive to produce, so there is a discount to this crude vs WTI or Brent (known as the Heavy Crude Discount). Oil companies in Alberta will not see the same upside in WTI and Brent price increases if this spread widens, which could easily happen if we continue to face issues getting oil to the coast. This discount is slightly offset by the currency exchange fortunately.
So while oil prices have increased roughly 70% from the low of 2017, we wouldn’t expect to see a corresponding 70% increase in commercial real estate activity. But the market is definitely getting better, so we expect 2018 to finish strong.
Our headline was based on taking the low price of 2017 (oil closed at $42.53 (WTI / USD$) on June 30, 2017).
Oil prices, as reported by the media (and since we have a blog, we’re quasi-media) is actually quoted as a futures contract (not the spot price). Unless noted otherwise, these futures contracts are “front month” contracts, such that the price quoted is based on next month’s futures. When we say oil is over $70 in May, we’re technically saying that the price of West Texas Intermediate for June’s futures contract is $70 / barrel (in USD $).
A couple months after our prediction, prices jumped roughly 20%, and even though there was concern the US would simply mobilize it’s shale production to keep a ceiling on prices, we doubled down in January.
What fuels our obsession with oil? As we documented last year, Edmonton’s commercial real estate market is positively correlated to the price of oil. There is no other single variable that influences our commercial real estate market as much as oil. We are dedicated to researching this trend and also unapologetically proud of the oil & gas industry in Alberta.
Just as a blind squirrel can find a nut, a team of commercial real estate brokers can eventually get lucky in making a guess. We openly admit we have been completely wrong on other guesses, so don’t construe anything we say as investment or real estate advice. If there’s a guessing hall of fame, we’re probably shoo-ins with our .3333 batting average, but still, it was just a guess. View our full disclaimer here.