 |
|
Pedro Antunes
Director
National and Provincial Forecast |
Over the past five years the private sector has poured billions of dollars into resource sector projects. The payoff has thus far been abysmal, at least in terms of increased production. Indeed, energy and mining companies were riding the upward wave of commodity prices and expecting these to stay elevated so that their investment would eventually pay off. But how many times will the up and down cycle play itself out before we begin to believe that it will truly happen again? Commodity prices have been riding the peaks and troughs of market cycles since the beginning of time, or at least since markets have begun to price them. And the downward leg of this cycle has come to bite the resource sector hard.
This time, the up-cycle was much longer than usual. Crude oil prices, for example, posted seven consecutive annual gains from 2002 to 2008—an upward ride never before witnessed since commercial production began in the mid-1850s. Indeed, this time things seemed different. We were reaching peak production and consumption. And China, India and other countries were emerging as new economic powerhouses—their thirst for raw materials seemingly unquenchable—helping to convince ourselves that energy and other commodity prices were ratcheting up, year-in year-out, reaching price plateaus from which they could never again fall.
One example is of big oil companies that invested in the oil sands based on overly optimistic prices. In 2002, the “planning” price for oil was in the range of US$15 to US$20 per barrel, by 2004 this had risen to US$35 per barrel, then US$50 per barrel in 2006 and by late 2007, many companies were planning on US$60 per barrel and more! Indeed, estimated capital costs for some projects require a selling price of US$70 per barrel to be profitable—still, judged to be a careful assumption if made during the summer of 2008, when crude oil prices were more than double that value.
The escalation in energy and other mineral prices led to frenzied excitement and exploration perhaps not witnessed since the Klondike gold rush. Annual spending on mine development and exploration more than doubled from $27 billion in 2002, to $56 billion in 2008. Over the 2004 to 2008 period, spending totaled more than $72 billion above trend (see Chart 1)—of which, by our calculations, roughly $40 billion was in the oil sands. However, this amount, perhaps enough to build a dozen nuclear reactors, repave the Trans-Canada highway from Victoria to St. John's, or even rescue the Detroit Big Three (three times over) from the current crisis, did little to lift output in mining.
There are reasons behind the lack of increased production. Supply constraints and rapidly escalating construction costs greatly eroded the real value of this “extra” $72.4 billion. Moreover, new mining projects tend to have long construction phases, with the potential output from all this investment not yet due to come on stream.
Yet it still seems inconceivable that so much investment has resulted in so little output. Our forecast for resource sector production had been optimistic for 2008, but bottlenecks and delays resulted in a decline in output last year, at a time when prices were peaking. More specifically, from 2004 to 2007, real mining output inched ahead about 1 per cent per year and, in 2008, output retreated 3.2 per cent! Big investors truly missed the boat. And now, with most commodity prices having fallen precipitously, the incentive to get production quickly on stream has been much deflated.
Still, the payoff from this intensive investment will eventually materialize and, as the U.S. and global economies recover, commodity prices will also pick up. Hopefully, resource sector investors will be ready to benefit from the next wave of upward prices and perhaps too, we are all wiser, and planning for the eventual fall, as the cycle plays itself out once again.