Tuesday, January 27, 2009

What Goes Up...

What goes up must come down but what goes way, way up tends to come down an awful lot harder. That's the lesson of the Athabasca Tar Sands.

When crude oil prices were gamed last year upwards of $150 per barrel, Alberta's Tar Sands looked like a bottomless well of wealth. And, man, did that wealth get around.

I rode my motorcycle through the oil patch in the heydays. At a gas pump I met a young fellow who, as fate would have it, was from my own small town on Vancouver Island. He said how he'd been lucky to earn $30,000 a year as a labourer at home but was pulling in $130,000 a year as a labourer in the oil patch. The big-ass, top of the line pick up truck he was driving left no doubt that the kid was enjoying his newfound prosperity.

That was then, this is now. Oil has fallen to its rational price, well below $50 per barrel and, with the global economy in such a rotten mess, it's likely to stay there for a good while to come. Good news for some, bad news for others, especially if you're a province that got hooked on an enormous oil boom.

Booms touch every aspect of an economy. As more money starts circulating, prices go up - way up. The Tar Sands expansion brought an influx of workers from other parts of Canada, each of them a fresh consumer with pockets full of money. Oil companies found their Tar Sands project development costs skyrocketing in the supply and demand nutckracker they themselves had created.

Booms, whether technology or housing or oil driven, bring inelasticity to affected economies. The more expansion, the nearer the breaking point. Overheated economies rarely end well.

According to the Calgary Herald, Calgarians are bracing for a shock wave of bad news:

Calgarians will see more layoffs, cancelled projects and losses on investment this week and over the next several weeks as oil and gas companies deliver what analysts are predicting will be the worst fourth-quarter results in years.

The contrast with the third quarter, when many companies reported record profits, couldn’t be more stark. As oil prices plunged from all-time highs last summer and credit markets tightened, trust companies have chopped distributions to investors, stock prices have plummeted and 2009 spending plans have been cut to the bone.

UBS economist Jan Stuart warned in a published report last week there’s little in market recovery to fuel a rebound in commodity prices.

“Latest data confirm our projections of unprecedented, steep contractions of global oil demand in the last few months of 2008,” said the report, adding a three per cent decline in world demand in the fourth quarter will likely be repeated in the first three months of 2009 and demand is not likely to turn around until after the third quarter.

One constant problem with booms is that as notional wealth expands, so too does the willingness of business and individuals to take on debt. Debt, unfortunately, is not notional. Wealth can disappear but debt lives on and on and on. And when you do look to those assets you bought with your notional wealth and inflated borrowing power, you find that their value was as notional as your wealth.

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