It has become the unavoidable chorus of market analysts and lawyers everywhere for the past six years. We all recite: “Since the 2008 global financial crisis....”
And repeat.
Annoying as it is, that phrase is an inescapable reference to a historic shift in the Canadian and world economies. For Canada, commodities have long been the sturdy bones of our economy. Our surfeit of oil, gas, timber, potash, grains and various metals and minerals was the armour this nation wore as the world was battered by the US investment banking frauds and porous regulations in the American housing market that eventually dropped the bomb on the global economy.
Upon that Canadian commodities skeleton, it's been argued, is firmly attached the financial and capital muscle that helped Canada, far better than most countries, power through – and forgive us for repeating it again – the global financial crisis. We were envied. Canada's former finance minister, the late Jim Flaherty, was admired around the international banking world for his sage management of our trusted financial services system.
Lexpert explored the thesis in a 2012 article that it was our resource base, more so than our well-regulated and well-stocked financial system, which attracted the bulk of investment to Canada. But now something strange and hard to swallow is happening. We'll put aside the oil and gas industry for the moment, where prices have been relatively stable since 2008. But prices for other commodities Canada amply produces – where one would have reasonably expected them to rise in conjunction with the dawdling but real improvements in the global economy – have slipped instead since 2012.
In part, that's because China's heretofore explosive growth above 10 per cent annually has tapered over the last two years to the still strong 8 per cent ballpark. Still, that's diminishing China's appetite for our resources. Add to that the fact that developing countries in Africa, Latin America and Southeast Asia, along with India and China, are increasingly pumping out their own raw materials to compete with us and depress global commodity prices. As a result, we've now slipped from being the eighth-largest economy in the world in 2006 to the 11th.
According to the World Bank's Commodities Markets Outlook report, published this past January, all key commodity prices, aside from energy, “declined significantly in 2013.” Fertilizers led the decline, down 17.4 per cent from 2012.
And this is bad news obviously for our mining industry and the law firms representing them. They've been slugged harder than most. Precious metals followed fertilizers down the drain, declining nearly 17 per cent. Base metals sank 5.5 per cent the past year.
Sure, other commodities produced in Canada have suffered also (agriculture was down 7.2 per cent). But, let's face it: there aren't too many potato or edible oil legal practices in this country. But there are tons of mining and energy lawyers.
Get to know the best energy lawyers especializing in electricity in Canada here in this directory.
So we focus on them. Who is thriving? Who is just surviving? And who is diving? And if, as it has been hypothesized, Canadian commodities are the horse pulling along our financial cart, what happens to the international respect and demand for our financial services industry when that horse unexpectedly goes lame?
Adam Chamberlain may be a regulatory guy — he is Borden Ladner Gervais LLP's National Leader of their Team North and Climate Change Groups, based in Toronto. But he's well entwined with the Canadian mining sector and the M&A and securities lawyers representing them. “The sense we get is that 2013 was a very, very slow year, from an investment point of view.”
“Moribund,” was how PwC put it in its January 2014 “Capital Markets Flash” that reviewed 2013. Mining, usually the “darling” of the Canadian deal sector, reports PwC, accounted for just three per cent of deal activity last year. That's a gutter ball. There was only one lonely deal you could affix the word “mega” to. That happened when Russian uranium producer ARMZ paid $1.3 billion to acquire the remaining shares it didn't own in Uranium One Inc., a Canadian producer.
The decline in deals and investment has meant, of course, a trickle-down effect throughout the mining industry, says Chamberlain. For instance, the amount of money available for junior mining companies to conduct exploration is reduced. Budgets for this year's exploration will have been fed by last year's investors. But those were few and far between.
More bad news gets piled on. “You also see larger mining companies,” says Chamberlain, that have “significant debt liability exposure and are having to find ways of either ratcheting back projects to keep them alive yet not spend as much money, or perhaps sell equity in projects to share that liability to keep them moving.”
The past 18 to 24 months, says Kevin Rooney, have been “tough sledding” for the entire sector, but especially the juniors. Rooney recently brought his entire securities team from the former Heenan Blaikie LLP to Baker & McKenzie LLP in Toronto, where he's a partner and mining lawyer at the firm. As if low commodity prices weren't enough pain for the industry, it has also been struck by “sharply higher” operating and development costs, “which are of course putting intense pressures on these [junior] companies.”
So we are reaching a point, says Rooney, “where a lot of juniors are getting to the end of their rope. Their cash reserves are drying up.” For mining lawyers, who have mostly been twiddling their M&A thumbs, the dire straits of the juniors has led to some work as the healthier mid- and large-caps shop for bargain-basement juniors with proven finds.
Some lawyers are getting work helping a dwindling number of juniors restructure and team up with fellow juniors in equity swaps in order to pool available cash and offer better prospects as they anxiously wait for a buyer to come along who won't spit in their face with an insulting offer. But there's no denying in mining that things are painfully slower. “It's not the end of the world. But people are having to be careful what they do and it has slowed down people's practices,” says Chamberlain. “People aren't in that much of a rush to hire people. And they are being careful about the commitments they make. And everyone is looking for work.”
Rooney says Canadian corporate law firms – especially those weighted towards mining and energy practices – are now trying to find ways to restructure the costs of their services to make them more affordable for clients. “There is still work but there is no question that the pressures that have been facing mining companies the past 18 to 24 months are for sure affecting law firms.”
With many Canadian mining companies operating in multiple nations and legal jurisdictions, it has proven costly to have separate legal firms representing them in those countries, “so one way to reduce their legal spend is to consolidate that.” Rooney cites a TSX-listed Canadian client that not only has operations here but also in Mexico and Peru. “So right now they have three sets of legal counsel. And it certainly adds to their legal costs. So as part of a global firm now I can offer them hopefully seamless service in several jurisdictions with a single point of contact.”
The mining sector's woes are giving firms with more extensive global reach a greater edge now when seeking mining work; one reason Rooney says he joined his law firm Baker & McKenzie.
Rooney can't single out a particular kind of lawyer in mining practices – regulatory, securities, what have you – doing better or worse than others. “Rather I think it is the lawyers that are adapting to the challenges instead of pretending that it is business as usual that are going to be successful. If they can find a way to reduce costs for a client and also add value in other ways, that's going to be very helpful and attractive to their clients.”
He gives an example: Baker & McKenzie recently developed an iPhone app that provides clients with side-by-side listing requirements for the world's major stock exchanges. That's “a valuable tool for anyone thinking of an initial listing, a supplemental one, or even a change in the exchange they are listed on.”
Regulatory lawyers in the mining sector, for the most part, have so far been relatively immune to the downturn. That's because projects initiated during the good times before 2012 are only now going through the permitting stage. But, warns Chamberlain, “if the decline that I saw in the past year was to persist for the next three or four years, that would change the number of projects entering in to the permitting cycle.” He doesn't get much work at the front end, the exploration stage.
As projects get closer to being fully developed and require environmental assessments or other significant permits, that's when Rooney gets called. “My view is if the market comes back even modestly over the next few years, there shouldn't be too much of a change there.”
Still, there is a hint of optimism out there for mining. Both Chamberlain and Rooney – like practically every other mining lawyer on the planet – attended the Prospectors & Developers Association of Canada (PDAC) convention in Toronto at the beginning of March. Last year the mining convention, the world's largest, had some very worried sounding attendees.
But the mood, if not chipper, was slightly more hopeful at this year's conference, says Chamberlain. There is a sense that the US is inching towards more stable growth. And there was chatter that perhaps there had been an over-estimation of just how bad things are in the developing economies.
“I think a lot of people are hoping that that the impact on the marketplace was more than it ought to have been .... People are optimistic, but guardedly so. I don't think anyone is expecting the market to go gangbusters quickly.”
Oil, steady as she goes
As commodities go, it's been a rosier story for oil, at least price-wise. (Gas has been the sorry sister, with, until this past polarvortexed winter, prices severely depressed for years because of low demand and North American oversupply.)
While most non-energy commodities tumbled dramatically downwards after 2012, crude oil held on. In fact, says the World Bank, the period between 2011 and 2013 was the least volatile stretch for oil prices in the commodity's history. After it reached $100 per barrel (bbl) in 2011 for the first time since 2008, crude averaged $104 bbl in 2013, a dollar lower than the annual average the year before. Back in January, the World Bank was predicting oil would continue its stable pace, averaging $103 in 2014. Mind you, this prediction came shortly before Russian President Vladimir Putin sank his teeth into Crimea and chomped it off the Ukrainian rump in March. Geopolitical fears can often drive up oil prices.
Certainly, oil and gas M&A was down dramatically in 2013. But that seemed to be more about politics than prices, as the federal government, both through policy statements and amendments to the Investment Canada Act, tightened restrictions around investments in the Canadian oil sands by foreign state-owned enterprises. As well, Asian buyers, after their buying spree of Canadian energy assets in 2011 and 2012, settled down to unpack their purchases and see how things fit. It also didn't help that high operating costs in the energy sector were dampening profitability and, as a result, the appetite for deals.
According to PwC, aggregate deal value in oil and gas in 2013 was just over a third of what it was in 2012, and was the lowest in several years. Foreign direct investment in 2012 – admittedly an unusually stellar year with the acquisitions of Canadian firms Nexen and Progress Energy Canada Ltd. by CNOOC Limited and Petronas respectively – was $29.2 billion. Last year, it was just $2.3 billion.
Yet where work slipped away for lawyers on the one hand, it picked up on the other. “What I am seeing from our law firm,” says Randall Block, a partner in BLG's Litigation and Arbitration Group in Calgary, “is we are very, very busy. The whole issue of product takeaway from Western Canada creates all sorts of projects and work, frankly.” The takeaway conundrum – how do we get our petroleum products to current and new markets when old pipelines are full? – has, for many oil and gas lawyers, spawned project development work, pipeline work, project regulatory approvals, environmental work, governmental relations gigs and, of course, contract litigation.
Not that M&A is totally dead. In fact, as 2014 got underway, there were strong signals the sector might be in for a welcome booster shot of deals this year. Two hopeful flares: On February 19, suggesting it was bullish on rising natural gas prices, Canadian Natural Resources Limited announced it would pay $3.125-billion cash to buy conventional oil and gas assets from Devon Energy Corporation. Then, on March 17, Calgary's Whitecap Resources Inc. said it would acquire a light oil and natural gas portfolio in Alberta and BC from Imperial Oil Limited for $855 million.
“There is a lot more positive press in the last two months on the price of natural gas,” says Block, who believes the Canadian energy sector will work through its takeaway issues, that key pipelines such as Northern Gateway and Keystone XL will get approved eventually. “I consider that the oil and gas industry in Alberta has weathered the natural gas downturn quite well, and I think things are moving forward.”
Nevertheless, there may be some shape-shifting going on among M&A lawyers in the energy sector, thanks to the prospects for liquid natural gas (LNG). Natural gas has had some hard times, trading for years in the $2.50 an Mcf range, thanks to the fact that we now know how to frack for it and dramatically expanded our supply and known reserves in North America as a result. But this winter, thanks to heavy draw-downs on supply due to an unusually cruel North American winter, prices for that commodity shot up to the $4 an Mcf range, injecting some much-needed profitability into natural gas producers from domestic demand.
Then, of course, there's Asian demand. Despite the recent price increase of North American gas, a whopping price differential between East and West would still make it profitable to spend billions constructing LNG plants in BC and shipping the liquefied gas to Asian markets. (At the time of writing, North American gas was trading at $4.36 MMBtu on NYMEX.) In Japan, imported LNG was going for $16.63 MMBtu, a healthy (for us) $12.27 spread. The question is, will the Americans, thanks to rapid increases in production that may see the US soon overtake Saudi Arabia as the number-one producer of oil and gas, beat us to market? Or is there enough Asian demand for both countries?
Over at Blake, Cassels & Graydon LLP, partner Michael Laffin, who heads the Energy Group and chairs the firm's Asia Region practice in Calgary, says several years ago Blakes began bulking up its energy practice groups with lawyers equipped with the expertise to handle the massive LNG projects, several of which are now approaching final investment decision stages for BC. Lawyers with the requisite regulatory, environmental, First Nation, contracting and other skills were brought on. “But seeing the pace of development in LNG is even greater than one might have anticipated, we're asking, ‘How can we further expand into these areas?'
Laffin says that means that lawyers, especially those in the oil and gas and energy areas, have now shifted, particularly from M&A, to project work. Whether it's midstream, such as pipelines, or big projects like Northern Gateway or LNG, work is there now for lawyers who must create the legal structures and contracts right from the point of supplying feedstocks (natural gas) to the shipping and buying of the final LNG product. “There is a whole new industry being born in the legal profession because of LNG. And it is big project work.”
For those energy lawyers who may be twiddling their M&A thumbs, Laffin continues, “some of their expertise is easily transferred, especially when it comes to how [LNG] projects should be structured from a corporate perspective.”
Might suffering mining M&A lawyers, sniffing the potentially lucrative work in LNG, switch gears as well? Not so much, suggests Calgary's Robert Engbloom, senior partner at Norton Rose Fulbright Canada LLP. “There are common components around the pure legal elements of M&A in those two sectors. But there is quite a difference in the underlying business. And to be an effective M&A advisor you have to have a very good understanding of the basics of the business.”
His firm has a few M&A lawyers who started in mining, then got exposure to oil and gas, and are capable in both arenas. “Others, like myself, are very familiar with the oil and gas M&A world. And I understand the principles in mining M&A. But I don't understand the mining industry nearly as well as I do the oil and gas industry. There is certainly some shifting, but I haven't experienced or seen a significant migration of people back and forth between the two resource sectors.”
For energy lawyers at least, the commodity picture seems positive. “Gas, I think that could go to $5 an Mcf,” says Laffin, adding the price will push up as Canadian LNG projects come closer to reality. Unlike others, he also isn't fretting over China's economic future, even if Chinese Premier Li Keqiang warned that his country's economy faces “severe challenges” in 2014. Still, Li maintained the government was aiming for a 7.5 per cent growth in GDP this year, after an increase of 7.7 per cent in 2013.
“I read these reports about China, about commodities, about their slump. China is going to get it right economically. There is no doubt about it. And we should not worry about them.” For the health of Canadian commodities, it might be a matter of China clearing the air. “The air quality in Beijing is of such [poor] quality now that the Chinese government is pouring billions into improving air quality,” explains Laffin. How will they do that? “It's going to be a move away from coal to natural gas from various sources,” hopefully including Canada. Indeed, depending on which source you check, China has pledged to spend as much as US$277 billion to reduce its air pollution.
Tethered together?
Given that, aside from fossil fuel products, Canadian commodities, especially metals, have lost their lustre, will it mean the shine will come off our financial sector as well? Not in Kevin Rooney's mind at Baker & McKenzie. “Our banking system is very strong. And I don't think that is dependent on commodities.” Even as metals slump, and as South America, South Africa and Australia build up their own mining finance infrastructure, Canada, points out Rooney, “is still the premier jurisdiction for mining investment. That is still unquestioned.”
The 1,500-plus mining stocks listed on the TSX and TSX Venture Exchange might not be raising the billions they were two years ago and before. But the financial sector, the capital markets, the brains and know-how that grease that machine, are still in Canada and highly functional, thanks in no small part to the stable cradle of our political and regulatory system.
“My experience in dealing with the independent investment banks, as well as the bank-owned dealers, is they have a real commitment to the sector,” says Rooney optimistically. “They have invested in it both in terms of their own personnel and raising money for this sector. I don't think it's just an interest in the sector when it's frothy. There's a genuine understanding that it is important to Canada, and it's a lifeblood for this economy.”
Our commodities and financial services systems are, no doubt, tied together, says Norton Rose's Engbloom. But neither does he see that a slump in demand for our natural resources will erode international respect for our financial system. “Clearly the strengths of our country in economic terms is our very, very strong and expansive resource base, coupled with a very strong financial base and very strong financial institutions. I think those two fit together very well, and they go hand in hand in supporting the strong position that each of the resource sector and financial sector enjoy,” says Engbloom.
“So in that sense, I see them linked. The resource sector is a very capital-intensive sector. And the finance sector is very strong and capable in providing financing and other financial services. So I view them as being quite symbiotic in supporting each other in becoming the strong industries that they are.”
Engbloom does not buy any criticism that the two sectors don't dance well together, that they sometimes get out of step with each other's needs and economic realities.
“From my perspective I would say they understand each other well and they work together well. Could we improve on that? I guess we can always improve on where we are. But I would have provided pretty high marks to both sectors. And high marks to how the sectors interact.”
Anthony Davis is a freelance business and investigative writer based in Calgary.
