Opportunities for the 1990s

Mr. Seymour

Reverend Sir, distinguished head table guests, members and friends of The Empire Club of Canada: It is my pleasure to welcome as our guest speaker today J.M. "Jack" MacLeod, President and Chief Executive Officer, Shell Canada Ltd.

In a research report dated March 5, 1986, a leading United States investment dealer stated that:

"The fundamental changes in Saudi crude-oil pricing policy... securing a significantly greater share of the world export market through netback pricing... has been primarily responsible for the dramatic decline in world oil prices since the beginning of the year... However, even Saudi Arabia is probably surprised by the rapidity and magnitude of the crude-oil price decline... Furthermore, the kingdom is now aware of and, more importantly, encouraged by, the effects of the recent price slump on the capital and exploration spending plans of the major integrated oil companies.

"Clearly, one of the most assured ways to permanently increase demand for... low cost... Saudi and other OPEC crude-oil exports... is to severely inhibit oil and natural gas reinvestment in the... high-cost producers... principally ... the United Kingdom, the United States and Canada. "Against this remarkable reversal of events... major producing provinces like Alberta... and companies like Shell. . . find they must reassess their future plans with considerable expediency and thoroughness. Contingency plans must be developed encompassing several price/time scenarios."

Evidence that this reassessment is well under way appears daily. Today's "Report on Business" said that "Shell Canada Ltd., bolstered by Alberta Government assistance of as much as eighty-eight million dollars, has dispelled some of the gloom in the oil patch with a two-hundred-andsixty-million-dollar experimental oil-sands product... Alberta has given the Calgary-based oil giant a three-milliondollar grant to assist in the ten-million-dollar first phase.

"However, Shell cautioned that it will assess the new solvent extraction method for taking oil from the tar sand for two years... and will not make a decision on proceeding with the two-hundred-and-sixty-million-dollar construction until the end of 1987."

Decisions of this magnitude require strong leadership born out of long and varied experience in the petroleum industry. Our guest today is eminently qualified on both counts.

Jack MacLeod is described by friends as a "tough, pragmatic, no-nonsense character, who plays a terrible game of golf." A native of Cape Breton, MacLeod studied metallurgical engineering at the Nova Scotia Technical College before joining Shell on graduation in 1954.

From this point, he advanced through a number of varied management appointments of increasing responsibility, including his appointment as Executive Vice-President in 1982. He held that position until he went to London to join Shell International Petroleum Co., part of the Royal Dutch Shell Group, in 1983. He assumed his current responsibilities on May 1, 1985.

Notwithstanding his major corporate responsibilities, Jack MacLeod also found time to serve as chairman of both The Canadian Gas Association and The Canadian Petroleum Association.

Ladies and gentlemen, it gives me great pleasure to introduce J.M. "Jack" MacLeod, President and Chief Executive Officer, Shell Canada Ltd., who will address us on the subject, "Opportunities for the '90s."

Jack MacLeod

Mr. Chairman, special guests, ladies and gentlemen, it is a great honour for me to be here with you today. Months ago, when I accepted your kind invitation, I had in mind that my theme would in some way relate to long-term challenges and opportunities for Canada. I was also convinced that one of the anchors for my remarks would be a vibrant petroleum energy sector wherein increasing investment and activity levels would be bolstering our nation's opportunities-both short and long term.

That conviction seemed appropriate so shortly after the Western Accord and related actions by governments had largely unshackled our industry from excessive taxation and oppressive control. Granted, there remained uncertainty about international oil prices.

Clearly, something happened on the way to the forum! On reflection, however, I have found it no less appropriate to frame my remarks within the title "Opportunities for the 1990s." Within that framework, I propose to deal briefly with three issues that I suggest have in common a critical need for management of change to position our industry and our country favourably for opportunities for the 1990s. Those issues are volatile oil markets, national fiscal planning, and international trade.

Since the early 1970s, it has become ever more evident that planning for uncertainty and management of change are critical to success in our industry. We have had at least our share of uncertainty and change to deal with.

Today, we must once again cope with a major discontinuity in our business environment. The implications of this discontinuity and how we manage in response to it go far beyond the oil and gas community. They cover a wide spectrum of the Canadian business community, reach the consumers of our products and, in turn, affect provincial and national economic performance.

The price of our base commodity, oil, has dropped like a stone-some sixty per cent in recent months. Furthermore, there is no compelling evidence that a bottom has been reached. Key questions are: What led to this event? and Where is price headed?

Within the industry, until quite recently, we have been cautiously optimistic that some reasonable degree of oilprice stability would prevail. Our conventional wisdom was that price would most likely continue a modest decline in real terms throughout this decade. We foresaw that, during the 1990s, the oil market would become demand-driven and real price would increase-gradually or otherwise-depending upon the relative individual influence of major Middle East producing countries.

While holding this general view, we have been acutely conscious of the forces in play in the market since the two oil shocks of the 1970s. Particularly since the 1979 shock, they have been exerting an increasingly destabilizing pressure on the market. These forces have included decreasing oil demand (ten per cent in six years), increasing non-OPEC production (twenty-eight per cent in six years) and growing diversity of interests within OPEC.

Notwithstanding this pressure, OPEC marshalled sufficient cohesion to manage the market, and consequently oil price, in a reasonably orderly way until late 1985. The key to OPEC's market management was Saudi Arabia's willingness to play the role of swing producer, within an otherwise somewhat loosely observed system of OPEC production quotas. The result was the unfolding over the last few years of the modest real price decline scenario.

Last October, Saudi Arabia decided it would no longer play a disproportionate role in limiting production. The market has collapsed for the simple reason that, since that time, the aggregate supply available from willing sellers has exceeded demand.

Failing new action by oil producers to control production, it appears that an average surplus of supply availability of some two million barrels a day will overhang the market during 1986. Furthermore, although the numbers can vary somewhat, it is entirely possible that a surplus of some significance can overhang the market for the next several years. This suggests depressed prices for some considerable time.

It is also possible, however, that within a few months the key players may re-exercise sufficient production restraint to at least partially restore price levels. This, despite it being highly unlikely that non-OPEC producers will reduce the relatively modest volume of some seven million barrels a day that, in aggregate, they trade internationally. This, also despite the fact that between last October and now, OPEC members have utterly failed to agree on allocation of production quotas that would effectively balance the market.

In the industry, we have no way of forecasting what will actually happen, or when it will happen, between the boundaries of some price restoration and continued price collapse. Although we cannot forecast specific events, I believe that four conclusions can be drawn.

Firstly, the price discontinuity we are experiencing signals an extended period of price volatility. Secondly, the band of uncertainty within which we must plan has broadened dramatically. Thirdly, it is not likely that we will see $20 U.S. /barrel or higher prices for some considerable time.

I shall withhold the fourth conclusion for a moment. The sky is dark and clouded, but it has not fallen.

Oil is a depleting resource. It continues to be a valid assumption that the market will become demand-driven during the 1990s, and environment for increasing price trends. It is the environment in which, once again, oil resources should provide a more sustainable and predictable contribution to economic strength and stability of producing nations, including Canada.

In the meanwhile, we have entered a period of severe adjustment in the industry. Last week The Canadian Petroleum Association announced the result of its survey and analysis of capital-expenditure plans for the resources segment of the industry. Compared with 1985 expenditures of ten and a half billion dollars, the CPA estimates that original 1986 plans for expenditures of some eleven billion dollars are being revised down to seven billion dollars, some forty per cent of which has already been spent.

It is apparent that severe adjustment has some severe implications, both internationally and here at home. Those implications include an exacerbated problem in management of corporate debt within our industry. They involve a considerably diminished capacity by our industry to maintain, much less increase, employment levels and to contribute to gross national product in the short to intermediate term. Some, but not all, of the diminished contribution by our industry will be offset by the benefit of lower energy prices to other sectors of the economy.

My fourth conclusion, withheld a moment ago, is that with the present outlook, skillful management of change has become absolutely critical to preserving the ability of our industry to grasp opportunities over the next few years and in the 1990s.

In summary, our industry must find ways to ensure that the opportunities for developing new reserves, which will be needed in the long term, are not lost. As best we can, we must keep many of the opportunities on hold, but alive during the depressed period of prices, and maintain a balanced view of the short term versus the long term. We must maintain financial stability within the industry and provide a fair return to investors.

Management of change is in progress within our industry, particularly in the resources segment. It is extending to our relations with governments concerning royalty and taxation levels. For those of us in the refining and marketing segment of the business, it must extend to our customer relations. Speaking for Shell, it has been, it is, and it continues to be our purpose to share the benefit of lower oil prices fairly with our customers. But the key words are share and fairly, because it is essential that we retain some of this benefit internally to strengthen our capacity to provide our customers with the improved service that they deserve and that we are committed to provide.

It is also essential that we generate cash from all segments of the business to fund the highest practical level of investment in the short term and, later on, in the opportunities that will increase in scope in the 1990s.

In my view, skillful management of change has become as critical for our government as for our industry, if our nation is to have the ability to grasp opportunity in the world around us in the 1990s. There are many dimensions of management of change by governments. Two that I wish to comment on briefly are national fiscal planning and international trade.

Successful management of change in these areas requires the setting of objectives, economic restructuring and tough fiscal control. The two issues are becoming even more closely interlinked as we face a future where the major driving forces in the world economy are technology and trade.

There are clear signs of danger for Canada in the future, unless the need for change is accepted and managed skillfully.

Despite our trade surplus, our share of total world exports has been declining. We have been a resources-based economy. As such, individual industrial sectors-forest products, mining and agriculture for example-have been subject to cyclical performance. Now we are in a severe downcycle in petroleum. Resources-based prosperity can no longer camouflage weakness in other economic sectors.

Resource commodities are losing their high-value status. We can see the successful invasion of markets-including Canada's-by products laden with information and highly sophisticated technology. Even today's automobile is not so much a product of steel, plastic and rubber, as it is of computerized functions, precise geometry and fine instrumentation. Today the highest value-added component of a car is knowledge, not the metals and plastics that are used to build it.

Our international competitors know this. The world-ranging products of Japan, Korea, and others are visible evidence of a massive technological buildup by our competitors and of their drive for world markets. If we fail to meet that competition, we do so at peril to our national prosperity. We would fail as a nation to grasp fully the opportunities of the 1990s.

Canada's ability to successfully adapt to and manage these profound changes will be greatly strengthened, I believe, by commitment to tough fiscal control and economic restructuring through free trade. I would now like to deal with each of these briefly.

As a country, we have come perilously close to losing control of our financial flexibility. As a country, we are like a corporation with its debt/equity ratio wildly out of whack. As you know, corporations in that state do not have much room to grow, meet the competition, innovate or manage change.

The federal government deficit, as a proportion of our gross national product, has grown alarmingly in the last few years. Our performance is worse than that of the United States and much worse than those of Germany and Japan. We are virtually at the bottom of the performance ranking among major developed countries.

In 1967, Canada's centennial year, the federal debt amounted to eighteen billion dollars. By 1985, it had risen to two hundred and twenty-five billion dollars. Without tough action to control the yearly deficits, it would rise to some four hundred billion dollars by 1990. It is gratifying that the Government has set out to reverse this trend-to reduce the deficit to twenty-two billion dollars or three and one half per cent of GNP, by 1990.

Some skeptics wished for more serious reductions in government spending and less reliance on tax increases. Some skeptics question whether interest-rate performance, declining oil prices and follow-through on implementation of promised spending reductions will frustrate achievement of the goal that the budget set. To a degree, I share all of those concerns.

However, I believe it is of the utmost importance that we support the significant step in management of change that this budget represents. This is important as a contribution to setting the climate in which government can take the next essential steps. It is important that the international community hear of our support as part of the process of restoring international confidence in the Canadian economy.

The Business Council for National Issues, of which I am a ..member, has strongly supported the budget. In concluding this segment of my comments, I would like to quote from the analysis of the budget by the C.D. Howe Institute, of which I am a director:

". . the February budget was a significant installment in a credible fiscal plan, but the next installment requires major structural changes in spending and taxation. There are grounds for skepticism that the Government has the political will to follow through with what are likely to be very difficult changes in the third year of its mandate. But the Minister of Finance has proven the skeptics wrong before. If Canadians can be convinced that the deficit is their problem, as well as the Government's, and if they can be persuaded to support the further changes that are essential, 1986 could be a significant year in securing Canada's long-term growth prospects."

I believe all of us should see and support the budget in that context.

Let us turn for a moment to the international trade issue. I consider that the Government has, taken a commendable initiative in moving toward bilateral free trade negotiations with the United States. Credible fiscal management will enhance our position of strength in these negotiations. But the trade issue has, in its own right, a critical need for skillful management of change.

In the trade area, we are becoming vulnerable to forces outside our control. Unlike most industrialized nations, we possess no certain and secure access to a major market, although we rely heavily on such markets. You know the statistics as well as I do. The U.S. takes about seventy-five per cent of Canadian exports, a trade that supports some two million jobs or about twenty per cent of our work force. This two-way trade is the largest in the world, one hundred and fifty-five billion dollars in 1985. Just the increase in Canadian exports to the United States that year exceeded the total of Canada's exports to Europe and Japan.

But is this market secure? Many Americans are disenchanted over their country's trading deficits. Last year, the U.S. had the worst trading record in its history.

Protectionist sentiments are growing in the U.S. This poses a threat to Canada. In fact, we have already been hurt by and threatened with quotas, higher duties and surcharges on a wide variety of our export products.

Here at home, we talk of Canadian options, even a yearning for the status quo. The status quo is a bankrupt response to fast-moving events. And they are making less attractive any option other than a comprehensive trade package with the U.S.

A bilateral agreement would open up secure access to our major market, our closest neighbour. There would be a rationale for specialization of Canadian industry and it would make viable larger, lower-cost production runs. It should point the way to greater competitiveness by Canada in global markets beyond the United States.

To quote the great U.S. inventor and diplomat, Benjamin Franklin: "No country ever was ruined by trade." One may add that a great many have built prosperity on trade-including, of course, Canada.

Liberalized trade has been an objective of various Canadian governments for half a century. Now we have an historic opportunity to take the next logical step in this process-to negotiate the removal of the main barriers to trade with the world's premier market.

There are fears that we cannot compete on equal terms. Or that we may lose our cultural identity and a degree of our sovereignty. I for one have considerably more confidence in our underlying strengths, our survival sense, our negotiating skills, and our willingness to accept a challenge.

The Canadian writer and journalist, Bruce Hutchinson, some years ago expressed his confidence in Canadian good sense. In an `open letter' to Prime Minister Pierre Trudeau, he wrote in part:

"The Canadian breed. . .has never failed a single decisive test when the alternatives were clear. If you can clarify the present alternatives, the right choice will be made again. Whatever else it may lack, the nation is rich in sanity."

The challenge today, as I see it, is to mange for change, to make our own choices-not let them be made by others. We prize our freedom and independence. These legacies, however, will never be secure in a stagnating or stuttering economy. They will be safeguarded more certainly in a vibrant, outward-looking, self-confident and internationally competitive society.

In summary, if my industry and our country are to grasp opportunity in the short term and more particularly in the 1990s, management of change will be critical in equal measure to the industry and the country.

The appreciation of the audience was expressed by Douglas Derry, a distinguished Past President of The Club.