Why NOW is a great time to invest in your furnace?

The oil roller-coaster

Operators of high temperature industrial equipment know one thing: it is very costly to run furnaces when energy costs are high. A barrel of oil in January 2008 cost $88.41; six months later on July 11th, 2008 it reached $147.27, before it came crashing down by December to $33.87. (Annual Energy Outlook 2008 with Projections to 2030. US Dept Energy).

The rise in the cost of crude oil led to a rush into new technologies that have in actual fact been available for many years but have not been widely implemented for many reasons, most of which have to do with the poor expectation of a fast ROI. For the first time in years, energy efficiency issues were being discussed at seminars and technical symposia and more importantly getting attentive audiences.

The energy price crash means that the immediate incentive to look at energy saving technologies has gone away. Without any financial investment, everybody in early 2009 is getting a 75% break on energy costs compared to last summer, without the need to go through the hassle and risk of an implementation project.

There are still some issues that have not gone away: the green argument, the global warming argument, the sustainability argument, the good corporate citizen argument, but the most important argument is the economic argument. In many industrial processes the energy cost component is a major component of the production cost and any reduction here quickly shows up on the bottom line. All of these issues will probably remain firmly on the back burner until we get hit by the next shock to the system.

The forecast

The US forecast for energy prices in 2008 made for a fascinating read, completely missing the wild convulsions in the market, and instead predicting a gradual decline in the price for the next 20 years. (Annual Energy Outlook 2008 With Projections to 2030. US Dept Energy) 

Some expert Blogs carry a few alternative views. With apologies in advance for paraphrasing them, here is what some said about the oil industry:

1) “Oil price and the $700B bailout” by Steve Austin,

In early 2008, at the first signs of recession, hedge funds pulled money out of the markets and parked much of it in energy sector stocks. These stocks were considered a safe bet because China/India were experiencing rising oil demand and the East/West economies were considered de-coupled. This race to invest in commodities generated huge profits for investors and provided an incentive to borrow more to invest.

When the banking industry collapsed, the hedge funds needed cash in a hurry, and they raised this by selling energy stocks, stocks which they had borrowed money to purchase. So down went the value of the energy stocks taking commodities prices with them. This was the root cause of the fall in the oil price.

As we enter 2009 the oil landscape has reversed dramatically from a year ago. The price of oil is lower than the production cost and new exploration and processing projects have been cancelled. China is flush with cash and is currently buying all the oil it can get for strategic reserves and OPEC countries are selling oil at any price to finance pet projects and keep populations sanguine.

A worrying underlying trend is the depletion of major oil fields which for 2008 is worse than predicted by 9.1% year over year. So when the economy recovers which it eventually will, expect a strong bounce in the price of oil.

2) “There will be no new refineries” by Giuseppe Marconi

He worries about the future ability to process extracted crude oil. He argues that oil companies will find it difficult to make the financial case for a new refinery because by the time the project reaches break even, the supply of crude will be in decline, due to the scarcity of the resource.

A new refinery takes anywhere from 5-10 years to permit, design, build and commission and 15 to 25 years after that to reach break even. With high energy costs a new refinery should provide a quick return on investment, however in any due diligence process one of the main questions that must be answered concerns the certainty of supply and cost of the feed going forward through the lifetime of the refinery.

A major uncertainty is the timing of so called “peak oil”, i.e. the moment in time where the world wide production rate of oil reaches its peak and thereafter begins an inexorable decline. Most pundits put this at between 2005 and 2015. A few dissenters with a more optimistic disposition stretch this out to 2030. Incidentally we past the peak oil discovery year in 1965 at about 55 G barrels/yr. Last year prospectors discovered about 10 Gb and we are using reserves at the rate of about 31 G barrels/yr increasing.

With reduced crude oil availability, look for volatile prices and lower production rates. Low production rates stretch out the amortization period of a new refinery and increase the financial risk. Then political considerations (NIMBY), ecological, and environmental concerns, etc, must be considered. Finally, any investor is almost guaranteed a protracted process for obtaining permits to build the refinery without any guarantee that the development costs will be covered if the application is turned down. It is hard to imagine how anyone would be even tempted to waste time on a refinery project at this time. 

3) And lastly, syndicated columnist Gwynne Dyer on April 28th, 2008 wrote Oil Prices: Another Prediction:

This was a prediction article that missed the catastrophic influence of a stock market system gone mad but nevertheless argued that energy prices will rapidly recover as the industrialized economies emerge from recession.

There is a recognition that unconventional energy sources might in the near term bring down the price of oil, at the cost of higher emissions, as is the case for the Alberta Oil Sands reserve, but by 2015 “the global tolerance for any process that involves high emissions of greenhouse gasses is likely to be very low.”

“Five years ago global warming was a distant worry in most of the world and in North America, where the denial industry had its headquarters, it was widely disbelieved.”  Gwynne has argued consistently that increasing atmospheric CO₂ levels are a concern and that we neglect this problem at our collective peril.

In a later articles Gwynne linked military planning for global climate change to increasing panic in the scientific community as it dawns on those concerned that things might actually be much worse than has been officially conceded. 

So why invest now?

Our accountant gave us a wonderful piece of advice last year during one of our planning sessions. Why invest in someone else’s company when you have your own company in which to invest? When you invest in your own company, you are in control. You control the spending and cutting decisions, and when the investment is in place you reap the benefits of efficiency and economy of operation. At the end of a capital project there is an owned asset that can not be arbitrarily proportioned down in real value by random fluctuations of a capital market gone mad and brokers slashing retirement fund assets.

The unfortunate reality of our industry is that when plants are busy and need new equipment, it is often the worst time to carry out a major project. Not only is it difficult to spare the downtime, but suppliers are also busy which results in high costs and long delivery times. During slow times there is hesitation about spending money. We should look to this period as a moment of opportunity - the economy will recover, fuel costs will increase, and a slowdown is a very economical time to prepare for the future.

There are very good reasons to execute projects at this time. Equipment manufacturers have seen a steep decline in business and are looking for work. Engineering contractors are working on projects that are too far along to stop, with the majority of short to mid term projects stalled pending a return to more favorable market conditions. Fabrication facilities are not running at capacity as they were in early 2008. With production levels generally low it is easier to book construction shop time and schedule down time to implement projects affecting pre-commissioned equipment. Construction material costs, especially steel, are generally down in price compared to mid 2008 costs and local contractor’s costs are generally down for the same reasons.

For the informed entrepreneur there are bargains available. There is also a lot of help available. All levels of government in most of the developed economies are actively seeking ways to increase industrial activity as a means of securing local jobs in hard times. There are grants, tax incentives, low interest rate loans, loan guarantees, green funds, strategic development funds, relocation funds, accelerated capital write down options, and scientific and R&D credits available for anyone willing to go through the application process.

A typical furnace project has a duration of 6 – 12 months. If commencing early in 2009 it can be on stream at roughly the same time that the world economy is starting to revive. A typical furnace project usually aims to improve production capacity, product quality, reduce fuel costs or reduce emissions, so the results of these projects shows up directly on the bottom line.

So while now is probably not the best time to build a steel plant or oil refinery, it is a great time to look at your heating equipment and start the process of planning what needs to be done to improve your High Temperature furnaces, and we at Burns Energy are ready, with the latest tools at our disposal, to assist you.