Most hotel markets hate high oil prices—high energy prices cause transportation costs to rise, which can negatively affect travel activity. For hotel markets that are home to energy companies and production activity, however, high oil prices result in major projects, drilling programs, jobs, and business activity, which ultimately generate a significant boost in lodging demand. Given how long it has been since high oil prices have been a factor, many of us have forgotten—or have never had a chance to experience—how high oil prices impact lodging markets that are reliant on the oil sector.
West Texas Intermediate (WTI) oil has not been above $100 a barrel since late 2014, when the price of oil plummeted below $50 per barrel because of a supply glut caused by record production from the US combined with ongoing production increases from OPEC. The price collapse had a massive impact on energy-reliant markets in Canada: oil companies downsized, laying off thousands of employees, cancelling projects, and slashing capital spending programs in the process. For oil-dependent hotel markets, demand dried up just as new hotels that had started construction during the boom times opened, which spurred the added pain of rate wars in which hoteliers battled for the few guests that were still around. Trapped in this feedback loop of misery, with the price of oil between $30 and $70 per barrel, these hotel markets remained relatively stagnant for the remainder of the 2010s.
Flash forward to 2022, when the convergence of three global factors caused oil prices to spike back to previous highs: the rebound in the demand for oil from the tapering of the pandemic crisis; the near-decade-long lack of capital investment by oil companies, which is now limiting their capacity for increasing production; and the eruption of war in Ukraine and the associated Western sanctions on Russia, which has upended long-established supply chains and left many countries looking for new sources of oil and gas.
With the anticipation of increased activity in the energy sector in the wake of these changes, broad-based optimism has returned to oil-reliant lodging markets throughout Alberta, Saskatchewan, and Newfoundland. But the reality is that $100 oil does not benefit all energy-reliant hotel markets in the same way or to the same degree, and the emerging opportunities, where they exist, vary greatly depending on the type of oil-production activity that supports the lodging market and outside factors that can spur or inhibit growth in energy-related lodging demand.
The oil sector generates different kinds of hotel demand
There are generally four types of oil-production activity around which lodging markets are formed: the oil sands, conventional oil, upgrading and processing facilities, and corporate operations and planning. Each type of oil-production activity generates distinct forms of lodging demand.
Oil Sands
In the Alberta oil sands, lodging demand is mainly generated from the construction of major capital projects. Once these capital projects are completed and become operational, the lodging demand associated with construction subsides. The established operations nonetheless generate some lodging demand from mining and in-situ operations personnel, companies involved in maintaining upgrader facilities, transportation and logistics companies, and corporate travel.
Since 2014, global oil companies have significantly cut their capital spending on major projects and have focussed on utilizing their existing facilities. If oil prices remain elevated for a prolonged period of time, the economics of new projects could again become viable, and development activity would likely return and result in additional demand for lodging facilities. Although development activity will return to some degree, it is unlikely to return to the levels experienced during the last boom given the general expectation that the demand for oil will peak in the next decade, particularly with government policy encouraging a transition away from carbon-intense fuels.
Conventional Wells
For conventional oil resource projects, the activity surrounding oil or gas wells is the primary generator of lodging demand. A single well can generate a number of room nights for local hotels throughout its life. Pipeline construction, transport services, surveyors, and other professional services also generate local lodging demand.
All three phases of well development generate lodging demand: exploration and seismic crews seeking to identify the appropriate areas to drill wells; well drilling; and then well operation. Most crews work away from home and therefore require lodging.
Given the high intensity and flexibility engendered in the relatively small scale of these operations, well operators are incredibly responsive to changes in the price of oil. As the price of oil rises, additional drilling programs can be started, resulting in significant lodging demand growth in the markets where wells are being developed or exploited.
Oil Upgrading and Processing Facilities
Some lodging markets are oriented towards refineries, upgraders, and processing plants for the oil and gas industry. In these markets, a lot of lodging demand is generated from plant maintenance activity. Every couple of years, these facilities go through a process called a “turnaround.” Turnarounds are necessary maintenance periods that allow time for the upkeep of operating units to maintain safe and efficient operations. To conduct a turnaround, specialized contract crews come to the facilities for approximately six weeks to perform the necessary maintenance work. During this time, the lodging facilities in the market are typically full for the entire length of the turnaround, and the crews often require additional rooms in nearby markets.
Maintenance activity is not dependent on or responsive to changes in oil production activity. As such, it consistently provides a base level of lodging demand for hotels in these markets regardless of changes in the price of oil.
Corporate Operations and Planning
The larger cities that are close to oil-producing regions—Calgary, Edmonton, and Regina—are home to companies that own, operate, and service oil developments. In these markets, lodging demand is generated from business activities related to the operation of oil companies, the planning of future projects, and the manufacturing of goods for the oil sector. With the increase of business activity resulting from the increase in the price of oil, lodging demand will increase as companies return to growth mode and begin planning and executing new capital projects.
The four major factors that affect growth in oil-related lodging demand
Capital Spending by Oil Companies: As discussed, oil companies spending money on major projects, exploration programs, and drilling programs generates demand for hotels located in the vicinity of project activity. With the price of oil back above $100, capital spending programs are expected to increase significantly in 2022. If the price of oil remains around current levels, capital spending will likely increase more in 2023. Hoteliers can thus expect to welcome more oil-sector workers in the years ahead.
Oil Company Strategy: Following the collapse of oil prices in 2014, oil companies focussed on reducing expenses, improving efficiency, and paying down debt. In general, oil companies now have strong balance sheets and are experiencing massive profits with the rapid increase in the price of oil. However, oil companies have been primarily using the profits to buy back shares and increase dividend payments to shareholders, which does not translate into demand for hotel rooms. Once oil companies start allocating more funds to capital spending, hotels will see an increase in lodging demand from the oil sector.
Global Supply & Demand: The price of oil is a function of global supply and demand. At present, demand is growing, but supply increases are not keeping pace because of a confluence of factors: capital spending by oil companies has been at bare-bones levels for the past seven years, creating capacity constraints; OPEC has been cautious and made only moderate supply increases; ramping up production has inherent logistical and structural challenges that take time to resolve; and the current war in Ukraine has disrupted the flow of Russian oil, which is the world’s second largest oil producer. The general consensus among energy analysts is that demand will outpace supply in the near term, keeping prices high. This should push Canadian oil companies to increase their capital spending, which would generate more demand for the hotel sector.
Government Policy: The Canadian Government’s policies will continue to have a significant impact on the health and growth of the energy sector. Greenhouse gas polices, project approval processes, taxation, and “red tape” all play a critical role in the investment decisions that energy companies make, which in turn shape the business activity that these companies generate. The current regulatory framework and policies have made it difficult to attract additional investment into Canada’s oil sector in comparison to other areas, such as the US or the Middle East. To invest in Canada, energy companies need clarity around the government’s energy policies and the costs associated with them, or else they will opt to invest in other markets where energy policies are perceived to be more reliably stable.
Key takeaways and opportunities
Better times are clearly ahead for the hotels located in Canada’s energy markets for the foreseeable future. With oil prices hovering around $100 per barrel, drilling activity is already increasing, and additional investment and activity are expected so that oil production levels can meet growing demand. Strong lodging demand growth is underway as we emerge from the pandemic and oil companies increase their capital spending budgets to increase production. The return of lodging demand will start to fill up the many new hotels that were built in markets reliant on the energy sector during the last oil boom, providing hoteliers with the opportunity to increase room rates. Although performance is expected to improve substantially, the return to 2014 RevPAR levels is still likely a few years down the road.
From a hotel investment perspective, there will be many opportunities to purchase a hotel at a steep discount to replacement cost. Hotel owners in energy-reliant markets face refinancing challenges, requirements to increase the equity in their properties, and brand-mandated property improvement plans, and there will likely be instances of strategic selling. Very attractive returns can be achieved by investing in hotels in energy-focussed markets; however, it is imperative to have a team with the expertise to properly evaluate the market and the hotel asset, identify the upside and the potential risks, and ensure that the property is acquired at an appropriate price. Energy markets will always be volatile with high peaks and low valleys, but now is a good time to jump in and realize the benefits of the ride up.