After three years of stable oil prices, the energy sector was thrown into a tailspin when oil prices
plummeted in the second half of 2014—dropping about 40% in a very short time. This rapid decline
is having a profound impact on Canadian lodging markets that depend on lodging demand from oil
production.For these markets, the low price of oil presents significant operational challenges. Lower
demand means lower revenues. Moreover, the preceding era of high oil prices—and the robust
lodging demand associated with those high prices—lasted for so long that the upswing in the cycle
was taken for granted, making the sudden negative shift in market fundamentals seem even more
severe. Oil-dependent lodging markets fall into four different categories that are responding in
distinct ways to the low oil-price environment. After examining each category in detail, we will
consider two market vulnerabilities that can compound the negative effects of the downturn. Lastly,
we will examine the cycles in oil commodity prices and capital investments to try to get a handle on
what hoteliers invested in these oil-dependent markets can expect in the short and medium terms.
Four Market TypesThe timing and severity of the impact of low oil prices on lodging markets will
depend on the type of oil-related activity driving the market. 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 and responds uniquely to the low
price of oil.Oil SandsIn the oil sands, lodging demand is mainly generated from the construction of
major capital projects. The oil sands have benefitted from billions of dollars of investment over the
past few years, but as these capital projects are completed and become operational, the lodging
demand associated with construction subsides. As was the case during the global recession, oil
sands companies are now postponing or cancelling their major capital projects, focussing instead on
existing operations. This will have a major impact on lodging demand in these markets.Given the
dependence on construction crews, project managers, and consultants as a source of demand, the
near-term outlook for lodging demand in oil sands markets is bleak. The established operations do
generate some lodging demand from mining and in-situ operations personnel, companies involved in
maintaining upgrader facilities, transportation and logistics companies, and corporate travel, but
without construction activity the demand for lodging will be weak in the immediate future. Once oil
prices increase to a level where the economics of the postponed projects become viable again,
development activity will likely return and revive demand for lodging facilities.Conventional Wells For
conventional oil resource projects, the activity surrounding oil or gas wells is the primary generator
of lodging demand. A single well has the ability to generate a number of room nights for local hotels
throughout the well's 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 locate the appropriate areas to drill wells; well
drilling (which involves three to four crews of four to five people needing accommodation from the
start of the drilling to its completion); and then well operation. Although each company approaches
scheduling differently, crews typically work two weeks of 12-hour days and then get a week off. 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. For this reason, the impact of low oil prices hits these lodging markets
much more rapidly than other oil-dependent markets. Once oil prices drop to a point where it does
not make economic sense to continue to develop additional wells, oil companies simply limit their
drilling programs, and the workers associated with the drilling activity leave the market. However,
once oil prices recover to a level that makes drilling and the development of wells viable again,
lodging demand quickly bounces back.Oil Upgrading and Processing FacilitiesSome 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 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. These processing facilities will continue to operate through the economic downturn and will
require ongoing maintenance regardless of the price of oil. As such, the impact of the drop in the
price of oil on lodging markets associated with these facilities will be minimal in comparison to
markets whose lodging demand depends on other sources of oil-related activity.Corporate
Operations and PlanningThe 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. The
decline in the price of oil has had a negative impact on these companies, and has resulted in layoffs
and financial difficulty for the smaller operations. However, the negative impact of the decline in oil
prices on large city lodging markets will not be as significant as it is for markets that rely directly on
activity related to oil extraction. This is due in part to the economic diversification of large cities.
Compounding Factors: New Supply and Rates WarsThe fallout from the low price of oil harbours two
additional dangers that go beyond a simple drop in demand: new supply coinciding with low
demand, and rate wars.New SupplyThe recent energy boom spurred a lot of interest in hotel
development in markets both large and small. Many of these hotel projects are now under
construction and will be opening for business over the next couple of years. The addition of more
guestrooms to a market will compound the impact of a drop in demand on occupancy levels. With
the decline in demand, the overall pie gets smaller, but the addition of the new hotels adds more
players wanting a piece of that pie. The end result is a highly competitive environment in which no
one gets a satisfying amount of the pie—except the guest, who will likely get lodgings at a significant
discount. Hotels that were once accustomed to turning away demand midweek may now find
themselves with empty rooms. New hotels may not ramp up as quickly as projected, and their time
to stabilization may be prolonged. These new hotels are nevertheless positioned to compete
aggressively in the markets they enter, as it is the older lodging supply that suffers the most when
new lodging supply enters a market during a downturn.Rate WarsWhen hoteliers start to feel the
pressure of declining occupancies, they have a tendency to shift their approach from maintaining the
average room rate (a prudent operating strategy) to increasing market share through discounting
rates (a counter-productive operating strategy). They hope to take demand from their competitors
and see their occupancy increase and revenues rise. This short-term thinking has long-term negative
consequences, as it ultimately pushes competitors to offer similar if not greater discounts to retain
their demand base, setting off a rate war that benefits no one—and hurts everyone. In a very short
time, a rate war can cause the average room rate for a market to plummet, and it can take up to
five years for a market to build back the rate integrity that was lost in a matter of months. With oil
prices expected to increase throughout 2015 and projected to increase further in 2016, the oil sector
is expected to start to recover next year. However, lodging markets that engage in rate wars will be
suffering for many years beyond that.Oil Prices, Market Cycles, and Lodging DemandOil prices are
volatile by nature—a point that was easy to forget during the years of stable oil prices and booming
oil development. Historical data show that periods of rapid and robust growth are typically followed
by a drastic correction. From a lodging perspective, this means that hotels experience boom years of
high occupancies and strong average rate growth, followed by bust years of low demand and an
intensely competitive environment where hoteliers have to fight to sell rooms and maintain their
share of the market. If properly managed, strong performance during the boom years will make up
for the soft years and allow an investor to hit appropriate returns over a long-term holding period.No
two downturns are identical. Each downturn is caused by a unique set of issues related to not only
supply and demand but also broader economic and political issues. The price of oil fluctuates up and
down both widely and rapidly. Given these complexities, we are fundamentally unable to predict the
price to which oil will recover or the timing and duration of a recovery. During the previous decline
from 2008 to 2009, the price of oil dropped from a high of $134 per barrel in July 2008 to a low of
$39 per barrel in February 2009 and then rebounded substantially within a 12-month period to $74
by December 2009—none of this could have been reasonably predicted beforehand. Because
predicting what the market is going to do is basically a matter of luck, it is important to avoid
anticipating the market. Instead, hoteliers should implement sound operating practices to maintain
rate and increase competitiveness during the downturn, seek efficiency in operations, and be patient
and ready to act when the market solidifies. The drama of the recent plunge in oil prices may seem
catastrophic, but based on past market cycles it is perfectly reasonable to expect things to improve
in the not-too-distant future. The following table illustrates oil sands capital expenditures and
operating costs from 1997 to 2013. The average annual price of West Texas Intermediate Oil in US
dollars is provided for comparison. It should be noted that data for 2014 are not available at the
time of this article.As is clear from the above graph, the oil sands have seen a massive progressive
increase in investment since 1997. There were only two brief periods of contraction, one in 2003 and
the other in 2009. The major decline in 2009 was due to the global recession, which caused the price
of oil to plummet. Owing to the low price of oil, many oil companies put their projects on hold until
the price of oil rebounded and again reached historic highs. Capital expenditures shot back up in
2010 to nearly the level set in 2008, and then progressively surpassed all previous records each
year through 2013. During the periods in which capital expenditures declined, operating costs
increased progressively without interruption.The graph also reveals that there is a correlation
between high oil prices and capital spending in the oil sands. A sharp drop in the price of oil is
connected with temporary cutbacks in capital spending. When the price of oil regains strength, there
is an intensification of capital spending as oil companies hasten to get their shovels in the ground as
soon as conditions are favourable enough to do so. This performance history sheds some light on the
likely effect of the current drop in oil prices. The lower price of oil is expected to cause temporary
cutbacks in capital spending, but robust investment will likely resume once oil markets stabilize and
regain strength. Depending on where the price of oil settles, the massive investment that took place
from 2010 to 2013 may not be replicated for some time, as this investment was stimulated by the
atypically high price of crude. ConclusionStakeholders who invest in lodging markets that are heavily
reliant on the energy sector need to understand what they are getting into from the start.
Historically, these markets have been volatile, experiencing years of strong growth punctuated by
years of drastic declines. The hotel sector is unique in that it has to deal not only with the impact of
oil-price volatility on lodging demand, but also the potential for new hotel supply and the onset of
rate wars. These dynamics can contribute to the overall success or failure of a hotel investment. As
long as the current slump in oil prices continues, hotel markets that rely on demand related to oil
production are likely to experience challenges. However, the pressure will likely ease over time—
already, most crude oil forecasts put year-end prices at a higher level than the current price, and
further increases are projected for 2016. As oil prices increase, oil companies will likely increase
their capital spending (after the drastic cuts in 2015), increasing the demand for lodging facilities
once again.