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Alberta oil sands facing a new enemy Financial crisis forces a corporate retreat from oil sands; billions of dollars of planned investment now on the shelf; Alberta government urged to rethink royalties; long-term impact on planned projects uncertain, but immediate impact is severe Gary Park For Petroleum News Shifting sands
The oil sands of Alberta are living proof of the old adage: The bigger they are the harder they fall. Even faster than they grew from a marginal resource to a key element in North America’s energy future, attracting capital spending estimates of C$317 billion over the next 22 years, the oil sands have gone into a tailspin, induced by the collapse of oil prices that did more damage in a few months than years of cost over-runs, shortages of construction labor and materials and the threat of harsh climate-change measures. Petroleum News’ Canadian correspondent Gary Park examines the fallout from a drastically revised oil sands agenda and the chances of a recovery in a two-part series. Those who trumpeted the virtually unlimited commercial potential of Canada’s oil sands may have finally met their match after years of fending off skeptics and critics.
Since production of tar-like bitumen made its debut 40 years ago, the deposits of more than 300 billion barrels that sprawl across 36,000 square miles of northern Alberta have been the object of ridicule, scorn and even contempt.
Once dismissed as a scientific experiment and a pure mining venture of no consequence in the global oil equation, the oil sands, through intense lobbying by government and industry, are now widely recognized as the world’s second largest proven concentration of oil after Saudi Arabia.
More importantly, the industry view of the resource changed dramatically when operating costs came down from about US$40 per barrel to US$11-$12 around the turn of the century as technology and reliability improved. But the fleeting promise represented by that trend was short-lived, with costs now back at the US$40 level.
Production from mines and in-situ projects is currently 1.3 million barrels per day and was on track to reach 4.5 million-5 million bpd by 2020 through planned investment in mines, upgraders, refineries and pipelines calculated at upwards of C$170 billion.
Dreams evaporated Then the financial crisis hit and the dreams evaporated faster than at any time during a prolonged period of rapidly rising labor and materials costs, higher Alberta royalties, a phased elimination of federal capital cost allowances for oil sands projects, the uncertain impact of climate change initiatives by Canadian governments and the incoming Obama administration and a losing environmental battle for the hearts and minds of Canadians.
“The economic times have come upon us very, very quickly,” said Alberta Deputy Premier Ron Stevens. “The price of oil has dropped by over US$100 per barrel in a handful of months. The stock markets have been cut in half in a matter of months and the credit system has become frozen or near frozen.”
Since markets and oil prices started their spiral from benchmark highs, the corporate pullback from the oil sands has answered those calling for a more manageable, measured pace of expansion.
But, the worry now within industry and government circles is that many of the projects either delayed or shelved over the past three months — estimated by CIBC World Markets to affect more than C$100 billion worth of investment and 800,000 bpd of the 1.6 million bpd of incremental production it had expected over the next five years — may have been irretrievably lost. Stalled upgraders alone carry a value of at least C$50 billion.
“These are changed circumstances,” said Bob Skinner, senior vice president of StatoilHydro Canada. “If oil prices remain low for a long time, it becomes problematic whether you could proceed with oil sands plans that were developed when oil prices were double what they are now.”
Geir Jossang, president of StatoilHydro’s Canadian division, said his company is maintaining financial flexibility by reducing “short-term investments and deferring things we need not necessarily go ahead with right now.”
Initial fallout severe While the eventual consequences of slowing or abandoning projects are being pondered, the initial fallout has been severe.
The construction industry has slashed its workforce requirements for the heart of the oil sands region to 22,000 from 44,000 for 2010.
The Canadian Association of Petroleum Producers has wiped an average 60,000-70,000 bpd off forecasts it released only six months ago for oil sands production over the 2007-12 period, reduced its 2012-17 forecast by 300,000 bpd to 2.83 million bpd in 2017 and lowered its 2020 target to 3.27 million bpd, off 1.23 million bpd from its low-end outlook in June.
CAPP Vice President Greg Stringham said oil sands developers are now on a moderate-growth path and may even benefit from the economic downturn if costs fall enough to restore the economics of projects now on the shelf.
But Justin Bouchard, a research analyst with Raymond James, said it remains to be seen if labor costs will fall as much as those for materials (steel alone has dropped by two-thirds from its peak levels) to make mega-projects viable again.
“We fully expect costs to come in lower, but the big question is how much lower?” Bouchard said. “Our concern is that labor and contractor rates may be stickier in the near term than expected.”
Long-term recovery expected Over the longer term, interest in the oil sands is certain to recover, said Don Thompson, president of the Oil Sands Developers Group, a nonprofit, industry organization that defines and addresses the sector’s regional issues.
“The world continues to be hungry for energy and the oil sands will continue to be a major source of energy security,” he said.
And, regardless of the number of deferred or cancelled projects, there will be considerable investment to keep the existing facilities operating, Thompson said.
Encouraged by hints from Alberta Energy Minister Mel Knight in December that the government is prepared to do an in-depth analysis if it becomes clear royalty increases have blunted Alberta’s competitive edge, CAPP President Dave Collyer said the province must show a “sense of urgency” to ensure it remains economic against other jurisdictions in conventional and oil sands production.
“That involves the fiscal structure; that involves the regulatory framework; it involves greenhouse gas policy. …” he said.
Growth will moderate Peter Tertzakian, chief energy economist at ARC Financial, wrote in the Calgary Herald that oil sands’ growth will moderate significantly from earlier projections as companies “weigh all the issues, including the cost inflation that arises from aggressive over-investment … in a remote area that has got a lot of environmental baggage” and absorb the lessons of the oil price crash.
However, he said it is important to understand that the current wave of budget cuts mostly affect upgrading plants.
“Although cost inflation, regulatory uncertainties relating to climate-change legislation and low oil prices have changed the sentiment on all projects, upgraders are the most capital-intensive component of the multibillion-dollar flow,” Tertzakian said.
”The realization is setting in that it will become more economic to pursue building upgrading facilities at existing refineries in the United States, although where the money will come from to do that is questionable, too.”
Tertzakian said that prior to the financial crisis expectations were high that Alberta upgraders would process 75 percent of the province’s oil sands production, up from 60 percent today. He now thinks that share will actually decline to 55 percent by 2015.
He told the Financial Post that before they embark on a new round of decision-making, companies will pay closer attention to the cost inflation that arose from aggressive over-spending in Alberta and, based on the lessons of the past few months, will be more sensitive to the potential for oil price crashes.
They will also be forced to think harder about whether they want to be in a business with such a poor environmental image, Tertzakian said, noting that the “environmental lobby has done a marvelous job of disadvantaging the oil sands.”
“That is the reality. It’s damaged goods and it is a high-cost producer,” he said.
In a final word for these difficult times, Knight said the Alberta government accepts that the new price range for oil is “not conducive to any new investment.”
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