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Providing coverage of Alaska and northern Canada's oil and gas industry
May 2009

Vol. 14, No. 20 Week of May 17, 2009

Winning the war is next

Canada’s industry turns to next growth cycle; CNQ calls for unified approach

Gary Park

For Petroleum News

A concerted push-back by Canada’s petroleum industry against out-of-control costs from contractors, suppliers and labor is starting to yield results, along with a warning that the gains could easily be wiped out unless companies prepare for the next boom by forming a united front.

The message was delivered in the clearest terms May 8 by Steve Laut, chief executive officer of Canadian Natural Resources (better known as CNQ), who said “it’s just a matter of organizing ourselves so we don’t (compete) head on head (and) ensure that while projects proceed concurrently, they are timed to avoid a simultaneous demand on specific contracting and labor components.”

“You don’t want everyone to do civil (engineering) work at the same time, or electrical work at the same time. You need to stagger projects, even though they’re concurrent,” Laut said.

He told analysts that the current group of major players in the oil sands is a “fairly well-disciplined group,” but also warned that “when certainty in commodity prices returns, players are likely to start construction on a cost-plus basis, with the ultimate concern that poor productivity and inflation will all reignite and we will all be back in the same unfavorable position” that saw prices for major projects overrun budgets by 50 percent and more.

“It will take a considerable effort from the industry to ensure we don’t return to a minimal focus on cost control that we have seen in the past from owners, contractors, regulators and labor,” he said.

Horizon C$3B over estimates

CNQ, despite its efforts to get a grip on costs as it entered the oil sands by proceeding with the Horizon project in stages and by building an airstrip to fly workers and contractors in and out, still ran about C$3 billion over initial estimates with its C$9.7 billion first phase coming on-stream in February and now pumping 75,000 barrels per day into sales tanks as it ramps up to capacity of 110,000 bpd.

Laut describes the results as a “successful execution strategy,” but acknowledges that there are lessons to be learned from the experience, which included design flaws for some components and incorrect metallurgy for fabrication.

Although work on Tranche 2 is already under way, Tranches 3 and 4 will only go ahead when CNQ is certain it can implement its lessons even more rigorously.

Laut said contractors’ capacity has increased significantly during the downturn and the recent consolidation of operators (the planned merger of Suncor Energy and Petro-Canada) should allow for a more orderly and effective scheduling of construction projects and major turnarounds.

Greg Stringham, a vice president of the Canadian Association of Petroleum Producers, commenting on the indications from some companies that future projects can be profitable at oil prices of US$60-$70 per barrel ($80-$100 was previously viewed as the threshold), told the Globe and Mail that re-designed projects will focus on building projects in “bite-size” stages and outsourcing fabrication jobs to Eastern Canada.

The new focus will also be on seeking fixed-price contracts to avoid the inflation that accompanied cost-plus agreements.

Laut conceded that coordinating industry efforts will be “hard to do in reality,” although it could happen by default.

Paul Verhesen, president of Clark Builders, which provides construction services across Western Canada, doubts companies will be eager to defer to competitors when “they all want to be first.”

However, he thinks the operators will have success in proceeding on a “more sustainable, cost-effective” basis.

Recent cost reductions

What has happened over recent months has been a sharp scaling back of costs, according to CNQ, Suncor, Petro-Canada, Royal Dutch Shell and Husky Energy.

Laut said conventional drilling and completion costs, especially for deep gas drilling, are 10-15 percent below 2005 levels, largely because of improved productivity and technological innovation, with a smaller contribution from lower service and supply costs.

He rates those gains as “impressive,” given that steel prices, which account for 28 percent of drilling costs, are up 48 percent since 2005 and regulatory costs, which account for 6 percent of spending, are up 35 percent.

Petro-Canada believes it could shrink the costs of its proposed Fort Hill oil sands mine by 30 percent to under C$10 billion, and the price tag for the joint Sunrise project by Husky and BP has been slashed by 44 percent to C$2.5 billion.

Suncor’s Chief Operating Officer Steve Williams said the cycle has turned through a “systematic, broad-fronted attack on costs. … We’re making real and substantial progress.”

Imperial Oil Chief Executive Officer Bruce March said that although the cost estimate for the Kearl oil sands project has climbed above its original target of C$8 billion there has been enough headway on costs that “we should have something exciting to share with you in the next several weeks.”

He suggested that Imperial’s snail-like pace in recent years could “win the day, at least in the next four or five years.”

Suncor has shrunk the cost of producing a barrel from C$41 in the final quarter of 2008 to C$33 currently and is chasing a further cut of 10-15 percent.

Shell is taking a hard line with vendors “around cost and cost performance” as it moves towards a late 2010 deadline for completion of a C$13.7 billion expansion of its Athabasca oil sands development.

Enbridge Chief Executive Officer Pat Daniel predicted “some notable decreases in costs (are on the horizon), but it is hard to quantify because it’s an early stage. We’re seeing far more competitive bidding from contractors for new projects.”






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