Canada’s risky energy windfall


Canada’s risky energy windfall


Canada’s risky energy windfall


Could rising costs actually imperil Alberta’s oil sands bonanza?


When Alberta Premier Ralph Klein travelled to Washington last month and met with Vice-President Dick Cheney, he brashly suggested the beleaguered U.S. Republican party might find salvation in Alberta’s vast oil reserves. “It would be politically wise for him to travel to the oil sands,” said Klein, noting the trip would shift focus away from unstable oil countries in the Middle East, and toward a made-in-North America solution to dwindling world oil supplies. Klein’s visit south, however, was more theatrics than trade mission. There is no lack of interest in Alberta’s oil, which at 175 billion barrels of recoverable bitumen places Canada second only to Saudi Arabia in oil riches. Suitors from China, the United States, India and France are all scrambling to get a piece of the action. The provincial government is so flush with oil money that it was literally giving it away through its $400 “prosperity cheques” for each Albertan. Such is the mentality amidst one of the greatest hydrocarbon booms in human history.

But as with any boom, where the money flows as if part of some endless stream, there is a cautionary tale. For decades, people warned that the oil sands were prohibitively expensive and complicated to refine. Unlike conventional oil that’s sucked up like water from under Middle Eastern deserts, this oil is locked in a mixture of greasy clay and sand,

hence the name oil sands or tar sands. But with the surge in oil prices (now close to $75 a barrel compared to about $20 a barrel less than five years ago), oil companies all over the world have thrown caution to the wind. Billions of dollars have been spent on the oil sands and as much as $100 billion more is expected to be spent in the next decade. Even with all this money at stake, few in the industry are talking about the challenges any-

more with any measure of concern. But they still exist, and for all the confident optimism of oil executives, those challenges now appear as daunting as ever.

One of the early symptoms of the stampede into northern Alberta, where the oil sands cover about 600 sq. km, is shortages—everything from porta-potties in Fort McMurray, the working-class hub of the oil sands, to office space in Calgary.

Basic necessities, from steel


to the giant tires used on mining trucks that scoop up the oil sands, are scarce. Of greater concern is the shortage of skilled workers.

About 30,000 more workers will be needed by 2010 as more projects get built and production goes up, says Greg Stringham, vice-

president of the Canadian Association of Petroleum Producers. “That’s really where the pressure is right now.”

This overheated market has caused budgets to balloon. The cost of Shell Canada Ltd.’s expansion of its massive oil sands project went up by 50 per cent this year alone, from $7.3 billion to closer to $11 billion—a big blow for the company and for the confidence of investors. Companies have gone to great lengths to deal with labour concerns. Canadian Natural Resources Ltd. built an airstrip on its site to ferry workers to and from work. Another company, OPTI Canada Inc., is building large sections of its project in modules in Edmonton to tap into that city’s labour market. Companies have also been looking outside Alberta—from Newfoundland to China— for pipefitters, welders, plumbers and engineers to work on the oil sands. The problems will be resolved over time, say analysts, but not before squeezing already-thin profit margins in the oil sands (about 15 per cent compared to closer to 30 per cent for a conventional oil project).

One of the key variables facing most oil sands projects is natural gas. Huge amounts of it are burned in the refining process, and if natural gas prices rise faster than conventional oil (as they very well might), margins get squeezed even harder. One major oil sands producer, Canadian Oil Sands Trust, reported that per-barrel production costs rose from $19.40 in 2004 to $26.34 last year,

due largely to a spike in gas prices. Many companies have hedged their bets by investing in natural gas. Others, like OPTI, which has partnered with Nexen Inc., have based their project on a new technology called gasification, which burns petroleum coke, an oil sands by-product, instead of natural gas. “For a project that’s going to last 40 years, it greatly insulates us from commodity price changes,” says Sid Dykstra, OPTI president and CEO.

All that gas is needed primarily to boil vast amounts of water to separate the bitumen from the sand. Up to four barrels of water is needed for every barrel of bitumen processed, and ensuring reliable access to that much water is no easy task. Analysts expect demand will only increase with newer in situ projects, which inject steam underground to separate the bitumen and then suck it to the surface. Needless to say, environmental concerns about water use are mounting.

These challenges—not to mention increasing pressure on companies to find ways to cut their C02 emissions—have forced companies to make major investments. “The key is technology,” says Rick George, president and CEO of Suncor Energy Inc., one of the oldest and largest oil sands players. “We need to work toward reducing our energy intensity and our emissions, continuously,” he says. Suncor spends about $100 million a year on research and development alone, says George.

Resting on old technology is not an option. “Even the existing projects, that look like they’re making lots of money, are continually having to upgrade to match the everchanging and more stringent standards,” says Tom Ebbern, a managing director at Tristone Capital Inc. in Calgary.

The oil sands are still a work in progressdeveloping new techniques even as production has surged ahead (surpassing one mil-

lion barrels a day and expected to triple by 2015). This has inevitably caused other basic challenges: run-of-the-mill screw-ups and delays. In May, Syncrude Canada Ltd. was forced to shut down its new $8.4-billion expansion for three months after residents in


companies would say they had to be economic in the range of $20 to $25 a barrel long-term, over 50 years,” says CAPP’s Stringham. “Most have moved that range up to say, long-term these projects are going to have to be economic in the range of $35 to $40 a barrel.” Managing huge oil sands expenses while trying to predict the cost of oil in 50 years is no easy task. “That’s the balance you need to think about in terms of making investment decisions in the oil sands business today— what’s your price forecast and what are the capital costs,” says Dykstra. Some analysts now say oil companies will need closer to $50 a barrel long-term. That’s more than double

Fort McMurray complained of a urine-like stench coming from the site. In January 2005, a major fire in one of Suncor’s oil sands upgraders caused severe damage, cutting output nearly in half. These failures might be chalked up to bad luck, but few companies have eluded big delays, production interruptions and cost overruns.

As costs have gone up, so too has the long-term oil price companies say they

will need to stay profitable. “Four years ago,

the average price of oil over the past 100 years.

Not every oil company expects prices to stay so high. John Browne, the head of BP PLC, the British-based oil giant, has said the price of oil is “unsustainably high” and could, in the not-too-distant future, dip back below $30 a barrel. At that price, many oil sands projects would surely fail. Browne’s statements offer some explanation for BP’s cautious approach. In 1999, it sold its oil sands stake and only last month announced it would focus on the refining side of the oil sands, rather than extraction, outfitting its refineries in the U.S. to handle Alberta bitumen. “There’s no question that if you’re putting in billions of dollars as a producer, you’re taking on enormous risk, and a lot of that is just commodity prices,” says Brian Frank, head of BP Canada Energy Co. “It’s a very, very risky business.” But there is reason to think that oil prices will stay high, many analysts say. “Around the world and not just Alberta, everybody is trying to ramp up infrastructure development,” says Ebbern. There may be more oil out there, but it’s in places where it’s too risky to go after it. “There is no more ofthat easy oil,” says Steven Paget, an analyst at FirstEnergy Capital Corp. in Calgary. “There’s oil with extremely high political risk, there’s oil with very high discovery risk, and then there’s the oil sands.”Against that backdrop, the oil sands have grown increasingly attractive, and the province’s windfall is regarded as money in the bank. True for now, but in today’s oil business, there’s no such thing as a sure thing. M