Is US Energy Security in Canada?

Changing outlook for Canada's oilsands

By Staff Writer with the Financial Times

For optimists about global oil reserves and US energy security, Canada's oilsands are a vital piece of evidence.

Located in three main deposits across an area the size of Florida, the Alberta oilsands are estimated to contain reserves of 179 billion barrels of oil, a figure exceeded only by Saudi Arabia.

The sands have been exploited since the 1970s. But as the price of oil soared, oilsands rose to prominence as one of the solutions to the US's dependence on energy supplies from the Middle East and other politically unstable areas.

Canada already supplies about 2 million barrels per day of the US's consumption of 12 million bpd: about half of that coming from oilsands. As other sources of oil decline, the importance of the oil sands is expected to grow.

The problem, however, is that costs of producing oil from the sands are high and rising fast.
As the oil price has fallen by more than 20 per cent from its peak in the summer, the outlook for Canada's oilsands has been clouded by fears that oil may not be expensive enough to keep the industry viable.

The oilsands, which look and feel like molasses, are found in bands between 6-10 metres thick.
Extracting the oil is laborious. Two tonnes of oilsands yield just 1.25 barrels of bitumen and a barrel of crude.

Foreign players have flocked to the oilsands in recent years. ExxonMobil, Royal Dutch Shell, Chevron, ConocoPhilips, Devon Energy and France's Total are among those with stakes in either existing or proposed projects.

Two of China's biggest energy groups, China National Offshore Oil Corporation and Sinopec Group, have invested in small Calgary-based companies with oilsands ambitions.

The half-dozen or so existing oilsands producers currently turn out about 1 million barrels per day. If all the projects now on the drawing boards come to fruition, output could rise to almost 3 million bpd by 2015.

But as investment has poured into the region, at a time of strong demand for skilled staff and equipment, costs have soared. Petro-Canada estimated earlier this month that the cost of expanding its Mackay River oilsands project had soared.

Dominion Bond Rating Service of Toronto concluded in a study that companies were taking a more cautious view of oilsands projects as a result of escalating labour and material costs.

The study noted that "the non-discretionary nature of oilsands capital spending, long lead times to first oil production and escalating costs in a highly competitive environment combine to create significant potential financial and execution risk for companies with major oilsands projects should prices weaken".

Several companies are having second thoughts about their projects. For instance, Husky Energy, controlled by Hong Kong businessman Li Ka-shing, is reconsidering plans to build an upgrader for its project.

"Under the current economics and also the labour supply, and the cost of construction, it is very difficult and it is very challenging to maintain the building in Canada," John Lau, Husky's chief executive, said earlier this year.

Murray Edwards, vice-chairman of Canadian Natural Resources, which has big plans for the oilsands, argued last month that many of the projects now being proposed would need oil above $50 a barrel to be profitable.

However, different companies take different views. Integrated oil companies have the ability to benefit from taking the oil they extract and to refine it and sell the products, which the companies that only have upstream operations cannot. That should help make the business viable at lower oil prices than for some competitors.

However, while oilsands may have their difficulties, none of the other options available to international oil companies is easy. "International oil companies are having to adapt to survive," says Jason Kenney of ING.

"Politically, outside of the OECD countries, things are getting worse and worse. With oilsands, at least companies have got a chance of keeping the reserves in the long term, and they know they can get earnings out of them."

This article was published by The Financial Times on 25 October 2006