Canada oil sands slowdown may halt runaway costs
10.24.08
Canada - By Jeffrey Jones
CALGARY, Alberta (Reuters) - A slowdown in spending on multibillion-dollar projects to develop Canada's oil sands, one of the world's largest deposits of crude, should help cure one ailment the industry has so far been unable to shake: runaway inflation.
Two of the biggest players in the oil sands, Suncor Energy Inc and Petro-Canada, served notice this week they aim to weather tumbling oil prices and the world economic crisis by deferring major expenditures on processing plants called upgraders, which turn the heavy crude from the sands into refinery-ready light oil.
That will allow them to generate some cash flow by selling raw bitumen from their oil sands mines, while holding down initial costs.
It could also help ease a shortage of skilled labor in northern Alberta, where the oil sands are located, which has worsened over the past decade as major oil companies embarked on projects, hampering productivity and adding to sky-high costs.
"The big guys have all suddenly drawn a line in the sand that wasn't there. Personally, I think this is a positive development," FirstEnergy Capital analyst William Lacey said.
In recent weeks, analysts and investors have questioned the viability of new oil sands projects as development costs stayed stubbornly high while credit markets froze up and oil fell below $65 a barrel, less than half last summer's record high.
Analysts have said brand new mining and upgrading projects would need oil prices of more than $80 a barrel to earn an acceptable return on investment.
Suncor, the No. 2 oil sands producer, said it will postpone completion of the upgrader for its C$20.6 billion ($16.2 billion) Voyageur project expansion by a year to 2013. It still aims to boost output 60 percent to 550,000 barrels a day.
Petro-Canada and its partners, Teck Cominco Ltd and UTS Energy Corp, said they may defer the upgrader at their Fort Hills project, putting off spending as much as C$10 billion and allowing bitumen output to begin in 2011.
The trade-off? Bitumen markets are more volatile than those for light, low-sulfur oil because the crude trades at varying discounts based on its own supply and demand fundamentals.
Petro-Canada Chief Executive Ron Brenneman said another option the partners are considering is buying a refinery that can process bitumen. The financial maelstrom may force some refiners to put plants on the block.
"We've been looking at what I call the buy-versus-make situation to see whether there isn't ultimately a more economic solution," he told analysts Thursday.
But he cautioned, "any time you look at something like that there's always some risk involved, and we haven't thought our way through what they economics might look like."
ROUTINE COST OVERRUNS
More measured approaches to the oil sands -- an oil resource that's second only in size to Saudi Arabia's conventional reserves but is far more expensive to develop -- should make them more affordable as cash flow shrinks and financing gets more difficult.
Hefty cost overruns have been routine during he years-long oil sands rush, with unbudgeted charges in the billions of dollars more than made up for by steadily climbing oil prices.
The boom also caused major strains on housing, hospitals, roads and social services in the oil sands hub of Fort McMurray.
Some companies, such as Total SA and StatoilHydro , had postponed their plans even before the current meltdown, with surging costs being one driver.
"The key frustration that a lot of the oil sands guys have had to date is degradation of efficiencies in labor," Lacey said. "We saw that manifested in the Fort Hills budget, where the overall efficiencies within labor had just degraded to a level where the project itself had become marginal."
In September, the Fort Hills partners surprised the industry by saying the project's estimated cost had ballooned by 50 percent in a year to more than C$21 billion.
Other major cost pressures on oil sands developers are now starting to ease as prices for steel fall and the value of the Canadian dollar drops with economic weakness and lower crude prices, executives say.
Suncor Chief Executive Rick George said he believes developers will have unfamiliar leverage with suppliers in the next six to 12 months as they negotiate equipment purchases.
"I'm not saying that the pendulum will swing that hard but finally we'll get down to a more rational kind of negotiation between owners and our suppliers and contractors," he said on Thursday. "It's a discussion we haven't had the opportunity to have for the past five or six years."
($1=$1.27 Canadian) (Reporting by Jeffrey Jones; Editing by Peter Galloway)
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