High costs squeeze oil sands
Break-even price jumps 31%
Claudia Cattaneo, Financial Post // September 05, 2008
CALGARY -- As oil backpedalled again yesterday to a five-month low, oil sands projects are getting increasingly squeezed as soaring costs boost the break-even price.
A new report found the break-even oil price required by new mining projects in the oil sands has jumped to $85 a barrel, an increase of $20 or 31% in barely more than a year.
In the report, National Bank Financial senior vice-president Peter Ogden said the break-even price -- which assumes an 8% rate of return, capital costs of $120,000 per flowing barrel and operating costs of $27 a barrel -- has crept up because of climbing labour and material costs and higher royalties in Alberta under a new fiscal regime beginning in January.
The break-even price in May, 2007, was $65 a barrel, assuming an 8% rate of return, capital costs of $100,000 per flowing barrel and operating costs of $20.50 a barrel.
Still, Mr. Ogden said he doesn't expect project cancellations just yet. "As the oil price does fall, you would expect the more marginal projects to be deferred, which would bring down construction costs, and therefore make the better projects more profitable."
Unless that happens, Mr. Ogden sees capital costs for mining projects trending even higher, to the range of $125,000 to $160,000 per flowing barrel.
Anticipating such deferrals, the Canadian Association of Petroleum Producers recently reduced its expectations for future oil sands production. The group now expects volumes to increase to 3.5 million barrels a day in 2020, 11.5% less than its forecast last year.
The price of crude fell US$1.46 a barrel in New York yesterday, settling at US$107.89, as the euro rose against the dollar, reducing the attractiveness of oil as an inflation hedge. Crude has declined 27% since reaching a record of $147.27 on July 11.
The break-even price for oil sands projects that use steam-assisted gravity-drainage technology has increased more modestly -- by $12 a barrel, or 21%, since May, 2007 -- to $70 a barrel, Mr. Ogden found.
Such thermal projects can make money at lower oil prices because they require less investment up front. The $70 breakeven price assumes an 8% rate of return, capital costs of $100,000 per flowing barrel and operating costs of $21 a barrel.
In last year's estimate, the break-even price was based on capital costs of $80,000 per flowing barrel and operating costs of $22 a barrel.
Despite perceptions that oil sands companies make lots of cash, the report suggests returns remain skinny, or in the 9% to 11% range for most projects. Still, he said companies are moving forward on expectations that oil prices will be higher, improving profitability.
Mr. Ogden predicted an increase in merger-and-acquisition activity, since lower oil prices have dampened the share prices of oil and gas companies to the cheapest level in two years, making purchases attractive.
He highlighted OPTI Canada Inc., UTS Energy Corp. and EnCana Corp.' s oil company spinoff as oil sands companies "with a target on their back."
Financial Post
http://www.financialpost.com/reports/oil-watch/story.html?id=772092
