Oil Sands Output Cuts Unlikely Despite Sliding Crude Price
OTTAWA (Dow Jones)--The plunge in oil prices has forced the first output cut in Canada, but shutdowns across the country's abundant oil sands are a distant prospect.
Earlier this week, Connacher Oil and Gas Ltd (CLL.T) said it will nearly halve output from its Great Divide oil sands project to 5,000 barrels a day indefinitely. The development in northern Alberta had been producing around 9,000 barrels a day of the sludgy bitumen, which sells for less than benchmark light, sweet crude due to its poor quality.
As oil prices sank, Connacher's profit margins got squeezed and then disappeared altogether.
"It recently became evident we could not secure adequate pricing for our bitumen sufficient to cover our operating costs and royalties," Chief Executive Richard Gusella said Monday on a conference call. "We held out as long as we prudently could but we cannot produce at a loss."
Crude's headlong dive off July's record of $147.27 a barrel and the crunch in credit markets has caused a spate of project delays in Alberta's oil sands, the second-biggest reserve outside Saudi Arabia. Oil ended below $40 a barrel Thursday for the first time since July 1, 2004, a day after OPEC announced its biggest-ever output cut in an effort to halt the slide. Non-OPEC producers may help by reining in production, likely acting as "automatic stabilizers" on the decline after the first quarter of 2009, Lawrence Eagles, head of commodity research with JPMorgan Chase & Co. (JPM), said Thursday.
But Canada's oil sands companies probably won't be among them. The high-profile delays in the oil sands affects costly new developments needing at least $80 a barrel oil to break even, but projects under construction haven't been halted. And while smaller producers may follow Connacher's lead, most will be loath to curtail any sources of revenue amid the economic slowdown.
"We've got our eye on the costs for sure, and people are fairly negative about the delays and postponements," said Paul Hagel, senior oil sands spokesman for Royal Dutch Shell PLC (RDSA). "But we would never consider shutting anything in - the prospect is not even fathomable."
Size Matters
The Anglo-Dutch major is one of the biggest producers in Alberta's oil sands, pumping out 155,000 barrels a day from its oil sands mine with minority partners Chevron Corp. (CVX) and Marathon Oil Corp. (MRO). The Athabasca development includes an upgrader, which converts the bitumen into a lighter - and more valuable - synthetic crude oil, and this feeds Shell's Scotford refinery near Edmonton.
"We've got an integrated business with the newest refinery in North America," Hagel said. "Just by way of having new technology on the ground, we can avoid some of the cost issues that other producers may have."
But the real benefits come from its size. The oil sands industry is dominated by a handful of big producers: the top three, Syncrude Canada Ltd., Suncor Energy Inc. (SU) and Shell account for more than half of the total output. To these heavyweights, Connacher's total production is a pilot project.
"Connacher is one of the smaller players on the oil sands scene so its reaction to the market environment can mostly reliably be used only as a litmus test for companies of its size," Lawrence Poole, a London-based analyst with IHS Global Insight, said in a note.
Unfounded Expectations
That's not to say it couldn't happen. In a research note last month, Merrill Lynch analysts warned that slumping oil prices could force around 1.6 million barrels a day of Canadian oil production offline, nearly 60% of the country's total output, half being shut in below $38 a barrel and the remainder below $30.
But the slide in crude has brought down natural gas prices, one of the biggest operating costs for projects that steam and pipe up bitumen from deposits too deep for an open mine. It has also toppled the Canadian dollar from parity with the greenback, giving Alberta's producers more bang for their buck.
"I think the expectation that oil sands will get shut in at $40 oil or even $30 is largely unfounded," said Chris Feltin, vice-president and director of institutional research at Tristone Capital Corp. "You've got to keep in mind that $30 oil is closer to C$38 or so, while cash costs of the high end are around C$30 a barrel. As long as the various costs are being offset by revenue, they won't shut in production."
There are also more practical reasons to keep operations humming, even if crude falls below breakeven costs. Shutting down production and ramping it back up takes time and money, and would be complicated by the winter weather which can be particularly vicious in northern Alberta. In late January, Syncrude was forced to halt operations after temperatures fell to -40C and froze instruments at the development.
Such unexpected incidents and planned maintenance shutdowns will likely be the source of any output cuts for the time being. Canadian Natural Resources Ltd. (CNQ) can still profit from its steam-driven Primrose project at $20 a barrel oil, the company's vice chairman told investors earlier this month.
Oil prices would have to get "very, very low" before Canadian Natural would think about cutting production, John Langille said, adding: "You would look at ways of getting your costs down to suit the marketplace."
