Oil Sands Truth: Shut Down the Tar Sands

Opec’s gift to tar sands producers: high oil prices

Opec’s gift to oil sands producers: high oil prices
Financial Post
Yadullah Hussain Jul 6, 2012

Canadian oil sands producers battling high development costs are getting help from an unlikely quarter: Saudi Arabia and its OPEC allies.

“OPEC’s pursuit of higher prices has underpinned the growth of non-OPEC producers,” says Julian Lee, senior energy analyst at U.K.-based Centre for Global Energy Studies. “Non-OPEC developers should be extremely grateful for OPEC for keeping the price of oil high and making all the exotic and expensive sources of oil economically viable.”

Of course, the cartel’s oil policies are driven by domestic politics rather than a desire to share the spoils with their rivals.

Middle East producers, which dominate OPEC, enjoy low crude development costs but need higher oil prices to fulfill their increasing commitments to their restive populations.

On the surface, Saudi Arabia, the world’s largest producer of oil and OPEC kingpin, has a breakeven cost price of US$22.11 per barrel, compared with US$88.3 for a barrel extracted from Canadian steam-assisted gravity drainage (SAGD) technology (plus upgrader), according to energy consultants IHS Inc. research.

However, that does not paint the full picture of the cost of keeping Saudi Arabia’s monarchy in power.

Deutsche Bank has a more novel “budget breakeven price” for OPEC and other producers, which factors in the price needed to balance the overall budgets of the regimes that use state-owned oil revenues to pay for public sector wages and infrastructure and offer subsidies to their populations.

By that reckoning the Saudi budget breakeven price for 2012 stands at US$78.30 and for the U.A.E. US$90 per barrel, which are comparable with the Canadian SAGD and upgrader breakeven price.

Until 2006, Saudi Arabia’s breakeven budget price was US$38.70, but by 2011 it had shot up to US$82.20, according to Deutsche Bank estimates. The kingdom’s breakeven price escalated as it injected petrodollars to stimulate its limping economy after the global financial crisis; it also opened its coffers to appease its citizens as the Arab Spring movement swept across the region. As neighbouring Egypt, Tunisia, Libya, Yemen and Bahrain were in the throes of popular revolts, Saudi’s King Abdullah bin Abdulaziz Al Saud pledged a US$131-billion spending and investment package — 30% of its GDP — which included public sector jobs for 60,000 citizens and double-digit wage hikes for existing government employees to keep dissent at bay.

“Unlike investment spending which can be scaled back, current spending involves wage bills which are far more sensitive to changes, especially if they are revised downwards,” said Paul Gamble, head of research at Riyadh-based Jadwa Investments, adding that the government’s wage bill has risen 76% in six years.

These costs are effectively now baked into assumptions as the world’s most powerful oil producer contemplates what price suits its domestic needs. And while Saudi Arabia has been cheering recent price corrections — driven by its desire to be seen as a responsible oil producer ­— expect the kingdom and its allies to move swiftly if Brent moves south of US$90, analysts say.

While the rate of increase in Saudi public spending may start to slow, it’s unlikely to swing into reverse, said Robert Burgess, chief economist at Deutsche Bank. “The pressure on breakeven prices is, if anything, likely to be upwards rather than downwards.”

With Saudi Arabia sitting on US$500-billion of net foreign assets in reserves, it has staying power in the event of a price crash, but other major OPEC producers that unleashed similar spending sprees are increasingly less comfortable with low prices. Venezuela, for example, has a breakeven price of US$86.72 per barrel, and is often a key advocate of supply cuts to prop up prices at OPEC meetings.

Even Russia, the world’s largest non-OPEC producer, needs crude to average US$115.90 per barrel this year to balance its budget. “Public spending is set to rise by 10% in real terms this year reflecting the cost of fulfilling pre-electoral promises,” Deutsche Bank’s Mr. Burgess said.

Such geopolitical developments makes the pursuit of unconventionals such as oil sands and deep water in benign jurisdictions very attractive for developers.

On the demand side, analysts point out that prices have held up pretty well in the face of a massive slowdown in the EU and structural decline in U.S. consumption, which bodes well for crude once the global economy eventually gath ers steam.

Emboldened by oil economics and investor appetite, The Canadian Association of Petroleum Producers expects domestic crude production to rise to 4.7 million barrels per day (bpd) by 2020 from three million last year, with oil sands output doubling to 3.2 million bpd during the period.

Yet oil sands inflation continues to edge up and is expected to hover around 5% each year until at least 2016, which could have an impact on the economic viability of projects, according to CIBC World Markets.

“Unsanctioned projects where little or no capex has been spent have the highest breakevens in our commercial data set,” noted Wood Mackenzie in a report. “As a result, they are particularly susceptible to delay and cancellation.”

The Canadian oil sector is not without challenges either: environmental opposition and labour availability, apart from a new set of logistical challenges which must be overcome.

“A lack of visibility on available transportation capacity and, in turn, the prices that may ultimately be achieved could impact oil sands projects’ commercial viability,” Wood Mackenzie said in a report to clients.
“The pressure on [Saudi] breakeven prices is, if anything, likely to be upwards rather than downwards.”

Luckily for Canadian producers, high development costs is an issue for developers across the world. An index measuring capital and operating cost of oil producers showed a 2.3% jump in the first quarter of 2012.

“Given the increased levels of spending it is not surprising to see a record quarter increase in capex escalation,” said Pritesh Patel, senior director of the IHS CERA Inc.

The politics and economics of crude mean none of the major producers can handle a period of sustained low prices: Saudi Arabia, Russia and Venezuela need to meet demands of their dissenting citizens, Iran to counter sanctions and Iraq to fulfill its long-term desire of being a major crude producer. That certainly puts a comfortable floor for oil sands developers to stand on and wrest the initiative. If only they can keep their own costs down.


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