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Petro-Canada Reviewing Oilsands Strategy

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Abstract: Petro-Canada's review of its multibillion-dollar oilsands strategy is the latest setback for Canada's unconventional oil sector, a pattern that holds implications for the U.S. politicians and consumers.

Analysis: The biggest threat to U.S. energy security is not Al Qaeda terrorists but spiraling construction costs for oilsands projects in northern Alberta.

Activities in the forests and swamps surrounding Fort McMurray are a long way from the minds of American politicians and consumers. But this weekís decision by Petro-Canada to hit the pause button on its multibillion-dollar oilsands strategy should cause U.S. energy players to pay attention to the remote region.

According to Energy Information Administration data, Canada provides about nine percent of daily U.S. crude supply. Canada competes intensely with Saudi Arabia, Mexico, and Venezuela for bragging rights as the top supplier of crude (excluding refined products, which pushes Canada to the top of the list) to the U.S.

Higher exports from this country have been based largely on increased production from crude extracted from a sticky mixture of sand and oil buried in the northeastern corner of Alberta.

Oil shipments to the U.S. from Canada have averaged about 1.5 million barrels a day (mmbbls/d) this year, compared with 1.2 million averaged throughout 1999.

The surge is due largely to Suncor Energy Inc., Syncrude Canada Ltd. (a consortium of eight owners), Shell Canada Ltd., and other firms pouring billions of dollars into developing the oilsands. The unconventional resource is estimated to hold more than 300 bbbls of recoverable oil, making it a world-class play.

While the spending bubble has lifted Albertaís economy for the past five years, a pin was firmly inserted into the sector by Petro-Canadaís decision to reconsider its oilsands plans in light of rising costs.

At its annual meeting earlier this week, the Calgary-headquartered producer said it will reduce spending by two-thirds, a cut of C$120 million, on detailed engineering on what was supposed to be a C$5 billion upgrade to its refinery near Edmonton.

"We are going to take the time between now and the fourth quarter to try to see if there aren't some better options for us to pursue that are more economic than the course that we were on up until today," Petro-Canada chief executive Ron Brenneman told reporters after meeting.

In late 2001, Petro-Canada launched an ambitious plan to enable its Strathcona refinery to use bitumen, an extra-heavy crude derived from the oilsands, instead of light oil.

The first stage, estimated to cost between C$2.4 billion and C$2.8 billion, was scheduled to allow one processing train to use 85,000 bbls/d of bitumen by 2007. A second phase, with a similar price tag, was expected to double production by 2010.

Petro-Canada also planned to spend C$800 million developing Meadow Creek south of Fort McMurray, a city of 35,000 people that acts as the hub for oilsands projects. Meadow Creek was supposed to help supply the Strathcona refinery by producing up to 80,000 bbls/d of bitumen for 25 years starting in 2007.

As so many other companies operating in northern Alberta have discovered, thereís a huge difference between a pretty presentation in a conference hall and bulldozers churning in the mud. It smacked Petro-Canada harder than a stadium-clearing homer swatted by Barry Bonds.

Suncor endured the costs of its Millennium project, soaring 70 percent to C$3.4 billion from its original estimate of C$2 billion. The price elevator for Shell didnít stop rising until the bills hit C$5.7 billion, up 50 percent from the initial target of C$3.8 billion. Syncrude is trying to pare the costs of its latest expansion, called Phase 3, from C$5.6 billion to something closer to the original target of C$4.1 billion.

Brenneman said his firmís increases were greater than 50 percent, although he did not provide a specific figure. This means the combined price for refinery revamp and Meadow Creek is near C$8.4 billion, dramatically changing the economics.

"It was only in the last month or so ... that the numbers started to pop up and that's when the alarm bells went off," he told analysts during a conference call.

Higher costs for labor and material plus reduced productivity from skilled staff spread thin by the boom were prime reasons for the headache-inducing budget changes, the executive said.

The announcement by Petro-Canada landed like the initial wave of cruise missiles on Baghdad at the start of the war--it was completely unexpected. However, the decision was consistent with the past behavior of Brenneman, a former ExxonMobil executive who has installed a rigorous focus on capital discipline since taking over in January 2000.

Besides pausing on the oilsands, Petro-Canada is also looking at international investment opportunities, including Iraq. The review is scheduled to be finished by the end of the year.

Brenneman said the two initiatives were separate, but it makes sense for more lucrative international projects to move up the companyís agenda at the expense of capital-intensive oilsands projects with low returns. Itís a logical move that would be supported by analysts and investors.

Petro-Canadaís decision, while not final, marks the latest in a series of setbacks for Albertaís oilsands, a trend which should concern U.S. policy-makers and residents.

TrueNorth Energy Corp., a subsidiary of Wichita-based Koch Industries, delayed its Fort Hills project earlier this year indefinitely after capital costs rose by C$1 billion to C$3.3 billion. TrueNorth planned to produce 95,000 bbls/d of bitumen by 2005, with expectations of doubling output by 2009.

Canadian Natural Resources Ltd. has pushed back by one year its massive Horizon project, meaning it will not start producing 110,000 bbls/d of bitumen until 2008 at the earliest. The multi-stage development is expected to pump 232,000 bbls/d of bitumen by 2012.

The toppling dominoes deserve some attention from the administration of President George W. Bush. Each delayed or cancelled oilsands project here means more dependence on Russia, Mexico, or OPEC members, increasing the possibility of disruptions because of political unrest or terrorist activity.

Crude exports to the U.S. from Venezuela, which dropped to around 500,000 bbls/d in the first two months of this year from 1.2 million bbls/d in the same period of 2002, demonstrate the rollercoaster-like ride that makes the industry so difficult to predict.

While Canada is far from perfect, common business practices, buried pipelines, and provisions in the North American Free Trade Agreement that govern energy mean this country is the most secure source of oil for the U.S.

The importance of reliable supply is only going to increase in the future as U.S. domestic production continues to decline. Volatility in supply, evidenced by what happened this winter to gasoline and home fuel bills, translates into higher prices and increased unhappiness among voters, a bad combination for politicians.

The options available to U.S. government are quite limited. It canít, for example, do much to influence the number of pipefitters and millwrights willing to work in the bush of northern Alberta.

With the House and Senate trying to hammer out a new energy policy, the assumption of growing crude production from Canada needs to be questioned. Itís no longer a slam-dunk, and a reduction in oilsands output could have long-term impacts on U.S. foreign policy.

President Bush, known for his religious faith, should be praying nightly that Petro-Canada and other oilsands players find ways to cut their costs and boost U.S. energy security.


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