CHINA ENERGY WATCH: Allure of Oil Sands Hard to Resist

BEIJING, Nov 15, 2006 (Dow Jones Newsires)

Canada's vast reserves of oil sands make it the promised land for countries worrying about their energy security, but a slow start by Chinese companies in breaking into the market has left them struggling to catch up with foreign rivals.

China is targeting oil sands - a mix of sand and a tar-like ultra-heavy crude called bitumen - to satisfy its long-term oil demand that the International Energy Agency predicted last week would hit 15.3 million barrels a day by 2030 on the basis of current policies.

Oil sand deposits are mainly found in the western Canadian province of Alberta, but are costly to refine. However, higher crude prices have made production from oil sands more feasible, while shipping crude to China from the west coast of Canada involves roughly the same distance as imports from the Middle East.

Political stability in Canada is also proving a magnet for foreign investment, with production from oil sands set to triple to 3 million b/d by 2015 and then double again by 2030. With recoverable reserves estimated at 174 billion barrels, experts say oil sands production can be sustained for at least 400 years.

However, Chinese oil companies' investments to secure access to oil sands in Canada or operational control of projects there have so far been small compared to what foreign multinationals are spending.

This was underlined when Royal Dutch Shell PLC (RDSB.LN) last month launched a C$7.7 billion ($6.8 billion) buyout of the remaining 22% stake in a Canada subsidiary that it doesn't already own. In contrast, Chinese rival CNOOC Ltd. (CEO) paid only C$150 million for its foothold in oil sands, buying a 16.69% stake in privately held company MEG Energy Corp. of Calgary.

Politics has played a key role in this, as the Alberta provincial government had until recently sent mixed signals about whether investment from foreign state-controlled companies to develop its oil sands resources was welcome.

Chinese oil companies have adopted a gradual approach, forging partnerships rather than aggressive acquisitions to avoid a similar outcry to the one that followed the aborted takeover bid by CNOOC Ltd. for U.S. oil producer Unocal last year.

China Petrochemical Corp., or Sinopec Group, has taken a 40% interest in the Northern Lights project with Calgary-based energy firm Synenco. This joint venture has leased 186 square kilometers of land in the Athabasca oil sands in Alberta.

In an interview with Dow Jones Newswires, Alberta Energy Minister Greg Melchin said forging partnerships with local firms was a "smart strategy" that would help get a suspicious Canadian public on its side as well as give Chinese firms valuable experience in the nascent industry.

China's charm offensive continued this week with the inaugural World Heavy Oil Conference in Beijing, which was jointly organized by China National Petroleum Corp. (CNPC.YY) and the Alberta government.

One message delivered by the Chinese was that they are not novices in heavy oil production since it accounted for 13.2% of China's total domestic output in 2005. CNPC is also working in Venezuela's heavy oil belt along the Orinoco river.

However, Melchin also signaled that Chinese companies would have to satisfy the provincial government's aims to gain acceptance in Canada.

"It would be easier for us in Alberta to welcome other countries like China, or other Asian countries, if they came and expressed an interest in helping us to meet our objectives," Melchin said.

These government aims include creating more high-value jobs in the province in petrochemicals or refining. Sinopec's joint venture with Synenco Energy Inc. (SYN.T) is currently seeking regulatory approval for a facility that will upgrade bitumen into a light, synthetic crude, with the initial phase of 50,000 b/d of production targeted to be on stream by the end of 2010.

Pipeline Plan Held Back By Lack of Chinese Contracts

The emphasis on downstream investment reflects concerns within Canada that China's long-term ambition is to seize control of the resource and ship it back home in raw form for processing there.

CNPC last year signed a memorandum of understanding with Canada's Enbridge Inc. (ENB.T) to build a 400,000 b/d pipeline from the oil sands deposits to a port on the Pacific coast, creating a gateway to the Asian market that would allow it to compete with the U.S. for Canadian oil exports.

Although this project is attractive to Canada because it helps diversify its markets beyond the neighboring U.S., it has so far been held back by a lack of oil sands resources under the direct control of CNPC or other Chinese firms.

"Anyone who wants to enter the oil sands (market) now would find it difficult because all the oil leases are held by private companies," said Brent Lee, director of crude oil marketing and business development of Calgary-based Suncor Energy Inc. (SU.T).

As a result, CNPC has been left with no option but to open talks with Canadian producers or multinationals on direct oil sales or investment in their production program, probably at a hefty premium.

"We have spoken to a number of the Chinese companies and I know they are still in active discussions with different partners, but (no agreements) appear to be imminent," Alberta government's Melchin said.

Richard Bird, executive vice-president of liquids pipelines at Enbridge, said it was unlikely that enough oil would be committed for the 1,127-kilometer long pipeline to the Pacific coast to come into service in 2011 as hoped.

As a result, momentum currently favored a competing pipeline to the U.S. Gulf Coast that had the potential to swallow all of the additional 600,000 b/d of heavy crude that would be earmarked for export by 2015, although Bird said the oil was best split between the two routes.

Suncor's Lee told Dow Jones Newswires that the Chinese had little chance of securing any of the additional 260,000 b/d of crude that his company is aiming to produce by 2012 unless the CNPC-backed pipeline was built. Suncor's crude output capacity totals 260,000 b/d currently.

Labor Shortages Hamstringing Current Projects

Experts say the cost constraints on developing the Canadian oil sands industry may play into the hands of Chinese companies and make their investment and deeper involvement necessary.

Bob Lockwood, president and chief operating officer of Cambridge Energy Research Associates, said $80 billion of new investment was planned over the next decade. This would have to rise further if Canadian oil sands production was to double again by 2030.

Alberta is also currently at full employment, with fewer than 3% of workers out of a job, meaning that it is short of the labor needed to ensure the oil sands industry fulfills its potential.

Melchin, of the Alberta government, said the local unions had "come to terms" with the fact that the province needed to look beyond its borders to fill the supply gap.

China's cheap pool of labor makes it an obvious choice, especially at a time when recent oil sands projects are suffering cost overruns of between 60% and 100% due to factors such as raw material prices.

According to Lockwood, prices of natural gas - the largest component of heavy oil operating costs - have increased by more than 150% over the past five years.

Limiting the environmental impact from increased heavy oil production was also adding to companies' cost base, making them look elsewhere for savings, such as the payroll.

Copyright (c) 2006 Dow Jones & Company, Inc.

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