Day of the Oil Sands?

Abstract: Does Shell Canada's Alberta expansion signal the beginning of all-out oil sands development?

Analysis: With last week's announcement that it plans a $4-billion expansion of its Athabasca oil sands project – just now 18 months old -- Shell Canada revealed apparent answers to a couple of questions on the collective mind of the oil industry.

Answer one, high crude oil prices are not just temporary; they are here to stay.

Answer two, the day is not far off when discoveries will fail to replenish the world's reserves of conventional crude oil. They will peak and begin to decline.

When that day comes, the only source of enough petroleum energy to replace the lost crude oil is the world's oil sands. The Athabasca deposits near Fort McMurray in Alberta where Shell is working are estimated to contain 1.6 trillion barrels of oil equivalent, with some 350 billion ultimately recoverable. That's more oil than is in Saudi Arabia. But making that oil available in sufficient quantity requires beginning development now.

A Long Time Coming
Development of oil sands and heavy crude oils began in Canada and in Venezuela in the late 1960s. Bitumen, the thick, tarry and semi-solid oil product is found mixed with sand. The sand can be surface mined and processed to recover the bitumen or bitumen can be extracted underground by heating with steam in a process called steam assisted gravity drainage – SAG-D.

The heavy bitumen can't be fed to conventional refineries. So the original Canadian commercial producers, Suncor and Syncrude, worked out processes to upgrade it to a product similar to conventional crude oil. Other factors – high production costs, low oil prices – kept development slow. Over the past few years, however, Syncrude, Suncor, Shell and others in Canada improved production methods and devised technology and equipment to bring costs down. With world crude oil prices in the $40 range, margins are excellent. It's been a long time coming, but profitability seems to have come to oil from oil sands.

Should we look for even further rapid development? The answer is "maybe." Though some believe that conventional crude oil reserves are in decline – or soon will be – not everybody does. Oil sands production involves large capital investments in massive mining, hauling and solids-handling equipment. Margins are lower, and projects run longer and earn profits over more time than conventional producing wells. Production of bitumen releases greater amounts of greenhouse gas than conventional oil production. Canada is a signator to the Kyoto Protocol, which could require producers to undertake CO2 abatement programs which might be expensive. Another environmental problem is groundwater protection. And pipeline and infrastructure development would have to keep pace with increased production. So, until an emergency, or it becomes clear that reserves are in decline, oil sands development will likely be measured and conservative.

Measured Growth
Canadian oil sands today produce something more than 1 million barrels per day, with about half of that flowing to the US where daily consumption runs 26 million barrels. With the price right, there is opportunity for expansion to make more oil from sands. Indeed, that is going on now. Crude oil prices above $40 provide a healthy margin, but they haven't been that high for very long. And a cautious industry, burned in the past by price collapses, will probably take conservative growth steps. Absent an all-out emergency, the investment required to make gains in production that rival conventional crude probably will take a long time to materialize.

That is not to say that present growth is insignificant. Syncrude and Suncor have expansions underway now. Syncrude produced 77.3 million barrels of sweet crude oil upgraded from bitumen in 2003. It has expansions underway designed to increase capacity to 325,000 b/d or 118 million b/y by 2005. Suncor, which also upgrades its bitumen to refinery-ready feedstock and also diesel fuel, produced an average 216,500 barrels per day in 2003 and aims for 260,000 b/d by 2005 and 550,000 b/d by the 2010 – 2012 interval. Shell Canada's present production will grow from 150,000 b/d to 200,000 b/d by 2010.

Will more producers join in and get oil sands projects going? This would be ideal in terms of having oil available to offset a precipitous drop in conventional crude. But who would pay for such preparation? And the memory of the '80s oil bust where prices went in the tank is still uppermost in the minds of many oilmen. That has made promoters of oil sands cautious. In even a mild turndown, the more expensive synthetic crude product would be the first casualty.

Turndown prospects seem remote, however. There appears to be a new strength to oil demand. Emerging economies everywhere are demanding more energy. China's phenomenal growth in imports over the past few months, for example, was reported last week to be running 39.2 percent ahead of 2003 on an annual basis – 600 million barrels through August.

Costs and R&D
Costs have come down and are continuing to drop as technology is improved. Quoted costs vary widely among sources. So do required selling prices. One source mentions a range of $8.50 to $12.00 per barrel for extraction plus another $10 to $11 for Capital costs, shipping and depreciation, for a final range of $18.00 to $23. It is not clear if this figure includes upgrading to synthetic crude oil. At any rate, this would require a selling price in the high-$30/bbl range.

R&D in all aspects of oil sands development apparently continues to be active and designed to bring down costs. One report last week said that a proprietary aqueous solution, DiamondFlo, showed in lab tests that it would reduce extraction and processing time and lower production costs compared to "current extraction methods," presumably the SAG-D process.

So while Shell's move may not signal all-out oil sands development, there can be no question that it is a strong move toward boosting production of a plentiful resource. A resource that comes from a friendly, northern neighbor of the U.S. And one that can dramatically lessen dependence on crude oil that comes from overseas.