Solid Economics for Oil Sands


Abstract: Canada's newest oil sands project looks profitable at $28 per barrel – even with escalating costs.

Analysis: Last week, Canada's fourth open-pit oil sands project moved within a step of reality. The Horizon Project, so named by Canadian Natural Resources, Ltd., awaits only a few bid clarifications for final go-ahead, the company said at a press conference held to present its third quarter report.

Horizon is the newest of the four open-pit oil sands projects underway in Canada's Alberta Province near Ft. McMurray. The others, Syncrude, Suncor Energy and Shell Canada, are already producing oil.

Deposits around Fort McMurray hold an estimated 1.6 trillion barrels of oil, making them the largest lode of hydrocarbons on Earth. Up to 330 billion barrels are recoverable according to estimates. For comparison, Saudi Arabia today possesses 262 billion barrels of proven reserves.

Because the tar-like, oil sand deposits are so huge, their development can potentially produce enough oil to affect domination of crude oil markets by OPEC and possibly brake the increase of oil prices.

Canadian oil sands already produce something more than 1 million barrels per day, with about half of that flowing to the US. Prices above $40 per barrel 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, has been predicted to take conservative growth steps. Shell Canada's announcement in September that it plans a $4-billion expansion of its Athabasca oil sands project – just now 18 months old – revealed a somewhat liberalized approach. And it provided strong indication that Shell believes high crude oil prices are not just temporary, but here to stay. It also indicates that the day is not far off when discoveries will fail to replenish the world's reserves of conventional crude oil. Canadian Natural apparently agrees.

Better Production Economics
The main bar to oil sands development has been production economics. Over the past several years, energy companies have spent billions to bring down the cost of producing oil from tar sands. Syncrude, Suncor, Shell and others in Canada improved production methods and devised technology and equipment to turn the sands into a type of synthetic crude oil.

With the improving technology, costs have dropped – from $30 a barrel in the 1970s to less than $12 a barrel reported by Shell and its partners in June 2003. Now that world crude oil prices are above $40 per barrel range, margins are excellent. Canadian Natural's latest economic forecast reinforces the idea that production economics are right. And the company even extended this confidence to cover increased estimated costs by 35 percent.

Canadian Natural says part of this confidence stems from a higher level of project definition and detailed engineering than predecessor projects.

The company is itself the managing contractor, breaking the project into pieces that can be individually bid to different engineering and construction firms. This also represents a significant departure from past industry norms, according to Canadian Natural.

The company has begun site preparation even as it continues to receive bids for portions of the project. Some bids are still being clarified and Canadian Natural will hold final go-ahead (which it calls "sanction") for 2 to 4 months. Any other work to keep the project on schedule (engineering, procurement and contract awards) also continues.

Still Robust with a 35 percent escalation
The higher projected costs arise out of projected increases in four major components:

  • Steel prices;
  • Fuel costs;
  • Tight labor markets, reflecting heightened project activity levels in Western Canada, and in particular, Alberta;
  • Apparent risk premiums built in to certain bids as a result of continued volatility in the above items.

  • The Phase One construction estimate now totals about $6.1 billion with contingencies and risks increasing that to $6.6 billion. The total for all three phases of the Project is now expected to be approximately $9.7 billion with contingencies of $10.5 billion. Start of production is planned for mid-2008 at 110,000 barrels of bitumen per day. Upgraded synthetic crude oil yields are in the range of 0.8 to 0.9 barrels per barrel of bitumen. By the end of Phase Three production is planned for 232,000 barrels of bitumen per day.

    Canadian Natural said its management believes that current and future strip commodity prices continue to provide a project that is as robust as originally estimated. "The project maintains an expected return on capital of 15% assuming the above capital levels with a long-term WTI price of US $28/bbl and a $0.78 Canada/US exchange rate," a company spokesman said. The return is based on oil extracted and upgraded to a synthetic crude and is after taxes. Returns at other crude prices are estimated at 20% with WTI at $40 per barrel and 25 percent at $50. Breakeven for the Horizon project is $14.50 per barrel.

    It looks as if oil sands developments have a momentum that can only be slowed by a drastic and worldwide economic downturn where the Saudi production cost of $2 to $3 per barrel could come into play. But those days seem to be long gone. One possible new cost component may be the need to develop carbon dioxide abatement methods. Canada is a signator to the Kyoto protocol, which requires reduction of greenhouse gases, and synthetic crude production methods are heavy on carbon dioxide emission.