Companies Emerge to Get More Bang for Barrel of Canadian Crude

CALGARY Aug 16, 2006 (Dow Jones Newswires)

A new industry is emerging to service Canadian oil sands producers looking for more bang for the barrel.

Not only is crude from Alberta's oil sands heavy and difficult to refine, but the North American market for it is saturated. As a result, a barrel of Canadian heavy crude - also known as bitumen - typically fetches around 25% less than a barrel of light, sweet West Texas Intermediate crude used as the U.S. benchmark.

That's a discount that Canadian producers are keen to narrow. So far, some companies have turned to building their own upgraders, processing facilities that convert bitumen into a lighter synthetic crude that's easier to refine and fetches a higher price. But many are reluctant to commit to investing the billions of dollars needed for those facilities, especially in an environment of cost inflation.

Independent firms are stepping in to fill that gap in an initial sign that a merchant upgrading sector in Alberta is developing. One facility - the 260,000 barrel-a-day Heartland project - is already under construction by BA Energy, a new Calgary-based independent energy firm. In addition, last week North West Upgrading Inc., with a similar profile, hired an engineering firm to complete specifications for its proposed upgrader in Alberta.

And upgraders are beginning to look like refineries at a time when the industry is racing to keep refining capacity growth on pace with demand. Canada's refining industry - with only 2 million barrels a day of throughput capacity according to the U.S. Energy Information Administration - lags far behind that of its southern neighbor because it has historically relied on the U.S. to refine its crude output.

The first C$2.4 billion ($2.15 billion), 77,000 b/d phase of North West's facility is expected to come on stream in 2010. The company is planning two extra stages, of similar dimensions and cost, that will expand the plant's throughput capacity to around 230,000 when complete. Regulatory approval for the first phase is expected in mid-2007, with construction seen starting in 2008.

North West doesn't produce any crude itself. Instead, it expects to process bitumen from producers eager to realize better prices for their output.

"There's a very broad spectrum of potential customers," said Robert Pearce, president of North West Upgrading. "Firms need to ensure that they're not getting bad prices for their crude production."

Heavy Oil Conundrum

The notion of an independent upgrading firm came to Pearce when he was treasurer at PanCanadian Energy, which later became EnCana Corp. (ECA), Canada's largest hydrocarbons producer. PanCanadian wrestled with the problem of how to upgrade its heavy oil reserves. For now, EnCana is seeking a refining and marketing partner for its oil sands development plans.

"We looked several times at how to upgrade those barrels, and it made me think about an independent option," Pearce said. "From a producer's perspective, the best upgrader is one that's been developed by someone else and is on their balance sheet."

Canadian energy companies are penalized for their heavy crude - to the tune of the $16 a barrel less they currently get for it compared with Canadian light crude. Estimating its upgrading costs at $6 a barrel, North West wants to lock in long-term service contracts with oil producers and avoid risks associated with sharp changes in oil prices. Under these agreements, North West would charge a processing fee but never take possession of the heavy oil feedstock or the output.

Such an arrangement is rare among global refining players, who take on the commodity price risk in the hopes of reaping profits from fluctuating prices in crude and product markets.

North West has already reached a deal with Canadian Natural Resources Ltd. (CNQ), whereby the producer will supply North West with 25,000 barrels of crude a day for a five-year period. North West wouldn't give further details of how the supply arrangement is structured.

The deal, which could eventually rise to 45,000 b/d, appears slightly surprising as Canadian Natural has plans to construct an upgrader of its own. However, encouraging the development of an independent facility is a smart decision, Pearce said.

"Canadian Natural are still going to be long in heavy crude even if they build their own upgrader, so supporting another is a good move strategically," he said. "It'll help ensure there's sufficient upgrading capacity available."

Canadian Natural was unavailable for comment.

Diversifying Product Streams

Unlike other processing facilities, North West's upgrader itself won't produce a single blend of synthetic crude, but will instead process the bitumen into refineable vacuum gasoil, or VGO; natural gas condensate; and ultra-low sulfur diesel, or ULSD.

Of those products, the VGO is the only stream that would need to be refined. The condensate will likely be used by local heavy oil producers as diluent to aid in transporting their bitumen to market, while the ULSD can be taken straight to the U.S., Pearce said.

"The independent revenue streams are far more valuable," he said. "With respect to the diesel, we'll be selling refined products directly. We will actually be a refinery."

However, the market for ULSD in Alberta isn't deep, and no pipeline exists that could take the diesel to market without contaminating it. Consequently, North West will have to market the ULSD by rail, possibly to Canada's West Coast, from where it can be shipped markets such as California.

The company has so far raised C$175 million for the project, leaving it with the challenge of securing another C$2.5 billion by 2009.

The project also fits in with the Alberta government's stated objective of processing as much bitumen in the province as possible, thereby securing more of the crude value chain.

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