Latest Project Aims to Wean Oil Sands Off Natural Gas Habit

CALGARY Jul 19, 2007 (Dow Jones Newswires)

While Canada's oil sands are booming, the energy-intensive nature of the projects there are holding the province back from the ranks of the world's trophy deposits.

Nexen Inc. (NXY) and OPTI Canada Inc. (OPC.T) want to change that.

The two companies are partners on the newest integrated oil sands project, which takes raw bitumen and transforms it into light, sweet synthetic crude oil. With initial production set for the end of the year, Long Lake is the fourth such project in the region.

In their case, not being the first-mover has given them an advantage. Most bitumen deposits in the oil sands are too deep underground for an open mine, and require an expensive process to drill down and pipe up the thick tarry material. In one key step, oil sands operators use natural gas to create hot steam in order to soften and extract the bitumen. As the price of natural gas has risen, so have costs.

Long Lake, on the other hand, intends to use synthetic gas derived from the bitumen itself to generate most of the steam, a cheaper alternative that breaks the oil's dependence on an outside fuel source.

Such cost savings will allow Nexen and OPTI to capitalize on the surging interest in Canada's oil sands, which aims to to slake U.S. refiners' thirst for crude oil. Canada is likely to cement its position as the No. 1 crude supplier to the U.S., boosted by close proximity and economic ties, while exports from Mexico and Venezuela continue to decline.

The oil sands, however, are competing with hydrocarbon basins such as the U.S. Gulf of Mexico, Central Asia and offshore West Africa for capital. While each poses its own technological challenges, they aren't of the scale witnessed at Canada's oil sands, analysts say.

Total oil sands output is projected to triple to 3.4 million barrels a day by 2015, according to the Canadian Association of Petroleum Producers. Suncor Energy Inc. (SU); Shell Canada, a unit of Royal Dutch Shell PLC (RDSB.LN); and Syncrude, a seven-company consortium - which run the three existing oil sands mines - are pushing ahead with aggressive expansion plans, with Suncor in particular targeting 550,000 barrels a day of output in 2012. The fifth integrated project, Fort Hills, will be contributing 280,000 barrels a day by 2015.

Synenco Energy Inc.'s (SYN.T) joint venture with China's Sinopec (SNP), would have swelled their number to six, but this project is on hold after cost estimates doubled. The Fort Hills consortium last month said its first phase will cost C$14.1 billion ($13.5 billion), or around the current industry norm of C$100,000 a barrel of daily production capacity.

The industry norm was closer to C$80,000 a barrel when construction started at Long Lake three years ago, so the project avoided the worst of the recent cost inflation, said OPTI Chief Executive Sid Dykstra.

"We're delighted that more through good luck than good planning we're at the stage that we're at now," Dykstra told Dow Jones Newswires in an interview.

Long Lake is expected to produce 60,000 barrels a day of crude once the first phase hits its peak in 2009. Plans call for output to rise to 360,000 barrels a day by the end of the next decade once operations are at full swing.

It hasn't been immune from cost overruns, however. The partners have already revised upward their capital budget twice, from an original C$3.4 billion estimate three years ago, and the timetable was pushed back by three months. In last week's second-quarter earnings calls, both Dykstra and Nexen CEO Charlie Fischer repeated that they don't expect first-phase costs to top C$5.3 billion.

Saving Energy, Making Energy

"The major criticism of the oil sands business is you need a lot of energy to produce energy," Dykstra said.

Reducing the amount of natural gas required could shave C$10 barrel off operating costs, according to Nexen and OPTI estimates.

Long Lake has taken existing refinery components and reconfigured them to use up more of the bitumen barrel and become virtually self-sufficient for its fuel needs.

The natural gas-dependent extraction process in use by non-mining oil sands projects was popularized in the 1980s, when gas prices were stable and hovered around $2 a thousand cubic feet a day. Over the past five years, prices have surged and, on the futures market, reached an all-time high above $15 a million British thermal units in December 2005. A million British thermal units is roughly equivalent to a thousand cubic feet.

Now that prices are holding around $7, "suddenly lots of companies start thinking about reducing gas input," Dykstra said.

At present, the industry consumes around 600 million cubic feet a day of natural gas, but this could quadruple by 2015, according to consultants Ziff Energy.

Bill Gwozd, vice president of Ziff's Gas Services division, said oil sands projects had become more efficient over time, with Suncor managing to halve its natural gas needs between 1995 and 2004.

But Ziff forecasts 2015 natural gas prices will be "similar to slightly lower" than $7.60/MMBtu, its 2007 estimate. Further cuts in gas consumption are vital if these costs aren't to eat away at profits.

Natural gas isn't the only thing putting pressure on oil sands companies' bottom lines. Wages are soaring; prices on equipment and materials have skyrocketed as some parts become increasingly scarce; and the Canadian dollar recently hit a 30-year-high against the U.S. dollar, making costs at home more expensive relative to oil revenues denominated in U.S. dollars.

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