Oil Sands on Front Line in Energy Sector's Battle with Costs
OTTAWA (Dow Jones Newswires), October 31, 2008
Once the archetype for runaway cost inflation, companies operating in Canada's oil sands may be sparking a global effort to rein it in.
Many companies there have made announcements either postponing investment outlays or delaying investment decisions. The latest was Royal Dutch Shell PLC, which on Thursday said it was pushing back the decision on whether to expand output from the oil sands, Alberta's vast reserve of tarry impurity-rich crude that's expensive and difficult to extract.
The Anglo-Dutch major said it will wait until costs fall to give the green light to boost output at its Athabasca project by 100,000 barrels a day, following an ongoing expansion that will bring production to 250,000 barrels a day in 2010.
Across the energy spectrum, company executives are pointing the finger at costs, hinting that they will need to fall significantly as oil prices have more than halved from July's all-time highs above $145 a barrel. Natural gas and crude oil producers are targeting their contractors, who didn't hesitate to raise prices when labor markets were tight and costs of materials were skyrocketing.
And costs may already be easing. Last week, ConocoPhillips (COP) Chief Executive Jim Mulva noted that costs for the industry were already starting to moderate on the slide in oil prices, including "softness" in rig utilization costs. The company, along with ExxonMobil Corp. (XOM) and Chevron Corp. (CVX), has indicated it is sticking to existing spending plans.
The high upfront capital costs often lead to heavy reliance on the credit markets, especially for start-up firms with no independent cash flow. But this option has slammed shut amid the global liquidity crisis, and oil sands developers have already started rejiggering project plans as a result.
Suncor Energy Inc. (SU) got the ball rolling last week, slashing capital expenditures and delaying part of its project, and Petro-Canada (PCZ) is likely to do the same. Nexen Inc. (NXY) and OPTI Canada Inc. (OPC.T) are also pushing back a decision to expand its newly minted Long Lake development.
These extra barrels may not immediately be missed given the dismal demand outlook in the U.S., where nearly all of Canada's oil exports are destined. But cutbacks to new and existing energy ventures may threaten future oil flows and cause a spike in prices down the road, as oil executives play a game of brinksmanship with their suppliers.
In the meantime, the slowdown may cool scorching inflation rates in Alberta - estimated at 10% a year - as fewer projects compete for the same limited pool of labor, aided by tumbling steel prices. And the turnaround will likely give producers more clout as they negotiate deals with their contractors.
"You're going to have some leverage on some suppliers, not necessarily today but six to 12 months from now, that we haven't had in the last five or six years," Suncor Chief Executive Rick George said last week. "What I'm really hopeful for is we can get Fort McMurray to calm down."
The remote Fort McMurray, the hub of the oil sands industry, has seen soaring housing prices and strained infrastructure as people from all over Canada and beyond have poured into the boomtown.
Soaring raw material prices, notably for steel, have played a big role. Oil sands will likely find some relief here: Steel prices have slumped three-quarters from summer highs as major consumers - China in particular - rein back demand amid fears of a global economic slowdown.
But the main culprit is labor.
As the oil sands became increasingly profitable on rising crude prices and technological advances, companies flocked to Alberta to exploit the biggest oil reserves outside Saudi Arabia. But labor was and still is limited, especially experienced labor, a result of the mass layoffs during the oil price slump of the 1980s.
Companies found themselves fighting over a shrinking pool of labor, offering huge wages even to recently qualified workers, whose lack of experience slowed progress and often led to delays and yet higher costs.
"You saw a lot of competitive bidding - guys going from camp to camp to camp for what seemed to be incremental gains," said William Lacey, an analyst at Calgary's First Energy Capital. "And while trying to persuade people to take lower wages is a highly sticky issue... with the slowdown, hopefully you're going to get some rational behavior happening in the market."
Through its affiliate Imperial Oil Ltd. (IMO), ExxonMobil is still sticking to schedule for the C$8 billion Kearl oil sands mine.
"[While] some of the other oil sands projects may be slowing down or whatever, that could actually provide some benefit to us in respect to lower cost, both for raw material and services," David Rosenthal, ExxonMobil's vice president of investor relations, said on a conference call Thursday.
Imperial is expected to make the decision to go ahead with Kearl in the first quarter of 2009.
But as delays and even outright cancellations tamp costs over the medium term, oil demand is expected to rebound when economies around the world shake off the current downturn. And as projects are taken off hold, costs will come straight back up, though perhaps not as much as before.
"Companies indicated they were comfortable with costs around C$100,000 (per barrel of production) but when we started getting estimates of C$160,000 or C$180,000, then we heard a collective gasp," First Energy's Lacey said. "That's when investors put their foot down and said, 'Enough.'"
Copyright (c) 2008 Dow Jones & Company, Inc.
Operates 31 Offshore Rigs
- Oil's Heavy Hitters Line Up to Dive Into Mexico's Deep Waters (Jan 26)
- UK Firm Intertek Says Employee Involved in Shell Oil Theft Case (Jan 17)
- Shell Looks Beyond Road Fuels to Secure Future of Refining (Nov 06)
Company: Imperial Oil more info
- Canada's Imperial Oil Misses Profit Estimate As Expenses Weigh (Feb 02)
- Canada's Imperial Oil Posts Unexpected 2Q Loss (Jul 28)
- Imperial Oil Profit Boosted By Asset-Sale Gain (Jan 31)
Company: Suncor Energy more info
- Suncor Going Autonomous in Oil Sands (Feb 01)
- Suncor Says Makes Progress In Oil Sands Project Dispute With Total (Oct 26)
- Canadian Oil's High-Priced Run Set to End as Supply Surges (Oct 11)