News Articles Featured | Petroleum Economist | August 10, 2011
Shaun Polczer, CALGARY: Canada's oil-sands producers were nervously watching North American oil markets this week to see if prices will fall below breakeven costs.
Oil's dramatic fall threatens to undo billions of dollars of investment¬†in oil-sands projects and slow production growth at a time when costs for new projects and expansions were already rising by as much as 7-10% a year, according to some estimates.
Back to the future: boom and bust
It's the classic boom-and-bust syndrome that has broadly characterised Canada's oil industry, but it's more acutely felt by oil-sands operators whose basic underlying risk is the selling price of their production. That's apart from operational issues such as maintenance and unplanned shut downs from explosions and fires that have impeded output over recent years at mines operated by Suncor and Canadian Natural Resources.
Canadian producers have been further hit by a 25-30% rise in the value of the Canadian dollar – dubbed the Loonie for the aquatic bird that adorns dollar coins – since late 2008. The currency has been trading at, or near equal value to its US equivalent on a sustained basis for the first time in three decades, although it briefly dipped below parity this week for the first time since February. A higher Canadian dollar reduces profits for US dollar-denominated oil exports and generates lower netbacks. Suncor alone reported a foreign-currency translation (mostly to US) charge of $684 million last year.
Further, Canadian oil typically trades at a discount to US light sweet benchmark WTI to account for transportation costs and lower product quality. The gap was $15 a barrel between Western Canadian Select bitumen and WTI this week, with a $25 discount to North Sea Brent – $110/b for Brent equates to about $70/b for oil-sands crude.
Cutting it close
That's cutting it a little close for companies such as Suncor, Canada's largest oil-sands producer, which reported cash operating costs of C$51/b in the second quarter. Suncor is in a C$21.6 billion joint venture with Total to build the Fort Hills and Joslyn oil-sands mines and the accompanying Voyageur upgrader to convert bitumen into synthetic crude. Suncor was forced to delay the C$6 billion Voyageur project in 2008 as a direct result of the financial crisis and the same could happen again if oil prices drop to post-recession levels. Meanwhile, Imperial Oil, backed by ExxonMobil, is in the middle of building its C$10.9 billion Kearl project, which is set to begin pumping 110,000 barrels a day (b/d) by late next year. Costs at the project are soaring, although Imperial is much too far along with Kearl to consider cancelling it now.
As of November, the Alberta government estimates there are C$111 billion of planned oil-sands projects in the province – many of which have only just come back on the books since they were delayed following the last bust in 2009.
Cheaper oil's knock-on effect
A big oil-price crash would represent a substantial blow to both the local and national economies, which have benefited from higher oil prices. Lower oil prices seem to have helped keep Canada's debt among the lowest of G8 members at about $1 trillion. But they also translate into lower royalties and taxes for government coffers. Alberta's revenue stream is already the most volatile in Canada; every dollar drop in the US oil price amounts to a C$141m hit to the treasury. By that count, it's lost almost C$2 billion in the past week alone. The province is forecasting a C$3.4 billion deficit in this fiscal year at an average oil price of $95/b.
But there are further risks on the global front, too. In its annual budget document in March, Alberta's finance officials identified rising interest rates in Europe and the US as a significant risk to future investment. "A rapid increase in interest rates and/or disruptions in financial and credit markets could threaten global trade and investment. The high capital intensity of Alberta's oil-sands projects leaves Alberta particularly vulnerable to these shocks – as witnessed in 2009," they said.
Despite US troubles, optimism reigns
Canada is still expected to weather the worst of the storm, however. In contrast to the financial troubles in the US, Canada has emerged from the recession in reasonably good shape. The extended period of higher oil prices has helped offset declines in the country's traditional manufacturing sectors and kept public finances under control. Despite market volatility, prime minister Stephen Harper this week reiterated plans to eliminate Canada's federal budget deficit by 2014, a year earlier than planned.
Canada knows all too well the price of fiscal mismanagement. It was downgraded to AA by Standard and Poors' in 1994 and it took almost a decade to be restored its AAA status. While there's little likelihood of it happening again, even in the event of a big downturn, Canada would most certainly suffer from the US' economic malaise.
About three-quarters of its GDP is exported to the US, which is also the largest customer for its oil and gas. According to the most recent figures from the Canadian Association of Petroleum Producers, Canada supplied 2.5 million b/d of crude and refined products to the US in 2010, more than double the next-nearest supplier – Mexico, at 1.25 million b/d. Oil and gas, including oil sands, generates about C$100 billion a year and there's no denying the effect a big drop in oil prices would have on the country's account balance. In a 2011 study, the Canadian Energy Research Industry forecast employment from oil sands would increase almost 10 times to 905,000 jobs over the next 25 years, adding about C$2.1 trillion to the national economy, or C$84 billion a year from the oil sands alone.
Long-term resource; long-term thinking
It's not clear how much of an effect the latest turmoil will have on those estimates, because the oil sands are by nature a long-term resource. Many of the mines are expected to operate for 30 years or more and planners must think beyond next year or even a decade out. It's not about what happens to oil prices six months from now that matters.
Nonetheless, next year's spending plans are being drafted and there's little doubt short-term spending could be slashed if market conditions persist. And as past crashes have shown – it will.