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Canadian oil sands sector seeks new markets

By Gary Park

The Canadian oil sands sector is searching for renewal based on consolidation, lower costs and a firmer crude price.

But US environmental legislation threatens the industry's sole external market.

As a result, interest in alternative markets has been reignited, but as each option is explored new challenges emerge.

An early showdown between producers and those opposing a shipping route to Asia seems likely.

An enforced time out from the breakneck pace of oil sands expansion in Canada is not all bad, giving the sector a breather while it sorts out some fundamental changes of direction.

It has a chance to shuffle the ownership deck, casting aside those whose ambitions are greater than their financial backing; to figure out where North American climate-change legislation is headed; to rein in out of-control costs; and perhaps above all, to take a serious look at opening up markets beyond the United States.

In answer to an inflationary cycle that has sideswiped mega-projects over recent years, with budget overruns commonly ranging from 50% to 70%, operators are leaning on labor unions and suppliers, forcing them to reopen contracts - apparently with some success, according to key players such as Canadian Natural Resources, PetroCanada and Suncor Energy.

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At the same time, there has been one clear message from the industry that there is strength in numbers - fewer, that is.

The proposed C$19 billion ($15.5 billion) merger of homegrown giants PetroCanada and Suncor, which is confidently expected to be completed in the third quarter, carries the inherent risks of an overriding commitment to oil sands.

While acknowledging they are taking a gamble, the CEOs of the two companies are even more certain that integration is their best hope of advancing their most lucrative oil sands projects and saving billions of dollars in the process. (See related map: Canadian west coast pipeline projects.)

Already they are talking about an early restart of Suncor's C$20.6 billion Voyageur mine and upgrader, one of more than C$100 billion worth of projects shelved since late 2008.

PetroCanada CEO Ron Brenneman is emphatic that the combined entity can save by eliminating duplication of costly upgraders and pipelines, as well as building on some early success in reducing original budget forecasts.

Suncor CEO Rick George said the slowdown has helped refocus a lot of minds by "flushing" the sector of weaker companies and marginal ventures.

"The pricing point has now come back more to the industry as opposed to our suppliers and contractors," he said.

"We should see operating costs drop by 10% to 15% on a comparative basis. And we should see our capital investment costs drop in the 20% to 25% range."

George said the new Suncor-led company will take a "premier position" in oil sands "which will not be able to be duplicated by anyone."

Although certainly not on the same level in terms of size, other mergers and buyouts are expected as peers shift to unconventional resources.

Already on the table in Alberta is a hostile C$830 million offer by France's Total for UTS Energy, which has a 20% stake in PetroCanada's Fort Hills project and shares a joint-venture with mining giant Teck Cominco in a bundle of other highly-rated bitumen leases containing an estimated 1.88 billion barrels.

With no production to generate cash flow and faced with the challenge of meeting its share of Fort Hills costs, last estimated at C$25 billion, UTS is trapped in a dead-end.

Many other start-ups, so-called bottom-feeders, are in the same fix.

Whether as stand-alone operators or junior partners, they are frozen in a time when commercial viability was broadly tied to oil prices of at least $40/barrel to expand existing plants and $100/b to embark on substantial new projects.

For now, a major surge in oil sands merger and acquisition activity hangs on state-run foreign companies or super-majors.

There have been rumblings of possible bids for the oil sands assets of Canadian independents Nexen and Canadian Natural Resources, stirred by word from TAQA, the Abu Dhabi National Energy Co., that it is open to an outright purchase or partnership in the oil sands sector.

TAQA has invested C$7.6 billion over the past two years, merging three Canadian conventional producers as part of its plan to build a C$20 billion Canadian enterprise.

TAQA CEO Peter Barker-Homek said oil sands could be back "into the money by the end of the year" because global oil production is forecast to decline 6.7% in 2009 based on current investment and oil sands capital costs are also shrinking as a result of project postponements and delays.

"What was profitable at $70/b last year could be profitable at $50/b this year," he said. "It depends on the flexibility of the particular venture."

International players

The international component of oil sands production has grown steadily over the past decade, with state-owned companies from Japan, South Korea and Taiwan, along with France's Total and Norway's StatoilHydro taking various stakes in existing and planned projects.

Speculation has also persisted that Spain's Repsol, Italy's Eni and India's ONGC Videsh are all biding their time.

Perhaps most importantly in terms of new markets, China, through Sinopec and CNOOC, secured minority holdings in two undeveloped projects, signaling an interest in shipping raw bitumen across the Pacific, but then retreated from the spotlight for five years.

That was until April, when Sinopec boosted its share of Total's Northern Lights project to 50% from 40% for an undisclosed sum, without indicating whether the 100,000 b/d synthetic crude project is any closer to revival after a two-year hiatus.

Sinopec's repositioning stirred fresh interest in the status of rival pipeline plans by Enbridge and Kinder Morgan to deliver oil sands crude to deepwater ports on the northern British Columbia coast for shipment to Asian refineries.

Such interest is also being propelled by fast-moving efforts in the US Congress to slash greenhouse gas emissions to 83% of their 2005 level by 2050 - setting the stage for measures that have potentially major consequences for the oil sands sector.

A climate change bill unveiled by Democratic Congressmen Henry Waxman and Edward Markey would establish a cap-and-trade system to help industry achieve the GHG targets by imposing low-carbon standards for gasoline and other fuels. This would make it much harder for US refineries to sell fuel derived from the carbon-intensive oil sands.

US President Barack Obama signaled his desires in a new budget by proposing that companies buy 100% of their carbon allowances in the form of tradable credits as a way of raising $650 billion over the next decade.

"This is not a ban on tar sands oil, but it is definitely a disincentive," said Susan Casey-Lefkowitz, Canadian program director of the US Natural Resources Defense Council.

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