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Digging deep

Conventional wisdom suggests Canada's oil sands producers should be in full retreat in the face of falling world oil prices. That hasn’t happened—yet

While there is certainly cause for alarm-the oil sands is the marginal barrel in the global market-Canada's oil sands production is expected to grow 65,000 barrels a day in 2016 and another 0.85m b/d by 2021, according to the Canadian Association of Petroleum Producers (Capp), an industry group. Oil sands producers are expected to spend C$30bn ($23.11bn) this and next year to complete mines that began construction be-fore 2014 when the oil-price rout began.

In that sense, it's business as usual for the time being. With so much sunk capital tied up in new developments and previously planned expansion projects, it's too late to stop now, no matter what happens with oil prices over the next 18 to 24 months.

Digging in the dirt

Canadian Natural Resources is spending C$2bn this year to complete its Horizon expansion by late 2017, which will double the mine's capacity to 250,000 b/d.

Imperial Oil, majority owned by ExxonMobil, has permits in hand to increase its Kearl mine production from 220,000 b/d to 345,000 b/d by 2020. It already doubled output in the first half of this year.

In March, the company applied for regulatory permits to construct a C$4.2bn expansion of its Cold Lake in situ project, which is pumping 163,000 b/d of thermal bitumen. If approved, it would add 50,000 b/d starting in 2019.

Imperial is also deciding whether to proceed with the C$7bn Aspen thermal bitumen project 45km north of Fort McMurray, which would produce 45,000 b/d for 40 years. A final investment decision is expected later this year.

Meanwhile, Suncor is pushing ahead with the C$15bn Fort Hills mine in partnership with French supermajor Total and Canadian mining giant Teck. Construction began before oil prices collapsed in 2014 and 195,000 b/d is expected to start flowing in late 2017. But plans for a C$11.4bn Voyageur upgrader to convert bitumen into higher value synthetic crude were scrapped in 2014 as the magnitude of the downturn became clearer.

Stormy sailing ahead

Despite pushing ahead with an ambitious growth agenda, setbacks abound. So far, 17 planned projects representing some C$100bn of new investment have been cancelled outright or indefinitely delayed.

The highest profile of these is Cenovus Energy's Christina Lake in situ thermal expansion in partnership with ConocoPhillips. Planned expansions would have lifted capacity to 310,000 b/d from 150,000 b/d at present, but were placed on hold in late 2014. Cenovus has said it is reconsidering options for the project but no definitive decisions will be made for at least a year.

As with all oil sands developments, the primary driver is cost. In its most recent quarterly results Cenovus boasted it has managed to reduce oil sands operating outlays 31% to a forecast of C$9.38 a barrel in 2016. The impressive cost improvements weren't enough to stave off a C$267m second-quarter loss though.

Cenovus's loss highlights the divide within the oil sands industry between producers of thermal bitumen and upgraded synthetic crude. Bitumen is pumped from the ground via steam injection wells and sold unprocessed at a steeply discounted price-sometimes half of Brent. Upgrading is a pre-refining stage that reduces the viscosity of heavier oils and increases its value. But it is also expensive and producers are reluctant to spend billions of dollars in the middle of a downturn to build the needed hydrocrackers and cokers.

For example, Suncor's all-in costs were C$46.80/b, an average that includes lower-cost bitumen as well as upgraded synthetics. The Fort McMurray fires helped to increase those costs and Suncor says it expects to drive them down to C$30/b by the end of the year. Still, it's clear oil sands are a marginal-value proposition without a serious oil-price recovery.

Adding to the difficulties, the Alberta government has introduced hard caps on oil sands emissions and a carbon tax that casts uncertainty on future costs. Details are still unclear, but oil sands producers will either have to find a way of producing more barrels with fewer emissions or leave them in the ground lest they be subject to punitive taxes. Indeed, that is precisely what companies such as Suncor have proposed doing.

This tumultuous time is leading to a restructuring of the entire oil sands sector. Inevitable consolidation is underway.

Suncor has spent C$9bn to acquire a majority stake in Syncrude Canada, the world's largest oil sands mine. Maybe it knows something others don't.

Meanwhile, high debt loads and defaults have taken a toll on smaller players in the oil sands. These companies aren't being acquired; they're being liquidated under court protection.

Sunshine Oilsands, a junior startup backed by China Investment Corporation, Sinopec and other major Chinese investors, has filed for bankruptcy and in September last year applied to be delisted from the Toronto Stock Exchange after posting more than C$1bn in operating losses.

On 10 August, Connacher Oil and Gas, a junior oil sands producer, obtained an extension from its creditors to give it time to sell off all its assets, including a refinery in Montana and thermal oil sands production plants near Fort McMurray.

They join a list of smaller players including Southern Pacific Terra Energy, Calgary-Shoreline Energy and Spyglass Resources that have declared bankruptcy in the past 18 months.

The result is that the oil sands is be-coming a game for the large multination-al oil companies that have been able to weather the storm while smaller players are swept away.

Retrenchment is nothing new in the sector. Since its inception in the late 1960s oil sands development has faced successive boom and bust cycles and survived.

This too will pass, but nobody knows when.

Downturn shakes up Syncrude

Suncor has taken advantage of the economic pain being felt across the oil sands to snap up a majority share of the Syncrude joint venture, Canada’s largest oil sands project.

In the past 18 months the homegrown oil sands champion has been on a buying spree, spending more than C$9bn ($6.84bn) buying out partners in the venture.

Syncrude is the world's largest oil sands mine, producing more than 350,000 b/d of upgraded synthetic crude that fetches prices more comparable to Brent or WTI than the deeply discounted prices brought in by un-processed heavy Canadian oil. Suncor inherited a 12% stake in Syncrude through its merger with Petro-Canada in 2009, a figure it has increased to 54% since January through successive acquisitions of Canadian Oil Sands (37%) and Murphy Oil (5%).

Indications are that Suncor-Canada's largest oil sands producer at 0.5m b/d and growing-is looking to raise that stake further.

It may find more willing sellers in the venture's Chinese partners. Sinopec (9%) and China National Offshore Oil Corporation (7%) both bought stakes in Syncrude at the peak of China's overseas oil shopping spree. But the state-owned producers are now going through some buyer's remorse as they feel the pressure from low prices and criticism at home that they struck bad deals in their rush to establish a foothold abroad.

ExxonMobil, which owns 25% of Syncrude through its Imperial Oil affiliate, could also be looking to sell while it focuses on expanding its 220,000 b/d Kearl mine. The US supermajor operates Syncrude under a management contract, although the status of that arrangement seems unsustainable now that Suncor has a clear majority interest.

Upping its stake in Syncrude gives Suncor a chance to expand its oil sands production while also potentially helping to drive down costs at separate nearby operations. It's a bold gamble given the cloud hanging over the oil sands' future with low prices as well as new carbon taxes and hard caps on greenhouse-gas emissions put in place by the Alberta government. But Suncor is deeply enmeshed in the sector and knows the risks and the threats. It seems like it wants even more.

This article is part of a report series on Canada's oil sands. Next article: Clock ticks on Canada's pipeline debate

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