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Canada's home-ice advantage

Vast reserves are the oil sands' main advantage. Local producers think they can drive costs down where foreign entrants couldn't

Investing in Canada's oil sands has long been a tightrope of enormous returns versus the time value of money.

With the world's third-largest oil stash—after Saudi Arabia and Venezuela—the value proposition of some 165bn barrels would seem clear. Yet the size of the prize has long been overshadowed by the combination of huge upfront costs and volatile world oil prices. Billion-dollar overruns on major capital projects are the norm and producers have had to struggle to keep operating costs low enough to be profitable.

Major oil companies were willing to overlook those hurdles as long as conventional reserves were declining and they could book hundreds of millions of barrels with virtually no exploration risk. Paradoxically, high oil prices in the early part of the decade only encouraged inefficiency and wasteful spending, forcing a rethink of investment strategies.

Production, now 2.4m barrels a day, has climbed (though not as quickly as older forecasts expected). The Canadian Association of Petroleum Producers says it will reach 3.12m b/d in 2020 and 3.67m b/d in 2030.

The rise of tight oil, particularly in the US, has prompted major producers such as Shell and ConocoPhillips to abandon the oil sands for greener pastures in the Permian and elsewhere in North America.

Though it speaks to the need for oil sands production to be cost competitive with tight oil, the exodus of foreign majors has produced an opportunity for homegrown players such as Suncor Energy and Canadian Natural Resources (CNRL) to become consolidators in an industry only recently dominated by international oil companies.

Typically, producers have sought to diversify operational and price risk by forming joint ventures such as Syncrude Canada. By stepping in as the majors have exited, both Suncor and CNRL have shifted gears by taking controlling stakes in four of five major oil sands mines.

The strategy is twofold. First, both companies are hoping to create economies of scale that will allow them to reduce costs and maintain profitability in a so-called lower-for-longer oil-price environment. On that front, Suncor is targeting cash costs of $24-27 a barrel in 2017, offset by Syncrude costs of $32-35/b. CNRL's Horizon mine comes in at a respectable $26-$28/b.

Second, higher working interests allow the parties to control the pace and scope of future development, which will be influenced by looming environmental policies. In 2016, the Alberta government implemented a hard cap on oil sands emissions of 100 megatonnes per year. Though the industry isn't expected to brush up against those limits for at least a decade, the era of rampant growth is over.

Rather, the focus will shift from expansion to maintenance and streamlining the efficiency of existing operations. The government hopes this in turn will open up investment opportunities in clean emissions reduction technologies such as carbon capture.

The oil sands may seem a complex value proposition with many moving parts. Yet Canadian producers seem uniquely positioned to understand the risks and rewards of what remains one of the world's largest—if costliest—oil plays. Call it home-ice advantage. As oil sands shift to a manufacturing model, time and patience will be the key.

This article is part of a report series on Top 10 upstream bright spots. Next article is: Plenty of optimism in West Africa

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