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Canada's missing barrels

The majors have carried billions of barrels of oil sands reserves on their books. The price downturn is making them disappear

This era of lower-for-longer oil prices has raised a thorny question for Canada's oil sands producers: at what point does oil in the ground cease to exist on the balance sheet? The answer is when the US Securities Exchange Commission (SEC) says so.

The question became more acute after ExxonMobil was forced to write off 3.5bn barrels of its oil sands reserves in its annual 10-K filing. It amounts to the entire booked reserve base of its Kearl oil sands mine that was commissioned in 2013 at a cost of C$12.9bn ($9.81bn) and another 200m barrels of bitumen at its Cold Lake in situ project. The oil sands writedown slashed ExxonMobil's proved reserves by around 20%.

ConocoPhillips followed suit, cutting its proved oil sands reserves by half, effectively eliminating 1.3bn barrels of oil sands and another 1bn barrels of bitumen resources.

These barrels have disappeared from the accounting ledger without a trace. All told, it amounts to about 3% of Canada's entire proved reserves, which has been touted as the third largest in the world after Saudi Arabia and Venezuela.

The writedowns, however, don't mean that Exxon and ConocoPhilips are packing up and going home. Exxon's Kearl oil sands mine—operated by its Canadian subsidiary Imperial Oil—continues to produce unabated at 170,000 barrels a day. And Exxon insisted in the wake of the writedowns that it is forging ahead, and expects to bring those reserves back onto its books eventually.

The problem is how the SEC requires companies to tally up their reserves. The accounting rules are complex, but essentially say that companies have to use the average price for each month in the previous full year to determine the economic viability of a resource ever being developed. If that price falls below the cost of production, companies must remove the reserves from the books. The price for 2016 after a brutal price crash in the first half of the year was $29.49 a barrel for Western Canadian Select. ExxonMobil reported average production costs for its Canadian synthetic oil projects at $33.64/b for 2016.

This is not an easy decision to make for companies, because it essentially reduces the net asset value of the company. This has been a sticking point with the oil companies for years given that oil sands are capital-cost intensive and so developers would prefer to amortise those costs over the 25-30 years of the asset's producing life.

But rules are rules

Exxon, in particular, was the subject of an SEC probe, in cooperation with the New York Attorney General's office, which asserted that the reserves should have been written off after the oil price plunge in 2015. It signalled in October 2016 that it would have to relent.

Though it speaks to the high cost nature of oil sands development, it's also a bit of an accounting sleight of hand. Global majors like Exxon have invested heavily in oil sands extraction precisely because they have been able to book billions of barrels of reserves and carry them on the books as assets, while knowing it could be decades before they're ever produced. Canada is one of the few places in the world where this is possible.

And Imperial's integrated model has helped shield it from the price downturn. Its upstream segment—which is comprised almost entirely of oil sands output—posted a C$0.66bn loss in the full year 2016. Because it's fully integrated, it buys back those money-losing barrels for its downstream refining segment, which in turn posted a C$2.75bn profit, nearly double the year before.

Likewise, ConocoPhillips is in a 50:50 refining and production joint venture with Cenovus Energy, Canada's largest in situ thermal oil sands producer. The companies plan to increase production to 0.75m b/d and ship it to refineries in Ohio and Texas. What it loses in the upstream it more than makes up for in the downstream.

The bigger question is whether the writedowns affect oil sands development in the longer term. Statoil pulled out of the oil sands altogether in 2016 and Shell has said it doesn't plan to take on any new projects. But on the reserves front, producers have a silver lining. Unlike the SEC, Canadian reserves-reporting rules use projected future cash flows—by definition, forward looking information which isn't allowed in the US—to determine future economic viability. Assuming the recent rise in the oil price lasts until 31 December 2017, almost all of those missing barrels will magically reappear on the books in due course. Even under SEC rules, if oil prices perk back up, the reserves can come back.

For the majors, the oil sands were never only about producing oil, but also about being able to beef up the asset part of the balance sheet. The price crash has shown up the risks of that strategy.

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