Today’s Rout Is a Far Cry From Wildcat Years for Oil Sands

The collapse in the market for Canada’s heavy crude below $30 a barrel last week is hammering home a harsh reality for the nation’s oil-sands producers: There’s no one to save them this time.

Unlike previous market crashes that were relatively short-lived, the combination of persistent oversupplies and weakening demand are dealing a severe setback to what’s been one of the biggest growth stories in global energy markets. Oil-sands companies such as Suncor Energy Inc. already have been rethinking major developments that can require more than C$10 billion ($8 billion) in investment. Now even existing projects are barely covering costs or in a losing position.

“This is a major test of the industry,” said John Stephenson, chief executive officer of Stephenson & Co. in Toronto, a money management firm. “It’s going to be sustained, it’s going to be ugly and it’s going to go on longer than people think.” Long a resource investor, Stephenson is right now shorting energy stocks as he bets on more price pain.

When the price of Canadian crude fell to similar depths in 2009, U.S. monetary policy helped prevent a financial crisis from deepening and boosted demand for oil, setting the stage for a relatively swift recovery. This time around, there’s no end in sight to the oil glut, leaving companies no choice but to drastically cut costs to survive.

The rule of thumb for new projects in Canada’s oil sands is that a West Texas Intermediate crude price of about $80 a barrel is needed to earn a return. The paste-like fossil fuel from northern Alberta is selling at a discount of about $13 a barrel compared to U.S. crude, which is now well under $50. Western Canadian Select oil closed Friday at $33.62.

Sunrise Postponed

Husky Energy Inc. pushed back its timeline to start up its C$1.6 billion Sunrise 2A expansion from as early as 2017 to some time next decade. Cenovus Energy Inc. cut spending on new projects by 46 percent this year, halting construction of an expansion of its Christina Lake development and putting its Telephone Lake project on hold.

The technology and labor required to extract the thick bitumen has always meant high costs for oil-sands operations, said Rick George, former Chief Executive Officer of Suncor who led the company for more than two decades through several downturns. The remote locations of projects have added expenses such as road-building for transporting needed equipment to job sites.

In past downturns, the focus was on surviving and reducing expenses. “The parallels to now are the same: every company out there is looking at how they can get their costs down,” George said.

Cost Burden

Even before the most recent slump, demand was growing for cheaper and cleaner production methods to generate better profits and improve the reputation of an industry that emits more carbon per barrel than conventional crude drilling.

Oil-sands companies have quickly unwound from the heady days of $100 oil, with spending cuts that are rippling across the industry. Suncor, Cenovus, ConocoPhillips and others have announced thousands of job cuts and are demanding discounts from their suppliers.

Capital spending in the oil sands will fall 24 percent to C$25 billion in 2015, according to a January forecast from the Canadian Association of Petroleum Producers.

Producers are poised to reduce costs by 25 percent this year, more than the 22 percent reduction of the 2009 recession, said Randy Ollenberger, an analyst at BMO Nesbitt Burns Inc. in Calgary. The industry’s average cost to produce bitumen from existing operations will fall to just over C$40 a barrel from close to C$60 last year, said Ollenberger -- still about C$10 more than producers are currently receiving.

Rising Output

Oil-sands production will still rise to 2.3 million barrels a day because of prior investments, according to the industry group’s forecast.

“It still is a growth story, but it’s going to be at a different pace,” said Greg Stringham, a vice president at the Canadian Association of Petroleum Producers. “People are focusing completely on the cost side, whereas before there was more of a focus on the revenue and growth side.”

Most of the older operations, including the Suncor and Syncrude Canada Ltd. mines and the early steam-assisted projects such as Cenovus’s Foster Creek site, will keep production chugging along even if some aren’t covering costs at such low prices. It’s too expensive to shut down operations and restart later.

“Those projects keep going without missing a beat,” said Todd Hirsch, chief economist at ATB Financial, the Alberta government-owned bank.

Biggest Losers

Producers hit hardest by the low prices are companies that are still raising capital, or haven’t begun production yet, Hirsch said. “They’re the ones that are probably in real trouble.”

Canada’s oil-sands industry faced a similar test in the 1980s -- facing a supply glut that also kept a lid on prices -- when there were only two commercial producers and the technology for extracting bitumen deeper than the mining shovels could reach was still just a science experiment. The eventual $30-billion in yearly investments was still far off.

The industry was salvaged then by improvements in technology that lowered costs. The government had also stepped in as a direct investor, and the price of oil rose high enough to spur some new development.

Several fledgling startup oil-sands producers were able to survive the 2009 downturn by attracting investors betting profits would return once U.S. crude bounced back above $90 a barrel -- which it did the following year.

Struggling Juniors

Those so-called junior producers, including Southern Pacific Resource Corp. and Connacher Oil and Gas Ltd., are now struggling to stay afloat. As they come up against the claims of creditors, the companies are seeking to restructure or find a suitor.

For oil-sands projects already built and producing crude, costs depend on a number of variables, including site location and the method of recovery used.

The extraction process used by Cenovus on some sites can coax crude out of the ground for as little as C$12 a barrel. Suncor, the oldest producer in Alberta’s oil sands, has driven costs down to under C$34 a barrel at its operations, said Chief Executive Officer Steve Williams on Feb. 5 during a conference call with analysts.

Need Normal

Suncor plans to lower its costs further, but to meet its goal of a 15 percent return on capital the company still needs a “more normalized oil price,” said Chief Financial Officer Alister Cowan.

Other companies are in the same boat. Imperial Oil’s Kearl mine needs an average U.S. crude price of about $85 a barrel over its decades-long lifespan to earn a return, while Athabasca Oil Corp.’s proposed Hangingstone steam project needs $70 and Cenovus’s Grand Rapids requires more than $80, according to BMO’s Ollenberger.

When the dust has settled, the industry will look a lot different, said Michal Moore, a professor at the University of Calgary’s School of Public Policy.

“The wildcat image of the oil-sands industry is probably coming to an end,” Moore said. “Expansion is going to become more focused on existing assets and the business will become more predictable and stable.”

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