Oil Sands Bust

Oil Sands Bust

Prime Minister Stephen HARPER first dubbed Canada an "emerging ENERGY superpower" back in 2006. He was talking, primarily, about Alberta's oil sands. "We are a stable, reliable producer in a volatile, unpredictable world," he said, sending a clear signal that Ottawa intended to realize the oil sands' full economic potential, as well as the geopolitical clout that comes along with it.

It was music to Albertans' ears. With the world's third-largest proven crude oil reserves, some 175 billion barrels, behind Saudi Arabia and Venezuela, the province had long been aware it was sitting on a gold mine. All that was needed were global oil prices above US$80 a barrel (needed to offset the expense of separating gooey BITUMEN from the sandy soil) and the necessary political vision to make it all happen. Canada finally had both. Industry forecasts predicted that, over the next quarter-century, the oil sands would draw more than $364 billion in investment, create some 3.2 million "person-years" of employment and add $1.7 trillion to Canada's GDP.

More than six years later, however, Canada's superpower dreams are mired in a host of unexpected problems--economic, logistical and political--none of which will be easily solved. Bitumen is still being squeezed from the ground at a rate of 1.7 million barrels per day and growing. But it's no longer clear how oil companies plan to deliver all that heavy crude, which they once estimated would reach 3.7 million barrels per day by 2021, to refineries and, ultimately, the motoring public.

Existing pipelines in the region are running near capacity and efforts to build new ones have stalled amid protests from anti-oil sands groups who are concerned about the elevated greenhouse gas emissions associated with oil sands production. TransCanada Corp.'s $7-billion Keystone XL pipeline, which would link Alberta with refineries in Texas, fell prey to U.S. President Barack Obama's re-election bid, while Enbridge Inc.'s $6-billion Northern Gateway, needed to pump oil to a shipping terminal on the B.C. coast, faces opposition from the green lobby, dozens of FIRST NATIONS groups, and is the subject of a political standoff between two provincial premiers. Some oil sands producers have resorted to shipping their crude on railcars, a decidedly 19th-century solution, while entrepreneurs are proposing fanciful plans to move it through the Arctic or build heavy refineries on the lush B.C. coast.

The battle over pipelines comes as the United States, which imports roughly 1.4 million barrels of crude oil from Alberta every day, is suddenly swamped with its own oil from unconventional sources like the Bakken shale formation in North Dakota. A recent forecast by the International Energy Agency said the U.S. is on track to become the world's biggest oil producer by 2020, overtaking Saudi Arabia. New supplies, in turn, have depressed U.S. prices paid to oil sands producers. Meanwhile, demand from countries in Asia is soaring, but there is currently no good way to move the landlocked hydrocarbons overseas. To add insult to injury, refineries along the U.S. Gulf Coast, tantalizingly out of reach to oil sands firms, are running under capacity.

It's shaping up to be a nightmare scenario. Global demand for oil has never been higher and yet oil sands producers are forced to sell their product on the cheap. Already some analysts estimate oil sands producers are forgoing more than $27 million a day in potential revenue, causing companies to delay proposed projects and dial back planned investments. Alberta Premier Alison Redford has even warned of a "bitumen bubble" that threatens to siphon $6 billion in tax and royalty revenue from the province's coffers in the coming fiscal year. "We're at a critical point right now," says Geoff Hill, who leads consulting firm Deloitte's oil and gas group in Calgary. He argues that if something isn't done soon, the industry could face the unthinkable: "substantial slowdowns in the oil sands." Other countries will rush to supply the rapidly expanding economies of China and India while the U.S. will increasingly be capable of meeting its own energy needs. Forget about being an energy superpower, Hill says. "We could end up on the outside looking in."

The industry's current predicament would have seemed unimaginable just a few decades ago. Back in the 1970s, Alberta was anticipating a major production boom as oil prices soared amid the global energy crisis. But the industry quickly found itself thwarted by Ottawa's hated NATIONAL ENERGY PROGRAM, which drove away investment. Then came the oil bust of the 1980s. Prices fell and most oil sands operations became unprofitable. By the 1990s, however, after so many long years of frustration, global oil prices began to recover. And by the turn of the century, the industry, now armed with the latest steam-assisted technologies to drill oil sands bitumen in-situ, was once again on a full boil.

Few would have guessed that a relatively common piece of infrastructure--the lowly pipeline--would threaten to derail Alberta's oil dreams all over again.

The epicentre of the current crisis is the small town of Cushing, Okla. Cushing is a major U.S. oil storage hub and self-proclaimed "pipeline crossroads of the world." But in recent years it has become clogged with oil flowing not only from Canada, but from shale formations in the U.S., where new techniques like hydraulic fracturing, or "fracking," are used to coax oil from rock. The glut has led to a bizarre situation where the price of oil in the U.S., measured against the West Texas Intermediate benchmark, or WTI, is just $96 a barrel, while the price paid almost everywhere else in the world is closer to $114.

To alleviate the oversupply in Oklahoma, more pipelines are needed to move oil to Gulf Coast refineries. But that's only part of the problem. Additional pipeline capacity constraints in Alberta have helped push down the price of Western Canadian Select, a heavier grade of oil. It now trades at a discount of about $30 to WTI. "Our system is under pressure from high demand and increasing production, particularly in the oil sands region," says Graham White, spokesperson for Calgary-based Enbridge. "Most months the pipes are full." As a result, Enbridge has resorted to rationing space on its network while it embarks on a $20-billion capital spending program to increase pipeline capacity across the continent. In the meantime, some oil sands producers, including Cenovus Energy Inc., have resorted to shipping crude by railcar, a far less economical mode of transport. About 8,825 rail cars were loaded with crude and other petroleum products last March, up from 5,600 cars a year earlier, according to Statistics Canada.

The pipeline squeeze is only going to get worse. A report by the Canadian Imperial Bank of Commerce suggested that North American oil production is on track to grow at an "incredible rate" of 800,000 barrels a day, each year, through 2016, with more than half of that production expected to come from the U.S.

TransCanada's 2,700-km Keystone XL pipeline was supposed to provide relief by giving producers a more direct link to the Gulf Coast, the largest refinery market in the world. But the White House refused to sign off on the cross-border chunk of the pipeline following protests over its planned route through the ecologically sensitive Sand Hills region of Nebraska. That left TransCanada with approvals for only half a pipeline, connecting Cushing with refineries in Texas. That line, along with another Enbridge project to reverse the existing Seaway pipeline, also between Oklahoma and Texas, is expected to help reduce the Midwest glut. Andrew Potter, a CIBC analyst, argues that, even with both projects completed, the discount applied to WTI compared to the more international Brent crude price will still be about $10.

TransCanada has proposed a new route for the northern section of the Keystone XL, between Hardisty, Alta., and Steele City, Neb. But it's far from a done deal, despite a recent approval by the state's governor. Now, it must be approved by the U.S. State Department, which is soon to be headed by Massachusetts Sen. John Kerry. In a sign of the coming political battle, 10 U.S. governors and Saskatchewan Premier Brad Wall wrote a letter to President Obama urging his administration to sign off on a project that's "fundamentally important to the future economic prosperity of both the United States and Canada." Another 53 U.S. senators have made a similar plea, citing jobs and U.S. energy security. But opponents say the American public still isn't sold on the plan. "Right now the No. 1 customer of the oil sands has serious concerns about the product it's receiving, based on the greenhouse gas emissions," says Nathan Lemphers, an analyst with the Calgary-based Pembina Institute, a clean energy think tank. The National Resources Defense Council noted Obama's reference to the threat of climate change in his inaugural address and suggested: "If we are going to get serious about climate change, opening the spigot to a pipeline that will export up to 830,000 barrels of the dirtiest oil on the planet to foreign markets stands as a bad idea."

Rising U.S. oil production and the possibility of energy self-sufficiency has given further ammunition to the anti-pipeline lobby. They have dubbed the Keystone XL an "export pipeline" for Canadian oil. Analysts, on the other hand, point out that oil is a global commodity, and that the system to refine it and deliver it to consumers is complex. That's why the glut of North American crude hasn't had much of an impact on gasoline prices in the U.S. and Canada (many refineries in the U.S. and Canada are supplied with more expensive foreign oil). It's also why the boom in U.S. oil production from the Bakken, which produces a light sweet crude, is unlikely to dampen demand from U.S. Gulf Coast refineries, built to handle heavy crude--provided we can get it there.

Already, some oil sands operators are cutting back on investments in the face of mounting uncertainty. Suncor Energy Inc., for one, is considering whether to put on hold a proposed $11.6-billion upgrading facility, according to Bloomberg. Canadian Natural Resources Ltd. expects to reduce spending on oil sands projects and Cenovus is forecasting a drop in cash flow due to lower prices paid for oil sands crude. "Some companies have slowed things down because they're not getting the prices they need, and that's because of the pipelines," says Pierre Fournier, an analyst at National Bank Financial. The oil sands is at risk of becoming nearly as difficult to capitalize upon as it was a few decades ago.

The shifting U.S. public opinion surrounding the oil sands underscores the risks of being reliant on a single customer. Yet, efforts to get Canadian crude to overseas markets--namely Asia--have proven every bit as contentious as the Keystone XL, if not more so. Enbridge's Northern Gateway project would pump diluted bitumen 1,177 km from northern Alberta to a shipping terminal in Kitimat, on the B.C. coast. From there, it would be loaded onto tankers bound for China.

In a region where the memory of the 1989 Exxon Valdez spill in Alaska's Prince William Sound lingers, the Northern Gateway proposal has raised new fears about plans for a steady stream of ocean-going tankers, laden with unrefined crude, navigating the narrow waterways connecting Kitimat with the Pacific--a journey that's expected to take roughly 22 hours. Further risks are posed by the pipeline itself, which snakes through a region described as ecologically sensitive.

Both environmentalists and several First Nations groups have attempted to bog down a federal review process, with some success. Five protesters were recently arrested after sneaking into a joint-review panel meeting in Vancouver. Opponents point to a string of pipeline accidents, including a 2010 spill of an Enbridge line in Michigan, as evidence that the industry's safety record is wanting.

It has put B.C. Premier Christy Clark in a difficult position. She hasn't threatened to torpedo the project, but is demanding both top-notch safety measures and that the province receive its "fair share" of economic benefits. Alberta's Redford, on the other hand, has ruled out any royalty sharing. Ottawa remains hopeful, despite the impasse. "I am still of the belief that we can get this done, on the assumption, of course, that it passes regulatory muster," Natural Resources Minister Joe Oliver recently told Postmedia News, referring to the federal review scheduled to be completed before year's end.

Analysts aren't holding their breath. CIBC's Potter gives 50-50 odds that the Northern Gateway and another B.C. project, the $5.4-billion expansion of Kinder Morgan's Trans Mountain pipeline between Edmonton and Vancouver, will be completed before the end of the decade. Lemphers, too, argues that it's "highly unlikely" either West Coast pipeline project will go through. "You're seeing an unprecedented level of opposition to these pipeline projects," he says, noting that B.C. is scheduled to have an election this spring that could result in an NDP government even more hostile to the plans.

Desperation seems to be creeping into the discussion with increasingly fantastical solutions being offered up. Newspaper publisher and Victoria businessman David Black has proposed building a $13-billion oil refinery on the B.C. coast--the first new refinery built in Canada since 1984. The idea is to keep more of the oil sands' value within Canada (and B.C. in particular) by selling pricier refined products like diesel and gasoline to Asian customers. Black argues a coastal operation has the added benefit of reducing environmental risk since gas and light oil spills are easier to mop up. Meanwhile, another group of businessmen is backing a $10.4-billion plan to construct a new, 2,400-km "purpose built" railroad to carry oil from Alberta to Alaska, where it could then be shipped overseas on tankers.

The oil sands industry, on the other hand, remains confident extra pipeline capacity will be built. "It's going to be tight for the next few years, but pipeline companies can react," says Greg Stringham, vice-president in charge of oil sands and markets for the Canadian Association of Petroleum Producers. Existing pipelines can be modified or expanded to handle additional loads, he says. One example is the proposed $5-billion conversion of part of TransCanada's mainline system, which currently carries natural gas across the country, so that it could push synthetic crude eastward to refineries in Central Canada and the Maritimes. Another is Enbridge's Line 9 project, which would reverse the flow of its pipeline, moving oil from Sarnia, Ont., to Montreal. With global demand for oil high, Stringham says producers will find a way to deliver it to customers one way or another.

If he's wrong, Canada's chance to take advantage of the resource could slip away. "It makes it a very risky proposition for investors if we don't have access to key markets," according to Hill. And the boom in U.S. oil and gas means that country could effectively be energy self-sufficient by 2030 (although most analysts believe the U.S. will continue to import Canadian oil), according to a recent BP report. Plus, U.S. producers have a cost advantage. National Bank's Fournier estimates shale producers can make money when oil prices are in the $60 to $70 range, about $20 a barrel less than what the oil sands requires.

The new reserves in Canada's biggest market could dampen prices for years to come. Add to that a pipeline crisis with no easy solution and deepening environmental fears, and it amounts to massive challenges that threaten what was once thought to be a North American energy panacea, not to mention Canada's cash cow.

Fournier is taking issue with Ottawa's recent pledge to prevent foreign state-owned companies from buying Canadian oil sands firms after allowing the controversial $15-billion takeover of Nexen Inc. by the China National Offshore Oil Corp. Stephen Harper said that, in the future, such deals would only be allowed in "exceptional circumstances." The problem, Fournier wrote in a recent report, is that "the oil sands are facing exceptional challenges today. The massive resource is arguably more vulnerable than many would care to admit."

The world's existing energy superpowers need not look over their shoulders just yet.

Maclean's February 11, 2013