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A gold-rush mentality in the oilsands will kill the entire sector’s profitability, warns a mathematical model used to predict industry outcomes. Fuzzy-headed, yes, but so far it’s proven eerily accurate

By Jeff Gailus

The prisoner’s dilemma is probably the most popular game-theory scenario of all time. Imagine you are one of two suspects picked up by the police for, say, a New Year’s Eve bank robbery in Calgary. The detective knows he doesn’t have enough evidence to convict either of you, so he puts you in separate cells and offers each of you the same deal: testify against your friend in court and you will go free (though your convicted friend will spend 10 years in prison). If you refuse, and your friend turns you in, he goes free and you spend 10 years in prison.

There are other options, though. If you both testify, you each receive a five-year prison sentence. If neither of you testify, you both spend a measly six months in the local jail, out in time to enjoy the best of the southern Alberta summer. What do you do?

According to a game theory analysis recently completed by the Canadian arm of Deloitte Consulting, the answer to that question may provide some insight into the future of Canada’s booming oilsands industry.

The best-case scenario in the prisoner’s dilemma is for neither you nor your friend to testify. But game theory predicts that both you and your accomplice will turn each other in, dooming each other to spend five long years in prison.

Why? To make your decision, you need to try and predict what your incarcerated accomplice will do. You know that if he keeps his mouth shut, your best bet is to testify and walk free. But you also know that if your accomplice testifies against you, your best option is to turn him in too; otherwise, you spend 10 years in prison.

A Buddhist may well choose to keep quiet, but if you’re a petty criminal acting in what you perceive to be your own self-interest, your safest option is to snitch. You will either walk free or spend five years in prison, without risking the possibility of a 10-year sentence. This, according to game theory, is called the “natural” or most likely outcome. Both players, if they’re smart, will sing like canaries, which all but guarantees that you and your friend won’t be spending the summer at the beach.

Deloitte’s paper on the subject, “The Producers’ Dilemma,” predicts a similar outcome in the oilsands. Oil companies increasingly face a difficult choice. If they each, acting in their own self-interest, continue to invest in production at current rates, a host of problems – labour shortages, rising costs, infrastructure deficits, increased public concern about environmental issues – will increase production costs and encourage construction delays, which in turn means that investors could see lower (or at least sub-optimal) returns on their investment.

This, predicts “The Producers’ Dilemma,” is a “natural” outcome of the current pace of oilsands development, akin to each of the prisoners turning each other in. Rather than collaborate with each other and the provincial government to find an optimal pace of development for the entire sector over the long term, companies will continue to invest in oilsands production at a pace that will become “unsustainable,” a situation that may ultimately yield the one thing no one, industry or government, says they want: increased government intervention in the form of regulations, taxes or royalties.

I am sitting across the table from Dick Cooper, Deloitte’s national leader for energy and resources and one of the architects of Deloitte’s game theory project. We are in a small boardroom on the 31st floor of the Scotia Centre in Calgary, looking north across the ice-choked Bow River and the quiet houses perched above it. It is late on a winter Wednesday afternoon, and the sinking sun has turned the sky a deep blue that, it just so happens, matches Cooper’s shirt almost exactly.

Why, I ask him, would Deloitte want to dabble in game theory? Surely there were enough experts in the office towers around us, even in this very office, ready to offer up their prognostications about the future of the oilsands.

“We wanted to try and figure out what was likely to happen in a rapidly expanding industry that is becoming increasingly complex and risky,” he says quietly, his hands interlaced on the table in front of him. “We thought, instead of doing just another me too outlook for the industry, we’d add a new twist to it.

“But when we looked at all the industry players and the two levels of government, and we looked at all the choices they had, and started brainstorming around the different combinations and permutations of options that each one had and was likely to do, we realized that this is a complicated set of decisions. There were a whole range of options that we just couldn’t boil down mentally in our heads.”

And so they invoked the cool blue reason of mathematics, disguised as entertainment.

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