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End of an Era: New oil sands mines held back by cost

Imperial Oil’s Kearl oil sands mine has come in months late and billions over budget

Dec 30, 2013

by Eric Blair

013_endera_storyIn late April, Imperial Oil announced that the first phase of its long-awaited Kearl oil sands mine was finally being put into production. The $12.9-billion project will eventually ramp up to production of 345,000 barrels per day. It features environmental technologies such as a proprietary froth treatment process that eliminates the need for an upgrader and energy-saving cogeneration capacity, that will bring its bitumen onto market with the same life-cycle greenhouse gas emissions as conventional crude products. It’s a milestone for the oil sands, and a noteworthy achievement for Imperial Oil. It’s also, likely, the last of a dying breed.

That has little to do with environmental concerns or regulatory issues. Indeed, the Alberta government seems more than happy to continue approving new projects, while on a per-barrel basis mining projects produce less than half the amount carbon dioxide than in situ projects do. No, what might put an end to new oil sands mines is the very same thing that nearly prevented them from ever being built in the first place: the cost.

A report issued by the Canadian Energy Research Institute this past May suggested that the break-even price for new mining projects would be $99.49 per barrel, and $103.16 per barrel for integrated mining and upgrading projects. Their forecasted oil price? Approximately $95 per barrel, plus inflation.

By 2015, oil sands production from in situ projects will surpass production from operating mines for the first time.

It’s not alone. With the exception of Suncor and Total’s Fort Hills project, analysts at IHS (a global leader in energy information) don’t include all planned new oil sands mines in its forecast because of the mismatch between expected costs and expected oil prices. In other words, given current market conditions, Shell’s Pierre River mine (forecast production of 200,000 barrels per day), Teck’s Frontier mine (275,000 barrels per day) and Total’s Joslyn North mine (100,000) are all uneconomic. “If you look at the mining, it’s very expensive,” says Carmen Velasquez, an associate director of global oil with IHS, a Colorado-based information and consulting firm. “Just on a break-even basis with our modelling, taking into consideration tax and royalties and operating costs, we think a break-even is closer to $100 WTI. And so, if we look at where our forecast is for crude, it’s not that high. Especially WTI, with the increasing supply from the tight oil plays, we think that means we’ll see a weaker price going forward.”

The problem is labour. For an oil sands mine, labour demands are particularly onerous – and particularly expensive. “If you look at CNRL and Shell’s previous projects, you’re looking at more than 10,000 people on site at peak,” Velasquez says. “We think at least 30 per cent of the project is direct labour cost.” In situ projects, on the other hand, require far fewer hands on deck, and have the added benefit of having natural gas – cheap now, and almost certainly cheap for the forseeable future – as one of their key inputs. That’s why virtually all new projects will be in situ, and why, by 2015, oil sands production from in situ projects will surpass production from operating mines for the first time in history.

That’s certainly not what the National Energy Board predicted in 2000, when it released a market outlook to 2015 that featured a now-conspicuously optimistic discussion of supply costs. According to NEB estimates, improvements in technology and operational efficiency would drive costs down (on an inflation-adjusted basis) to $10 per barrel by 2004, and as low as $8 by 2015. But the supply costs for the first phase of Kearl came in closer to $20 – and it’s not necessarily an outlier, either. “If you look at Kearl when it was proposed, it was $3 to $5 billion for all three phases,” says Andrew Leach, an associate professor at the Alberta School of Business. “When it was re-sanctioned, it was $5 to $8 billion for all three phases. And yet, when the discussion is around the fact that they just spent $13 billion getting Phase 1 online, people say they missed their capital budget by a couple of billion. Yeah, that’s because their last estimate was that they’d get Phase 1 online for $10 billion, but somewhere in the middle you lost 200,000 barrels and a bunch of billions of dollars. You can go through the industry and find examples of this.”

And while it’s possible the industry could drive costs down through technological innovation or greater operational efficiency, Leach says that will only entice other companies to enter the space, eventually driving costs back up. “As we’re told over and over again, it’s a global market for capital,” he says. “But that’s true on the high side as well. If there’s high rates of return to be made, capital’s going to flood in, and it’s going to keep coming in until there aren’t any more returns to be made at the margin.” It might be a moot point given that the stickiness of wages make it difficult to drive costs down very far. “It’s really easy to hire someone away from another company and give them a $10,000 raise,” says Leach. “It’s relatively harder to say ‘I’m now only really able to make money if I pay you $30,000 a year less.’”

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The economics behind building new oil sands mines may be dubious, but that doesn’t mean existing open-pit producers won’t be able to increase their production. Instead, they’ll do it by expanding and improving existing projects. For example, Velasquez says, Shell has stated that it thinks it can squeeze an additional 90,000 barrels per day out of existing projects over the next decade. “In phases, they’re going to expand and debottleneck the stuff that they already have,” she says. “That’s much cheaper to do. We do think we’ll see increased production from mining, but it’ll be in those smaller tranches rather than a new mine.”

And if the wildly inaccurate forecast from 2000 is any indication, current predictions about the viability of new oil sands mines that look past the near future are just as unreliable. “There’s some uncertainty, I think, around tight oil and how long it will last,” Velasquez says. “In the next decade, if you look at our WTI outlook, we definitely start to see rising prices. Projects could look quite different then.”

Skill Surplus?

Perhaps not. The demand for skilled labour in the oil sands is expected to remain high for the next couple of years, and then to drop for several thereafter, in part because of the demise of labour-intensive open pit mines. But any new projects would bump the numbers back up.

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