Canadian Oil Sands - Myth and Reality

Peter Tertzakian, Chief Energy Economist, ARC Financial Corp.

Was M. King Hubbert, the famous American Earth scientist, really the first visionary to talk about peak oil? Indeed, many regard Hubbert as the Nostradamus of the oil industry, with his 1950s analytic work on peaking oil production part of any discussion about world oil supply today. But on the other side of the Atlantic Ocean, John Cadman was an oil oracle too, predating Hubbert by 30 years. Though Cadman’s thoughts about the future of oil were more qualitative, we are witnessing his important prophecies today. In the end, Hubbert’s numerical analysis and Cadman’s astute foresights go hand in hand.

A geologist by training, Cadman eventually became Chairman of Anglo-Persian, the predecessor company to British Petroleum, which has evolved into today’s BP. Accepting the Chairmanship of Anglo-Persian on 2 November 1927, Cadman said in his inaugural address, “Very many years must elapse before natural petroleum resources will be unable to meet the greater part of the world’s requirements. Of course, the time will eventually come when the world may have to look for a great part of its supplies from secondary and synthetic sources.”

Fast forward 80 years. Enough time has passed to have seen many of the world’s prime hydrocarbon reservoirs mature. Big oil exploration has gradually migrated from the easy geographies of Pennsylvania and Texas to the deep offshore waters of the Gulf of Mexico. Internationally, megascale oil projects today are found in places such as offshore Africa, the offshore Arctic waters of Russia, or many other places that are at what I call the “ends of the Earth”—geographically extreme places where the oil is buried deep under water and rock. In addition, a lot of oil is buried under deep layers of authoritarianism, corruption, civil strife, and geopolitical intrigue.

On the demand side, the President of the United States has acknowledged that the United States is “addicted” to oil. But the addiction does not end at the U.S. border; the craving for oil is global. Using Cadman’s phrase for consumption: “The greater part of the world’s requirements” is now a thousand-barrel-a-second oil dependency that is growing relentlessly year after year.

So, the time has come. The world’s requirement for more and more oil is taxing the industry’s ability to supply it easily. We have finally reached Cadman’s point of transition, where the world needs to look for a great part of its oil supplies from “secondary and synthetic sources.” Where is this happening on a big scale?

Oil companies from the world over—small and large, state-owned and independent—are flocking to Fort McMurray, Alberta, Canada. It is a remote, northerly outpost that is another example of how mankind is going to the ends of the Earth to satisfy its growing addiction to oil. Billions of dollars are pouring into the Fort McMurray region to extract bitumen from gooey, heavy black sand appropriately called tar sands or oil sands. Bitumen is the thickest form of crude oil and the last complex-carbon stop before coal. The majority of today’s refineries cannot handle bitumen because nature’s underground refinery has not cooked it enough over millions of years and turned it into coveted light, sweet crude. But in the hinterlands of western Canada, nature’s course is being accelerated. After being separated from the sands, bitumen is being fed into gigantic upgraders and converted into lighter synthetic oil grades that mimic West Texas Intermediate (WTI).

Fort McMurray was put on the international stage in 2004 when oil economists at the U.S. Dept. of Energy officially recognized that Canada’s oil sands contained more than 200 billion bbl in oil reserves, the second-largest accumulation of oil in the world after Saudi Arabia. There is still some debate about the overall size of Canada’s oil-sands reserves because unlike conventional light oils that are produced from wells, nonconventional oil from oil sands necessitates a costly, energy-intense process. However, there is no debate about the magnitude of activity going on. Aggregating all the active projects, the development of the Canadian oil sands is one of the largest energy ventures in the world today.

The torrent of investment into the Canadian oil sands is now estimated to be U.S. $65 billion over the next 10 years. When oil was U.S. $20/bbl, it took vision by companies such as Suncor to make investments in a region that was almost totally disadvantaged against cheap Middle Eastern oil. Everything changed when light, sweet crude rose above U.S. $35/bbl on a sustained basis. Because of that price rise, oil companies were given the incentive to accelerate the development of this secondary source of oil.

Overly Optimistic

As investment in the Canadian oil sands ratchets up, so too do the myths and expectations. Some are speculating that this secondary and synthetic oil resource is the cure-all for the world’s growing addiction to oil, a resource that soon will be producing more than Saudi Arabia. Others are taking the argument further and viewing oil sands as the magic bullet that will pound the price of oil back down to U.S. $40/bbl or less. Don’t bet on any of it.

The big mistake is assuming that Canada’s vast oil-sands reserves can be turned into large production volumes in a time frame and a manner similar to conventional oil. On more than one occasion recently, I have heard people talk about oil-sands production reaching 10 million BOPD by the middle of next decade. Here is the reality: If all announced projects come on line on time, then Canadian oil-sands production may reach about 4.1 million BOPD by 2017. But the probability that everything goes according to plan, and that all projects are on time and on budget, is next to nil. The region is remote, with major stresses and strains because of a perennial shortage of labor, services, equipment, and materials. Logistical problems are acute and it is well documented that the situation is going to get worse. One doesn’t need a spread sheet or calculator to figure this out. Merely recognizing that Fort McMurray is a small, remote town that is at the end of a very long (and still narrow) highway should tell you that the technical challenges, let alone social issues, are daunting. Pushing more than U.S. $65 billion worth of steel, equipment, and labor—and that is only the direct investment that is expected over the next 10 years—up this constricted highway is akin to pushing a herd of elephants through a door.

Incremental Gains

The realistic estimate for what level of total production can be achieved by 2015 is no more than 3 million BOPD, which is only an incremental 2 million BOPD greater than volumes being produced today. So, putting things into perspective, what is likely to be achieved in the Canadian oil sands over the next 10 years is roughly equal to a little more than one year’s worth of global oil demand growth. Certainly, it is no panacea for the world’s growing addiction to oil, nor for mitigating U.S. energy dependence.

What is going on in the Canadian oil sands is not all about synthetic oil production. Once again a flashback to Cadman’s era provides context. Recognize that Cadman’s mandate as Chairman of Anglo-Persian carried tremendous responsibility, over and above merely running an oil company. The First World War was over, and oil was a key strategic commodity that had helped the allies become victorious. Simply put, the Germans had run out of oil and it cost them the war. So, not only were secure supplies of oil needed to power Britain’s growing economy after the war, but finding more oil was also a strategic military requirement. Com-peting against U.S. and other European interests, Anglo-Persian was the British government’s key player in securing valuable oil concessions around the globe, in particular the Middle East. Back then, the rush of countries laying claim to the world’s valuable oil resources was termed the “Great Scramble.”

Today, the Great Scramble is back in many parts of the world as national and independent oil companies seek to secure the last of the major concessions. Not surprisingly, Canadian oil sands are a focal point attracting bidders from energy hungry nations around the planet. Multinationals and large independents are stepping up earlier commitments. New players such as Total are entering the arena. Not surprisingly, China and India are actively jockeying for position. Prices being paid for land in the region have quadrupled in the past year alone.

Era of Cheap Oil

All of this brings up an important question: Don’t these sophisticated oil companies—the biggest and best coming from all over the oil-addicted world—have anywhere better or cheaper to invest their capital? Sixty-five billion dollars says “no.” And that should tell you that Cadman’s prophecy has come to pass. Finally, there is more wisdom in Cadman’s speech: “...but he would indeed be an optimist who imagined that—on the reaching of such a stage (secondary and synthetic oil)—prices would remain as low as those existing in the past.”

Cadman recognized the days of cheap oil would come to an end and that secondary and synthetic sources would necessarily be more expensive. Today, some believe that the vast Canadian oil sands have the production potential to bring down the price of oil. On the contrary, the exploitation of this huge resource at the “ends of the Earth” is living proof that the days of cheap oil are over.

Peter Tertzakian is Chief Energy Economist for ARC Financial Corp., an energy investment firm based in Calgary. Tertzakian began his career as a geophysicist in 1982 with Chevron Corp., where he spent 8 years working in field operations, seismic data processing, and geophysical software development. In 1990, he left the oil and gas business and entered the financial services industry with a specialty in analyzing technology and energy-related businesses. He joined ARC Financial in 2002. His book, A Thousand Barrels a Second, was published in January. Tertzakian holds a BS degree in geophysics from the U. of Alberta; an MS degree in econometrics from the U. of Southampton, U.K.; and an MS degree in management of technology from the Sloan School of Management at the Massachusetts Inst. of Technology.