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David Yager – Yager Management Ltd.
Oilfield Service Management Consulting – Oil & Gas Writer – Energy Policy Analyst
July 5, 2017
“Shipping raw bitumen is like scraping off the topsoil, selling it and then passing the farm on to the next generation”. So stated Alberta PC cabinet minister Ed Stelmach during the 2006 party leadership race. The actual remark makes no sense because topsoil is finite and bitumen is all but unlimited. But it captured the imagination of many. In the middle of an oil sands boom of unprecedented proportions, the discussion was typically Canadian; don’t focus on what we’ve got but dwell on what we’re missing. The mantra grew that exporting bitumen before it was upgraded into synthetic crude or refined products was exporting jobs and wealth. This belief continues today.
The facts were clear. The Alberta government was piling up unprecedented wealth, the price of everything – particularly housing – was rising, and you couldn’t hire anybody at a reasonable wage so the province accelerated importing labor. Regardless, this economic reality was ignored by many, including Stelmach who became Premier in late 2006. The topsoil manifesto launched the political genesis of the Northwest Refinery Partnership (also called NWR Sturgeon Refinery Project, or NWR) near Redwater, the $5/$5.7/$8.5/$9.3 billion project the Stelmach government turned into reality.
NWR is back in the news for two reasons, neither encouraging. The first was June 23 when the National Post and Globe and Mail reported equity investors on the North West Refining side (North West owns 50%, Canadian Natural Resources Ltd. the other 50%) were seeking “liquidity alternatives”. They want or need cash. The other was the latest cost escalation to $9.3 billion – nearly double early estimates – and the startup delayed again from the fall of 2017 to sometime in the first half of 2018.
Is NWR a white knight? A catalyst for a new future in merchant bitumen refining into products and petrochemical feedstock? Or a white elephant, where Alberta again uses the interventionist hand of government and public cash to subsidize industrial activity that would not otherwise exist because the risk is too high or the economics don’t work.
History
Another platform PC leadership aspirant Stelmach campaigned on was a royalty review. Public hearings were held through 2007 then in September the New Royalty Framework (NRF) was unveiled. Subtitled “Our Fair Share”, it jacked up royalties by $1.4 billion a year but was widely assailed by industry and investors. The royalty increases came into effect January 1, 2009 in the depths of the world economic slump and oil price collapse but were essentially reversed in mid-2010.
The NRF also contained provisions to spur investments in “merchant” or third-party upgrading. All other bitumen upgrading was owned by oil sands producers. To accomplish this the NRF contained a Bitumen Royalty in Kind (BRIK) policy where the Crown would again take its bitumen royalty barrels in oil, not cash. This required the resuscitation of the Alberta Petroleum Marketing Commission (APMC) which was shut down by the Klein administration as unnecessary and expensive.
The other component of the NRF was $2 billion for Carbon Capture and Storage (CCS) projects brought forward by the private sector and financially supported by the government.
In 2008 cabinet approved a Request for Expressions of Interest from the private sector for ideas to upgrade Crown BRIK barrels. The first was NWR near Redwater. The applicant was North West Capital Partners Inc. run by project proponent Ian MacGregor. The APMC would supply 37,500 b/d of bitumen and pay a processing toll for 30 years to have it refined into diesel and other products. The tolls were intended to pay for the plant and processing. The value of the finished products was to be greater than the market price of bitumen plus refining fees.
The guaranteed processing tolls from the Alberta government secured the financing. NWR could borrow because its future operating income was backstopped by the province. With government support NWR could not lose money which made it commercially attractive to lenders and debt markets. Government financial support would remain in place even if NWR ceased operating.
Proposals for BRIK barrels closed in January 2010 and the NWR received approval in February 2011. By this time NWR was joined by Canadian Natural Resources Ltd. which would become a 50/50 equity partner in NWR and contribute 12,500 b/d of bitumen, making the total 50,000 b/d.
A government news release dated February 16, 2011 was titled, “Bitumen refinery agreement promotes value-added development”. It included a CCS project where Enhance Energy Inc., as sister company of North West, would create the Alberta Carbon Trunk Line (ACTL) to take the CO2 from NWR and nearby plants and ship it to conventional oilfields in central Alberta for enhanced oil recovery (EOR). Alberta committed $495 million from the $2 billion CCS pool.
Stelmach said, “This new refinery and CO2 pipeline will significantly advance Alberta’s capacity for refining bitumen into value-added products and increase recoveries from Alberta’s conventional oil reserves. These projects underline Alberta’s commitment to responsible, cleaner energy production”.
The original timeline was completion of phase one by 2014 with a plan to possibly triple throughput in subsequent stages. The original cost estimate was $5 billion. When the final terms were announced project boss Ian MacGregor told the legislature in 2013 the cost would be $5.7 billion with the cap on the processing fees set at $6.5 billion. He was quoted as saying, “We plan to build it for $5.7 billion…I get a lot of questions about what happens if this costs more than $6.5 billion? My answer is, it’s not going to. We meant $5.7 billion when we said it.”
Site surveying and construction began in September of 2012 and the first concrete was poured in August 2013. Processing components started arriving in early 2014 and pilings were installed in September. In mid-2015 the hydrocracking reactor was installed and by early 2016 some 400 modules in place. The NWR website’s last construction progress report was posted in August 2016 when the flare stack was erected.
Following construction and completion delays, the next signal NWR wasn’t working as planned occurred in late 2013 when it was revealed phase one would actually cost $8.5 billion, a 50% increase. The decision was made to proceed regardless but completion was set back to 2017, three years later than the original plan.
When operating at capacity, NWR is designed to turn 79,000 b/d of dilbit (50,000 b/d net bitumen) into 80,669 barrels of product consisting of low sulphur diesel (40,250 b/d – transportation), low sulphur vacuum gas oil (8,790 b/d – intermediate refinery feedstock), diluent/naphtha (28,266 b/d – diluent for bitumen shipping, naphtha for gasoline or petrochemicals), and butane/propane (3,363 b/d – petrochemical feedstock, other industries). Refining expansion due to “hydrocracking”, the addition of hydrogen and chemicals, is why more barrels will come out than go in. NWR incorporates a hydrocracker.
Economic Benefits
No government ratifies a large investment using public funds without claiming an attractive return. NWR/ACTL was going to be off the charts. The impression was NWR would not cost the province anything, only loan guarantees. In 2011 Alberta estimated 10,000 jobs during construction, $4.6 billion in economic activity for the province, $408 million in provincial tax revenues, $922 million in federal taxes and $53 million in benefits for local governments.
The real kicker was the ACTL CCS project. Besides disposing of millions of tons of CO2, for only $495 million the conventional oilfields receiving CO2 would yield enough additional oil from EOR to potentially generate up to $15 billion in incremental royalties.
The job creation component is all over the map but 10,000 is low. Figures are hard to find. In the early stages there were some 1,000 on site but most recently as the plant nears completion it is closer to 6,000. If you start with 1,000 people on location when work commenced in 2012 then ramp it up by 1,000 per year to the current 6,000 job level, the total is 21,000 person-years of employment to the end of 2017.
In May of 2017, the most recent project update on the NWR website, it is revealed to date there had been 39.9 million “exposure hours” on the site. Based on 40 hours a week for 52 weeks, that works out to 19,200 person-years of employment. If there were 6,000 workers on site to the end of 2017 this would work out to about 47 million exposure hours and the person-years figure to 22,700.
These are very expensive jobs. Based on the 21,000 person-years of employment estimate and the new $9.3 billion cost, these jobs work out to $443,000 each per year. Using the exposure hours model to the end of the year, the cost per job falls to $410,000 each.
Of course, wages are only a fraction of the total cost which includes billions in expensive equipment and components. But since all the project’s fans like to talk about jobs, there’s another way of looking at it. For $9.3 billion you could pay 25,800 people $60,000 a year for six years to never leave the house. Obviously, this is pure speculation but the point is major oil projects are capital intensive, not labor intensive. The jobs are great but overstated compared to the plumbing and infrastructure.
There have been grumblings since NWR was announced. The Wildrose Party official opposition questioned the math but really didn’t want to come out hard against bitumen upgrading because it garnered such strong political support. Maybe it would work. Nobody had any idea where oil or refined product prices were going to be for the next 30 years. Still don’t.
But the gloves came off in July of 2015 when former cabinet minister Ted Morton – who ran against Stelmach for the PC leadership in 2006 and effectively orchestrated his resignation in 2011 when he was finance minister – wrote an article in the Calgary Herald titled, “A Cautionary Tale on Refining for the Alberta Government”. Morton stated the cost increase to $8.5 billion would significantly escalate government exposure. “The province is now on the hook for $26 billion in processing payments…which translates into a processing cost of $35 a barrel, making it even less likely that the investment will break even”.
This means the spread between bitumen input and the product output must be greater than $35 a barrel for the Crown to break even. With refined product prices set by the marketplace and if margins are squeezed, the logical way to not generate direct cash subsidies would be to order APMC to supply BRIK barrels below market price so the losses appear elsewhere. The $35 a barrel processing cost is now higher with the latest $800 million cost increase.
Competitors in industry, particularly refining, have quietly questioned why Alberta needs another 40,000 b/d of diesel fuel when the market is more than adequately supplied because of existing refining capacity and the economic slowdown. This has reduced diesel consumption for construction and transportation.
But promoter MacGregor remains convinced refining diesel in land-locked Alberta is a good idea. In December of 2016 he told the Edmonton Journal, “We can do 10 of these things (NWR). There lots of bitumen here. We can do it economically. The U.S. is exporting a million barrels a day of diesel right now. They make our bitumen into a million barrels a day of diesel. Why don’t we do it ourselves”.
As for transportation, NWR plans to put its products into the same pipelines to market as dilbit. There will be no major bumping of product from the increasingly pressed pipeline infrastructure, but no relief either.
But transportation costs remain a huge factor for refined products. The refining business in North America has shrunk to become primarily regional with refining taking place near the market. The U.S. exports diesel but from refineries on tidewater with the lowest cost access to markets. When shipped from NWR, diesel must be priced at destination market price less transportation from Edmonton. While your writer is no refining expert, this looks like more pressure on the BRIK barrel processing fee.
Meanwhile, the Enhance Energy ACTL and its CO2 EOR royalty windfall also remains in the future. Responding to an inquiry from your writer, Alyssa Haunholter, VP Government Relations replied via email, “Enhance is in the final stages of completing the financing arrangements required to bring the ACTL Project to full completion. Although construction has been ongoing for certain aspects of the project, once the final financing is in place, the ACTL Project will move full force ahead so it is operational later in 2018.”
Meaning the 240 km. of line can be built and buried in a year or less. And to put something in it operators of the various oilfields must be ready to switch their fields to EOR using CO2 injection. With current capital constraints, that this can done by the of 2018 appears optimistic.
What Next?
On June 23 it was reported the North West Refining Group engaged an investment banker to search for liquidity. They include Northwest Capital Partners Inc. and Longbow Capital Inc. of Calgary and Northleaf Capital Partners of Toronto.
According to a report by Altacorp Capital, pro-forma earnings for 2018 when NWR starts operating are estimated to be $37 million rising to $215 million by 2020. As the first refinery built in Canada since 1984 and essentially backstopped by the Alberta government, it is engineered to make money for the equity holders. The Financial Post described the current capital structure as $860 million in subordinated debt guaranteed by the Crown and CNRL, $6.35 billion in bonds and $1.77 billion in bank facilities. That totals $8.98 billion in debt, a counter-intuitive way to finance a major capital project in the current “lower for longer…. possibly forever” oil price environment.
That said, these investors have apparently made some money. The Globe and Mail story quotes Altacorp analyst Dirk Lever indicating the 187.2 million shares could be valued at between $4.75 and $6, possibly higher. The Globe wrote as, “The last known grey-market trade was $1.45 per share. But Lever told the newspaper, “…admittedly for the right buyer the price could be higher”. At $5 a share the equity would be worth $936 million.
The article concluded, “Mr. Lever said the tolling agreement that is connected to the refinery is a natural fit for a large corporation or pension fund, ‘as the tolling agreement provides certainty as to payments with minimal downside’”. What does it mean when the original private sector investors are looking to sell out before the plant even starts operating?
The other was the latest cost escalation and completion delay. When it was revealed the cost was up to $9.3 billion, almost double the earliest estimates, Alberta Party MLA Greg Clark demanded the auditor general review the risks because the government of Alberta could be on the hook for substantial losses. The Wildrose Party said NWR, “…remains a sinkhole for taxpayers’.
But apparently the AG was already on the case. A Calgary Sun article June 28 reported the Auditor General’s office had conducted a performance audit last summer and fall with the full report to be released in the fall of 2017. But the article stated, “…it (the office) could not immediately confirm where all of the opposition parties’ questions have been answered”.
Besides the risk of financing a project of this size almost entirely with debt in the new world of unknown and volatile oil prices, it is even less intuitive Alberta’s current NDP government would be thrilled about private sector investors earning a profit while in the worst-case taxpayers must subsidize the difference between BRIK barrels and final product. Even worse, if the plant quits operating sometime in the next 30 years the government will at minimum have to deal with the outstanding debt.
Stelmach’s bitumen value-creating white knight, one of the last surviving elements of the ill-fated NRF, could in today’s market become a white elephant for Alberta taxpayers. Nobody wants NWR to fail. While terribly expensive, NWR jobs were helpful for the economy in the 2.5 years since oil prices collapsed, as was manufacturing and assembly. Everybody would love to turn bitumen into something more valuable and create jobs and value-added wealth in the process.
Here’s hoping.
About David Yager – Yager Management Ltd.
Based in Calgary, Alberta, David Yager is a former oilfield services executive and the principal of Yager Management Ltd. Yager Management provides management consultancy services to the oilfield services industry in a number of areas including M&A, Strategic Planning, Restructuring and Marketing. He has been writing about the upstream oil and gas industry and energy policy and issues since 1979.
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David Yager can be reached at Ph: 403.850.6088 Email: yager@telus.net
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