David Yager – Yager Management Ltd.
Oilfield Service Management Consulting – Oil & Gas Writer – Energy Policy Analyst
There cannot be a more valuable natural resource in the world that has been subjected to more attacks and criticism than Canada’s oil sands. James Hansen, a big shot with NASA, wrote an article in the New York Times in May of 2012 titled, “Game Over For the Climate”. He said the “tar sands”, as critics unaffectionately call this deposit, “contain twice the amount of carbon dioxide emitted by global oil use in entire history”. Ouch. His point was it was only a matter of time before this kills us all.
When Prime Minister Justin Trudeau on November 29, 2016 approved the expansion of Enbridge Line 3 to the mid-west U.S. and Kinder Morgan’s pipeline to Burnaby, a Greenpeace fundraising initiative stated, “We will not let them be built. Building these pipelines would trample First Nations rights, pollute the land, water and air, and fuel climate change”. New pipe won’t be easy.
Montreal mayor Denis Coderre and regional municipal leaders in urban Quebec have declared they don’t want pipelines that carry oil sands production in or near Montreal as anticipated by the Energy East project. In the upcoming B.C. election, the opposition NDP are already campaigning against a pipeline expansion carrying Alberta bitumen. Northern Gateway is already dead thanks to Prime Minister Trudeau.
In the world of resources the public hates, oil sands are in the same category as asbestos. It is astonishing in a world that consumes 96 million barrels of crude a day that the 2.7 million from the oil sands have been placed in such a special category for vilification by our fellow citizens, consumers and environmentalists.
The oil sands have never had it easy. Discovered centuries ago by early explorers, how to unlock the thick, massive but clearly valuable resources has intrigued and perplexed entrepreneurs for decades, if not centuries. An early pioneer was Sun Oil of Pennsylvania, the developer of the first oil sands plant Great Canadian Oil Sands (GCOS) which later became Suncor. An internal memo to Sun Oil’s CEO in 1951 stated, “…I know of no place in the world where I can, if I am the first to apply for a tar sands permit, obtain oil reserves for less than $1.40 per acre”.
The old saying goes, oil and gas is where you find it. They found it. The question was one of economics. How do we turn this massive resource into money?
GCOS went on stream in 1967 followed by the second major oil sands mining operation, the Syncrude consortium in 1978. Both were classified as experimental and not always profitable. After oil prices collapsed in the mid-1980s Syncrude had to report it was losing money on every barrel of production. But as prices stabilized and processes improved, the losses quit.
Meanwhile at Cold Lake, Imperial Oil (the Canadian unit of Exxon Mobil) began its thermal recovery operation in 1975 after several years of development. This was thermal “in situ” recovery that has since expanded dramatically using different techniques such as SAGD (steam assisted gravity drainage).
The problem was that for accounting purposes, oil sands – mined or steamed – were not considered the same thing as conventional oil. In the late 1990s the Alberta government, the Energy Resources Conservation Board and CAPP began to lobby the U.S. government to acknowledge that the oil sands were indeed oil and, for purposes of public accounting, should be considered real hydrocarbon reserves by their developers.
In 2002 Alberta’s oil sands lobbyists had a major breakthrough when the respected publication Oil & Gas Journal recognized oil sands as real reserves in their annual global reserve report. Washington’s Energy Information Agency did the same thing. Suddenly, Canada’s proven reserves jumped from 4.8 billion to 180 billion barrels of oil, an eye-popping increase.
In 2008 and after significant lobbying by Canada and oil developers, the U.S Securities and Exchange Commission finally updated its regulations regarding acceptable oil company proven reserve reports. Effective January 1, 2010, the SEC regulations were amended to “include unconventional liquids such as bitumen and shale oil”. The date of the pricing point for the previous year was also clarified. Oil companies had been developing and producing this crude for years. This had nothing to do with oil or profitability but it sure helped the book value of the company’s assets.
Unfortunately, the value of reserves on the financial statements of oil companies moves in both directions primarily based on price. Recoverable reserves of oil is ultimately based on the value of the production and the capital and operating costs. This is hardly a new nor complicated concept. The collapse of oil prices in the past two years has resulted in, at least for accounting purposes, the disappearance of enormous wealth on the balance sheets of oil companies. But the oil is still there, as is consumer demand. Only the accounting valuation has changed.
The headlines have been devastating. In December 2015, a year after the price collapse, a headline in on-line news outlet Brietbart.com blared, “Shale Drillers To Write Off 40% Of Oil Reserves”. While the U.S. allegedly had 2 trillion barrels of shale oil, the banks were only going to recognize a fraction of that in the low-price environment. In April of 2016 an article in Forbes was titled, “An $840 Billion Decline In Oil and Gas Reserves”. Same story. Accounting rules and reserve engineering analysis dictated an oil company’s assets were price sensitive and had to be adjusted accordingly. Virtually every oil and gas company in North America saw their lending covenants adjusted downwards because of reserve devaluations. Many went broke after the screws were tightened too far.
There are two realities. There’s the amount of oil God put in the ground and there is the accounting definition of what can be declared commercially proven reserves. They are not the same thing. Which brings us back to the oil sands.
After years of aggressive development there is no question there is a retrenchment of capital spending in the oil sands. But it has nothing to do with geology. Canada’s total bitumen resources remain unchanged at a staggering 1.7 trillion barrels with proven reserves of 10% of that, third largest in the world. It is entirely related to development costs, oil prices, government policy and transportation.
The news is hardly encouraging. The first company to pull the plug was Royal Dutch Shell when it abandoned its partially constructed Carmon Creek oil sands project near Peace River in late 2015. One of the reasons cited was pipeline uncertainty. Since that time the bad news has been cascading. Many operators such as Norway’s Statoil have decided to leave the oil sands in favor of other opportunities. As recently as February 27, 2017 Royal Dutch Shell advised it would not be pursuing further oil sands investment, preferring to produce what they already own. The company told Bloomberg, “There are no plans for growth capital to be invested in oil sands”. No good news whatsoever.
The events that triggered the greatest media speculation that the party was over for oil sands occurred when Exxon Mobil and ConocoPhillips reported oil sands reserve write downs for the fiscal year ended December 31, 2016.
Exxon Mobil’s news release read, “…inclusive of a net reduction of 3.3 billion oil-equivalent barrels from 2015. Reserves changes in 2016 reflect new developments as well as revision and extensions to existing fields resulting from drilling, studies, analysis of reservoir performance and the application of the methodology prescribed by the U.S. Securities and Exchange Commission”. Most of this was in Canada’s oil sands.
What the SEC gave in 2010 it took away in 2016.
Same story at ConocoPhillips. The Financial Post reported February 22, 2017 that, “ConocoPhillips has revised down over a billion barrels of oil sands reserves because of low global oil prices …the latest sign that some of Canada’s vast hydrocarbon potential may be left untapped.” The story wrote, “The U.S. Securities Exchange Commission document provides a detailed breakdown of the global oil reservoirs cut ConocoPhillips announced in quarterly results, when it de-booked 1.75 billion barrels of oil equivalent of reserves.” That number shows it wasn’t just the oil sands that were uneconomic at 2016 prices.
These big reserve write downs, only part of what happened all over the world, triggered a flurry of headlines wondering if the oil sands story was over. The Financial Post for the ConocoPhillips headline stated, in part, “underscoring the (oil sands) region’s price vulnerability. Oilprice.com, a specialist website, carried a headline blaring, “Have The Majors Given Up On Canada’s Oil Sands?” Bloomberg News wrote February 27, “Shell shuns new oil sands as low crude prices force cost control”. Theepochtimnes.com website article was titled, “End of An Era For Canada’s Oil Sands”.
Gone. Dead. This is over. Turn the page. And it isn’t true. MEG Energy and Cenovus have both announced expansions for 2017 for their SAGD operations. Last summer CAPP predicted a further increase in bitumen production of 300,000 barrels per day by 2020.
But Suncor CEO Steve Williams told the Calgary Herald February 24, “When we look at the absolute economics of Fort Hills (the last major oil sands mine under construction), those are not the projects we will be repeating in the foreseeable future”. Williams figures, “the era of investment in mining operations in coming to an end”. Not good news.
The problem is the media and analysts are very good at reporting the symptoms but not so good as diagnosing the disease. There is no question investment in oil sands has backed off considerably. But it is much more complicated than commodity prices alone.
Back in 1996 Canada introduced what was described as the generic oil sands fiscal regime, a combination of Alberta’s incentive royalty rates and Ottawa’s tax structure. At the same time Canada started lobbying U.S. regulators and the SEC to recognize oil sands as real oil, Alberta put in a base 1% royalty on production until project payout and 25% thereafter. Ottawa introduced an accelerated capital cost allowance to encourage investment.
And it worked. The fiscal framework was attractive and stable. Oil prices rose. The U.S. decided bitumen was oil. Halfway through the next decade the oil sands boom was underway. An expansion of unprecedented proportions followed. Moved the needle on the entire Canadian economy to the point that central Canadian politicians declared it disruptive to the rest of Canada. Alberta was too wealthy. This was somehow a problem.
There is no question that the future for oil sands investment is not what it was. But the slowdown is more complicated than compliance with SEC regulations. There has been an all-out, global assault on the oil sands from every direction. Yes, the development cost is high. The real question is whether or not the world wants safe, secure, reliable and virtually unlimited supplies of crude from Canada or whether other sources from the rogue nations that produce much of the world’s oil will suffice.
The generic oil sands fiscal regime is gone. Alberta’s base royalty pre-payout is up 500%. Ottawa’s accelerated capital cost allowance is history. Production volume is up so much the pipelines are full and low-cost, dependable takeaway capacity is being fought on every front. The Alberta government has raised corporate taxes by 20% and placed a cap on oil sands carbon emissions. The Oil Sands Advisory Group, appointed by the government to manage the cap, is populated by government-appointed, professional oil sands haters.
The federal government has chipped in with a national carbon tax. Whatever the current Prime Minister may say about pipeline capacity, municipal and provincial politicians in control the real estate between the oil sands and tidewater remain committed to obstructing low cost access to market for incremental barrels of bitumen production.
So when it is written the era of the oil sands is over, it may indeed be true. But it has nothing to do with Exxon Mobil or ConocoPhillips reserve write downs or oil prices. If the people and governments of Canada recognized the oil sands as the massive economic jewel that it is and got with the development program and quit putting up political and economic roadblocks, it is certain oil companies would be making different investment decisions.
Canada’s oil sands are a massive resource. The oil is there. Exploitation is profitable. A bit early to declare it dead.
About David Yager – Yager Management Ltd.
Based in Calgary, Alberta, David Yager is a former oilfield services executive and the principle 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.