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Petroleum News: This is no Shell game: Shell Canada has shredded the reputation of parent company Royal Dutch Shell for fiscal caution…

Comes to terms with inflation, gets serious about building oil sands future

By Gary Park
For Petroleum News

Shell Canada has shredded the reputation of parent company Royal Dutch Shell for fiscal caution by adopting what is arguably the boldest strategy yet to exploit the Alberta oil sands.

Shrugging off a series of operational hitches from the opening phase of its Athabasca project in January 2003, it has taken the first formal step towards expanding that operation, then tackling an even grander program of exploiting its reserves which total 31 billion barrels of in-place resources spread over three regions of northern Alberta.

Faced with a breathtaking rise in cost projections, Shell Canada has plucked up its courage and given a resounding vote of confidence to a corporate future that is anchored in bitumen.

On July 28 it set the ball rolling by announcing a proposal to go ahead with Athabasca’s Expansion I which would add 100,000 barrels per day to the existing 155,000 bpd by late 2010 by enlarging its Muskeg mine and its upgrader at the Scotford refinery complex near Edmonton.

A final decision still hangs on regulatory approvals for both the mine and upgrader and approval from Shell Canada’s board of directors, all of them anticipated in the fourth quarter.

It also needs a decision within 90 days by current Athabasca partners — Chevron Canada and Western Oil Sands, each holding a 20 percent stake — to join the next phase.

Mather: company resolved

But Shell Canada Chief Executive Officer Clive Mather left no doubt about his own company’s resolve.
While confident that Chevron and Western will team up with Shell Canada after participating in three years of planning, he said that even if they opt out his company is ready to go it alone on Expansion 1 and on long-term plans to grow Athabasca to 550,000 bpd by about 2020.

Earlier in the week of June 24, Western appeared to give its endorsement by releasing preliminary drilling results from 69,000 acres of leases acquired over the last 18 months by the Athabasca partners.

The junior company even said its analysis suggests that 500,000 bpd is possible by 2012 and further growth to 750,000-1 million bpd could be achieved over the long run, enabling Athabasca to leapfrog over its largest peers, Syncrude Canada and Suncor Energy.

Western estimated that “multiple expansions” could ultimately raise its own share of output to 150,000-200,000 bpd, which translates into 750,000-1 million bpd for the entire facility.

These high-flying goals are being unveiled against a backdrop of staggering cost increases.

Shell Canada has now pegged Expansion I, split 50-50 between the mine and upgrader, at C$10 billion to C$12.8 billion (Western predicts C$11.2 billion) far ahead of its most recent forecast of C$7.3 billion just 11 months ago and worlds away from the C$4 billion guess barely two years ago.

It now figures the capital costs for Expansion I will hit C$275-$350 per annual flowing barrel, up from C$200 in August 2005 and C$100 when the idea was first floated.

But Shell Canada insists the expansion “remains viable under a wide range of (oil) pricing scenarios.”

Mather wouldn’t pinpoint his company’s minimum oil price, but Scotiabank economist Patricia Mohr said the expansion needs a sustained price of US$60 per barrel to generate a 12.5 percent before-tax internal rate of return, while Tristone Capital’s research director Tom Ebbern said Royal Dutch Shell, which owns 78 percent of its Canadian division, is betting on oil prices of US$50 over the long term.

Shell Canada has also factored in a contingency provision for further increases in labor and materials costs, but won’t disclose that figure.

Mather said a project that could involve 6,000 to 7,000 construction workers, some of whom might be brought in from overseas, is a captive of global changes over the last few years.

However, compared to many of the alternatives, Alberta is still a “great place to invest, particularly given the scale of the resource we have and the capacity we have built up over the last three years to address it.”

But he emphasized that Alberta offers a “high-quality resource in an area of very low risk.”

“We have to believe with some confidence that it is right to continue on the path established by the base project and to develop this resource, not only over the next few years, but over the longer term,” he said.

“It will require much larger levels of capital than would be traditional with conventional oil production but that’s the way the world is,” Mather said.

He said levels of inflation comparable to Athabasca’s experience are being seen around the world.

But Shell Canada, by aiming high, is hoping to minimize some of that impact.

Pre-building infrastructure included

Western said Expansion I will include pre-building infrastructure such as utility plants, work camps and site pipelines, establishing a base to support a series of expansions by creating efficiencies and economies of scale over the long term.
Despite the soaring Expansion I costs, future spending will “improve the reliability and availability of base operations,” Western said.

One of the challenges is to ease the costs of building upgraders which have had other operators scrambling for alternatives.

Mather said Shell Canada is exploring a full range of options which could involve moving some Alberta synthetic crude and heavy oil to Eastern Canada where its has two refineries — a 130,000 bpd Montreal East plant, which currently operates exclusively on imported crude, and a 72,000 bpd refinery at Sarnia, Ontario. That would enable the company to better capture the “entire valued chain” and bolster Shell Canada’s access to Canada’s largest markets in Ontario and Quebec.

He also voiced confidence that advances in technology will eventually present more choices for upgrading raw bitumen than are available today.

On the broader front, Shell Canada is also eager to spread its wings beyond the Athabasca region to Alberta’s two other major deposits in Cold Lake and Peace River.

In fact, its resources in Athabasca that can be recovered through open-pit mining are a net 6 billion barrels, compared with 25 billion in-place barrels in Peace River and Cold Lake that are too deep to be extracted through mining, but can be tapped with in-situ methods such as thermal or enhanced recovery.

Significantly, Royal Dutch Shell listed the global giant’s entire proved reserves at 11.5 billion barrels.

For now Shell Canada is counting on annual in-situ additions of 26,000 bpd until it reaches 150,000 bpd, driven by its recent C$2.4 billion acquisition of Peace River operator BlackRock Ventures, which tripled its in-situ resources.

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