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Investors Chronicle: Addicted to high tar

SHELL IS TO BUY THE 22 PER CENT of tar sands oil producer Shell Canada that it does not already own for C$40 per share, or roughly C$7.7bn (£3.6bn). The tar sands sector is focused on the province of Alberta, where Shell Canada is producing 93,000 barrels of oil equivalent (boepd), and is set to increase this total to 330,000 boepd over the next decade.

But extracting bituminous oil trapped in sandstone is a high-cost process requiring great quantities of heated water and gas. In fact, the environmentalist lobby claim that more energy is expended producing a barrel of tar sands oil than is gained from its production.

Luckily for Shell and its Albertan contemporaries, though, the operation is economically viable as long as gas remains cheaper than oil for the equivalent amount of contained energy, and as long as the oil price itself holds up at high levels.

Of course, profit margins would suffer if North American gas prices rose. However, the real risk lies in the oil price. Tar sands production needs an oil price of at least US$35-40 a barrel for it to stack up economically. And this is a concern as although US$60 a barrel looks fairly assured in the near term, BP’s Lord Browne recently predicted a fall to US$40 in the medium term. This could spell trouble for oil sands, as extraction projects in this infant industry are prone to cost overruns. So break-even prices are probably under, rather than over, estimated.

What’s more, tar sands do not currently qualify as reserves under US Securities & Exchange Commission definitions, but Shell is pushing investors to ignore this fact as the revenues are real enough. The industry’s long-term future is a moot point too, as the Canadian government starts to seriously weigh the impact of this emission-and pollutant-heavy process on its Kyoto obligations and environment in general.

With this in mind, then, BP might be pursuing a more canny approach by not getting involved in the upstream oil sands production at all, but instead spending on refinery upgrades to reap revenues from processing other people’s tar.
 
3 NOVEMBER, 2006   ■   INVESTORS CHRONICLE   53

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