The Economist: Canada’s oil boom: Building on sand

May 24th 2007 | FORT MCMURRAY, ALBERTA
From The Economist print edition

The allure and perils of investing in Alberta’s oil sands

EACH tyre on the massive trucks carting gritty black goo around a mine in northern Canada weighs as much as four cars, an engineer explains excitedly; the trucks, in turn, can carry 400 tons. They are driving around a hole in the ground that is several hundred metres deep, several kilometres wide, and growing fast. Open-cast mines like this are planned for some 3,000 square kilometres of the surrounding area, and subterranean ones beneath a further 35,000 square kilometres.

Canada’s oil sands, or tar sands, as the goo is known, are outsized in every way. They contain 174 billion barrels of oil that can be recovered profitably, and another 141 billion that might be worth exploiting if the oil price rises or the costs of extraction decrease—enough to give Canada bigger oil reserves than Saudi Arabia. They are attracting huge investment from oil giants such as Royal Dutch Shell, Exxon Mobil and Total. But they are also stirring great controversy.

Until recently, most big oil firms shunned the oil sands as too expensive to exploit. In most cases, extracting oil involves chopping down the forest that blankets the region, draining the boggy ground, stripping off the topsoil and literally digging up the oily sand below. Producers must then mix it with water, heated using natural gas, to separate the oil from the sand. Some do all this underground by pumping steam into deeper deposits and pumping out the resulting slurry. Both processes produce bitumen, which needs extra treatment before it can be refined into petrol. All this consumes lots of energy, and so costs C$20-25 ($18-23) per barrel of output in operating expenses alone. Analysts at Citibank reckon the oil price needs to remain above $40 a barrel to make the development of the oil sands worthwhile.

But with oil selling for around $70 a barrel, and with big oil firms struggling to find new resources, the oil sands suddenly seem much more attractive. There is no exploration risk: the oil is definitely there. Once up and running, oil-sands mines produce a steady flow of oil for 30 years or more, whereas the output of more conventional fields is much less predictable. Best of all, the oil sands are in Canada, a hearteningly moderate and stable country.

So the oil majors are piling in. This month Total said it would increase its total investment in the region to as much as C$15 billion. Norway’s Statoil has just spent $2 billion on a Canadian firm with oil-sands rights. Shell, Exxon, Chevron and others are joining in. Production from the region, now 1.2m barrels per day, is expected to rise to 4m by 2020, putting Canada’s output on a par with Iran’s.

But not all the oil giants are convinced. BP, for one, has steered clear. If the price of natural gas rises, or that of oil falls, the oil sands will look less enticing. As it is, development costs have roughly tripled since 2001, according to industry figures, thanks to a shortage of labour and parts—such as those massive tyres.

Meanwhile, the province of Alberta is reviewing the tax regime. Back in the 1990s, when there was little interest in the oil sands, it sought to lure investment by setting a nominal royalty of just 1% of revenues until investment costs were recovered. Today, although production is booming, the province’s revenue from royalties is actually falling, as oil firms take advantage of that and other tax breaks. Critics argue that times have changed and that producers can now afford to pay more. More broadly, they contend that the rapid growth of the industry is fuelling inflation in the province and overloading its infrastructure, and should be slowed. The mayor of the main oil-sands district has called for a lull in new projects.

But the biggest uncertainty is over the environment. Extracting oil from oil sands produces two or three times as much carbon dioxide as pumping it out of a normal well, according to the Pembina Institute, an environmental group. Yet the Canadian government has vowed to reduce Canada’s emissions. To that end, it will soon require oil-sands projects to reduce the ratio of emissions to oil produced by 2% a year.

Activists at WWF, another pressure group, say a much tougher regime is needed. Meanwhile, California and 11 other American states are planning to adopt pollution laws that would ban the sale of petrol from emissions-intensive sources. Shell and other big investors in the oil sands hope to meet such requirements by siphoning off emissions from their mines and storing them underground—although the technology to do so is still in its infancy. The uncertainties surrounding the oil sands, in other words, are as big as the developments themselves.

http://www.economist.com/business/displaystory.cfm?story_id=9231894

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