Oil sands costs driving Shell elsewhere

Calgary — Globe and Mail

More than a year after it delayed a decision on a major new oil sands expansion, Royal Dutch Shell PLC (RDS.A-N58.390.050.08%) is backing further away from Canada’s richest crude resource.

Shell will dramatically slow its future growth in the Fort McMurray area, according to chief executive officer Peter Voser, who said that high costs in the oil sands are the reason the company is steering exploration dollars to other parts of the world, including the Gulf of Mexico and Kazakhstan.

A spate of decisions by other international oil companies to revive projects has created hope that the oil sands are recovering from the beating they sustained at the hands of high construction costs and lower oil prices.

But in Alberta, Shell’s reticence comes as a warning that cost inflation in the oil sands may not have been entirely cured – a fact that raises questions about the province’s ability to recover quickly.

Shell was once one of the world’s most aggressive oil sands developers, accumulating a large land base and laying plans for a series of mines and bitumen upgraders that together would produce 770,000 barrels per day.

It currently pumps 155,000 daily barrels from its Athabasca Oil Sands project and is building a 100,000 barrel expansion, which will be completed in the next year. It has government approval to nearly double that output to 470,000 barrels per day.

But Shell began to cast that growth into question in October, 2008, when it delayed a second 100,000 barrel expansion until costs had cooled in Alberta’s over-heated construction sector. Mr. Voser now says the company has “clearly scaled down” its oil sands ambitions.

“Over the past two years and certainly over the past six to eight months, I’ve taken the pace out of that because we have enough other growth opportunities,” he said in an interview with the Financial Times.

Mr. Voser’s comments come after a series of major project announcements just brought hope of an oil sands revival. ConocoPhillips Co. and Total SA announced plans for a major expansion in northern Alberta. Imperial Oil Ltd., which is controlled by Exxon Mobil Corp., decided last year to press forward with its Kearl mine north of Fort McMurray.

Perhaps most notable of all was the decision by Husky Energy Inc. and partner BP PLC to spend $2.5-billion on their Sunrise project, whose costs they said had fallen 40 per cent.

Mr. Voser’s comments, however, may serve as a warning that declining oil sands costs are not what they appear.

Though the company’s construction expenses have been far higher than some of its competitors – a fact that puts Shell in a somewhat unique situation – it does have an important vantage point on costs, since it was one of the few companies to build through the entire downturn.

Others, too, warn that promises of cheaper construction price tags may vanish once oil sands work resumes and competition for labour and equipment returns.

“A lot of these cost savings will be pretty elusive to capture,” said BMO Capital Markets analyst Randy Ollenberger.

Mr. Voser did not say whether the company is abandoning its oil sands growth targets altogether, or simply delaying them. Company officials declined comment until Shell reports its earnings next week. Shell has not backed away from the applications it has made to regulators who are still working to approve its full slate of potential projects.

Neither the Fort McMurray boom, nor the subsequent oil bust, were kind to Shell. The company saw a significant increase in the cost of its 100,000-barrel-a-day expansion, which it is now building, and whose price tag rose to nearly $14-billion from earlier estimates of $10-billion to $12.8-billion. Weak oil prices also brought losses to its oil sands operations in early 2009.

The company has stopped disclosing its oil sands earnings.

Shell has also faced growing pressure from environmentalists to leave the oil sands. At its annual general meeting in May, it will face a shareholder resolution demanding a special review of the risks of oil sands production. Shell has dismissed the resolution as the product of 0.15 per cent of its investor base, but Greenpeace argued that the company is bending to pressure.

Shell is “feeling the heat,” said Alberta Greenpeace activist Mike Hudema.

Mike Tims, the chairman of Calgary investment firm Peters & Co., speculated that Shell’s oil sands reticence is rooted either in “a more conservative view on future commodity prices or some kind of a response to the environmentalists.”

Shell has also announced it is closing down its Montreal refinery as the company conducts a sweeping corporate cull of lower-performing assets.

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