Caterpillar Inc. (CAT), Suncor Energy Inc. (USA) (SU): Could Canada’s Oil Sands Become “Stranded Assets”?

The boom in Alberta’s oil sands was initially hailed as a hugely promising development for Canada’s economy and energy security.

Recently, though, major threats challenging the economic viability of oil sands projects have begun to emerge. The main culprits are spiraling operating costs, depressed pricing for Western Canadian crude oil, and increased competition from shale plays in the U.S.

According to some commentators, if oil sands operators fail to overcome these challenges and – especially – if the price of crude oil sees a sustained decline, further investment in Alberta’s oil sands industry could dry up.

For instance, Jeremy Grantham, co-founder and chief investment strategist at Boston-based investment firm GMO, argues that oil sands projects run the risk of becoming “stranded assets”, unable to deliver sufficient rates of return to compensate for spiraling expenses. He explains:

I believe anyone investing in tar sands is very likely to end up with stranded assets in the next decade or two. Solar is getting cheaper by the minute, whereas petroleum is getting more expensive. It is only a matter of time before their expenses cross.

Is Grantham right? Let’s take a closer look.

Majors challenges give reason to pause
Due to the technical complexity of extracting bitumen, operating costs in Alberta’s oil sands are exorbitantly high. According to Mark Corey, a high-ranking official in Canada’s Department of Natural Resources, operating and capital costs have both more than doubled over the past decade, due largely to spiraling labor costs resulting from the chronic shortage of oil sands workers.

For instance, workers who operate Caterpillar Inc. (NYSE:CAT)‘s Cat 797 dump trucks – used for hauling thousands of pounds of bituminous sand – can expect to earn between $36 and $39 an hour. And if one includes overtime, some Cat 797 drivers are able to earn $150,000 a year, according to an article in The Wall Street Journal last year.

When you put it all together – labor costs, operating costs, and the rest – you end up with some extremely high break-even costs. Some of the most challenging economics are for operators that mine bitumen to convert it into synthetic crude oil. According to estimates by Wood Mackenzie, break-even costs for such projects range from $90 to $100 per barrel.

Given current oil prices, that means several projects are barely profitable, leading some oil sands operators to reconsider new ventures. For instance, Suncor Energy Inc. (USA) (NYSE:SU), one of the largest oil sands producers by output, has been mulling over the profitability of three mining-related ventures jointly proposed with French oil major Total SA (ADR) (NYSE:TOT).