Calgary’s downtown core has gone dark.
Canada’s energy capital is under a blackout after devastating floods made a ghost town out of the city’s office towers. It could take days for the water to recede and power to return.
Does the natural disaster in Calgary foreshadow problems in the oil sands? This year several large projects have already been cancelled and new problems threaten to stall growth.
Here’re the top three challenges facing the oil sands.
1) Rising costs
Operating costs in the oil sands have risen considerably since 2001 from $10/barrel (brl) to $20/brl due to rising natural gas prices, environmental compliance costs, and chronic supply shortages.
New projects also require greater upfront investment. Between 2001 and 2011, the average development cost of a 100,000 b/d project increased from $3.3 billion to $7.3 billion.
For example, consider Imperial Oil Limited (USA) (NYSEMKT:IMO)‘s Kearl oil sands mine. The project is expected to cost $12.9 billion, higher than the $7.9 billion originally estimated five years ago. Delays in the 110,000 barrel/day project were due to difficulties in transportation equipment to the mining site. Delays and cost overruns threaten the Imperial’s reputation as a premium oil sands developer.
Operators are also plagued by chronic labor shortages. Alberta’s 4.4% unemployment rate forces employers to look outside of the province’s borders to find workers.
Suncor Energy Inc. (USA) (NYSE:SU) has gone as far as creating an airline – called Sunjet – to shuttles workers from as far as Canada’s east coast. Sunjet transports 25,000 people per month and ranks as the nation’s 12th largest airline.
According to the National Energy Board, new in-situ projects require $55-$65/brl while mining projects require $70-$80/brl to be viable. While current prices support oil sand development, growing costs could curtail growth.
2) Pipeline gridlock
Rapidly growing oil sands production has already exhausted pipeline capacity. Because of the supply chain gridlock, Western Canadian Select – a benchmark for Alberta crude oil prices – trades at a $20 discount to West Texas Intermediate.
Industry analysts see TransCanada Corporation (USA) (NYSE:TRP)‘s Keystone XL pipeline as a savior. If approved, the project will ship 830,000 b/d of Alberta crude south to Gulf coast oil refineries. The project has been approved by the state of Nebraska but still awaiting the greenlight from the U.S. State Department.
But Keystone won’t end Canada’s oil glut. Growing production from the Alberta oil sands and North Dakota Bakken could outstrip pipeline capacity by 2018 even if Keystone is constructed.
For pipeline producers like TransCanada Corporation (USA) (NYSE:TRP), this opportunity presents a decade or more of expansion potential. For upstream producers, it means Canadian crude will continue to trade at a discount.
3) Environmentalist resistance
Canadian ‘dirty oil’ is increasingly unwelcome in many markets.
Last month, the European Union threatened to implement a carbon fee on oil sands product which it considers a greenhouse gas intensive oil source.
On Tuesday, U.S. President Barack Obama laid out his strategy to tackle climate change and reduce the country’s carbon footprint. That plan could involve blocking south-bound pipelines like Keystone.