Friday, August 22, 2014

When it comes to #oilsands a stable price is a low price no matter how high it is

Alberta's oil industry is having a serious cash crunch and the problem doesn't look to be reversing any time soon with the price of oil continually hitting a ceiling of affordability over the last few years. This ceiling has robbed Albertan oil companies and the government they own of all of the additional profit brought in by the "buy low, sell high" market mentality that they have been relying on for years. That market of rapid price gains in oil is now years into the rearview mirror and the reality of unsustainable and ever-mounting costs for low energy return on energy investment projects such as the oilsands, deepwater, and fracking are becoming very visible.

This situation is the exact situation I have been warning about for years being one of the few that have maintained that oilsands operations are not profitable at all once the subsidies, market volatility, and infrastructure to support the laborers were either stripped away or accounted for. Oil is at historical all time highs (when you discount volatile spikes like we saw in 2007/2008) yet still the Albertan government must borrow to pay for basic infrastructure upgrades and "cost cutting fever" is gripping oilsands players.

Cost-cutting fever grips oil sands players as economics called into question
Canadian oil companies are ruthlessly enforcing capital discipline as project costs creep up and shareholders pressure management to focus only on the most profitable ventures.

Suncor Energy Inc. announced a billion-dollar cut for the rest of the year even though the company raised its oil price forecast.

Others such as Athabasca Oil Corp., PennWest Exploration Ltd., Talisman Energy Inc. and Sunshine Oil Sands Ltd. are also cutting back due to a mix of internal corporate issues and project uncertainty. Cenovus Energy Inc. is also facing cost pressures at its Foster Creek oil sands facility.

Given that the low-bearing fruit have already been developed, the next wave of oil sands project are coming from areas where geology might not be as uniform,” said Dinara Millington, senior vice president at the Canadian Energy Research Institute.

The global oil industry is gripped with the cost-cutting fever amid shareholder pressure, but the oil sands are particularly vulnerable given their baked-in higher development costs, high wages, remote location and infrastructure challenges. In May, France’s Total SA shelved an $11-billion oil sands mine project planned with joint venture partners Suncor, Occidental Petroleum and Inpex Canada.

Oil sands are economically challenging in terms of returns,” said Jeff Lyons, a partner at Deloitte Canada. “Cost escalation is causing oil sands participants to rethink the economics of projects. That’s why you’re not seeing a lot of new capital flowing into oil sands.”

Existing in-situ oil sands projects in Alberta are produced at a break-even cost of US$63.50 per barrel on average, while integrated oil sands mining projects have a breakeven cost of US$60 to US$65, including a 9% after-tax return, compared to the Saskatchewan Bakken’s US$44.30 a barrel cost.

SAGD operations saw a 5.1% jump from 2011 to 2013 on average, while mining and extraction was up 6.1% and integrated mining and upgrading 7.9% during the period, CERI data shows. Last December, Canadian Natural Resources Ltd. and the Alberta government revised cost estimates of their 50,000-barrels per day upgrading project by 49%.

Costs in the oil sands are rising faster than general inflation, and it’s a culmination of many factors,” Ms. Millington said, adding that currently many producers are reporting a bit of a pause in new contract awards and backlog.

Indeed, large-scale developments present “material inflation risks,” RBC Capital Markets said in a June report.

Even “smaller SAGD projects like Sunshine’s West Ells or Pengrowth’s Lindbergh have announced cost increases while Athabasca’s Hangingstone has experienced modest scheduling pressure and delays,” Canada’s biggest bank by assets said.

The trend of cost rationalization is not unique to the oil sands and rippling across the global industry thanks to the “abundance” of assets, according to Barry Munro, oil and gas leader at Ernst & Young.

It’s not about scarcity of resources anymore. Companies are realizing they have far more assets than they are ever going to have capital to be able to exploit — they feel they have to structurally change their business model.”

Indeed, business plans are in a state of flux. Oil and gas deals in Canada rose 23% in the first half of the year, according to management consultancy Deloitte LLP, but much of the activity took place outside the oil sands sector.

“Deal activity has cooled in Canada’s vast oil sands reserves as producers have struggled with rising costs, in part because of stricter environmental regulations,” Deloitte said in a recent report. “Even with oil at more than $100 per barrel, some large producers have been cancelling projects because higher costs have crimped returns.”

Richard Grafton, chief executive officer of Grafton Asset Management, says oil prices may have to go higher for new investors to favour oil sands.

“Right now, the [price] band that we are in for a number of years is around $100, and frankly, may be we need at a higher price with access to global market, before we get excited about that [the oil sands],” Mr. Grafton told the Financial Post in an interview last week.

A recent report by London-based Carbon Tracker Initiative estimated that a number of oil sands projects would be economically impractical at oil prices below $130 per barrel.

RBC Capital, which is confident that the existing oil sands players will meet their production targets profitably, estimates the industry will require between $26-billion to $33-billion each year to maintain existing production and raise output by an additional 250,000-bpd annually till the end of the decade.

“Challenges and constraints exist such as pipeline capacity and technology development, however, financing is perhaps the biggest challenge facing development stage oil sands companies at this time,” RBC noted.
Perhaps the most interesting paragraph from this latest article is this one:
“It’s not about scarcity of resources anymore. Companies are realizing they have far more assets than they are ever going to have capital to be able to exploit — they feel they have to structurally change their business model.”
As anyone versed properly in 'peak oil' theory knows "running out" of oil is a physical impossibility because the extraction of energy requires energy itself to be accomplished (Energy Return on Energy Invested - EROEI). As we've covered on this blog several times currency (what we call 'money' today) translates to money as money translates to energy. Any trade of goods or services is a trade of energy required to produce the product or provide the service. Money is a physical representation or store of value of this energy, currency is a claim check on money (or at least it is supposed to be). So when one refers to the energy input of energy extraction this translates directly to the cost, or financing of a project. When the amount of energy required to input into the extraction process approaches the amount of energy you get from the output a project becomes economically unviable. We will never run out of oil because the economics of extracting much of the oil in the ground simply provide no return.

It is still very much about scarcity of resources but what few seem to realize is that until we reach the very end of the peak oil story the scarcity in resources is not going to show up in shortages of the resources themselves but rather in the available capital to finance projects and in the affordability of the resources themselves.

In example, here is an article I wrote awhile ago on Obama's claim that "energy efficiency" has resulted in a drop in fossil fuel consumption in the U.S. where as the reality is that it was the global recession depression that truly claims responsibility for the reduction in consumption.
Ok. Now, there is one part in particular that is true, but within the context he's using it is a complete lie: "Taken together, our energy policy is creating jobs and leading to a cleaner, safer planet. Over the past eight years, the United States has reduced our total carbon pollution more than any other nation on Earth."

It's true, they have, want to see that in a chart form?

U.S. consumers did not willingly reduce their consumption rather the needed capital to increase their consumption didn't exist due to the resulting credit crisis. Being that currency is not itself a tangible resource but rather represents these resources it can be said that this is a form of resource scarcity. When we hit the limits of resource affordability credit collapses and capital vanishes which results in a significant drop in demand long before physical resource scarcity can take effect. It is important to understand that an economy that requires ever growing supplies of energy will fail before the supplies of energy themselves fail in fact it's unlikely we will ever see physical resource scarcity as the underlining extraction process requires a stable economy and supply chain which the coming economic shockwaves from resource scarcity will likely disrupt.

So the so-called "abundance of assets" really doesn't mean much at all, just as Alberta constantly touting that it's "total reserves rival Saudi Arabia" doesn't mean much at all. Until those reserves, those assets, are out of the ground they are worthless. If investors are noticing that the returns on these projects are barely worth the time invested, let alone the risk, then we are nearing that moment in time when the light finally goes on in their brains that there is no economic benefit to spending a barrel of oil to get a barrel of oil. None what-so-ever.

This story becomes even more economically depressing when you remember that we are in a historically low-interest rate environment. These projects are not just having trouble getting financing, they are having trouble getting financing at central-bank orchestrated artificially low interest rates which if they were to rise would make financing that much more difficult. The U.S. shale "boom" is experiencing the same problems and has likewise been just barely affordable due to the low interest rate environment.

As I've pointed out before it's not like the federal and provincial governments don't know this, they're very aware, and if you go back and look at their policies, their forecasts, and the economic results of the last few years with this knowledge that they know in mind you'll see there has been a clear strategy to keep Albertans and Canadians in the dark of the true risk and low rates of return. There is a very commonly held belief that the oilsands are providing incredible returns for Canadians - reinforced daily with government and industry funded propaganda -  when the truth couldn't be further from.

The reality is for years the government has been abusing Canadian tax dollars in everything from marketing campaigns to Olympic trains while gambling on market moves and taking credit as prudent fiscal managers the whole while. Albertans lately seem very fed up with the entitled attitude of it's provincial government but what they don't seem to understand is that the Alberta government's #1 job isn't governing the province but rather ensuring access for the oil industry and also ensuring Albertans don't realize they and their children who will be left with the resulting mess and no resources to address it, are being royally ripped off.

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Richard Fantin is a self-taught software developer who has mostly throughout his career focused on financial applications and high frequency trading. He currently works for CenturyLink

Nazayh Zanidean is a Project Coordinator for a mid-sized construction contractor in Calgary, Alberta. He enjoys writing as a hobby on topics that include foreign policy, international human rights, security and systemic media bias.