My Oil Sands Budget Runneth Over

Although the consumer price index moderated last month, not all industries are out of the inflationary woods. Exhibit A has to be the Canadian oil sands, which is experiencing tightness in everything from giant tires to capable workers. With around $100 billion in current or planned industry spending, there isn't much room for a letup in costs.

The cost crunch, combined with cascading crude prices, is causing some casualties. On Tuesday, the Fort Hills Energy partnership -- comprising operator Petro-Canada (NYSE: PCZ  ) , Teck Cominco (NYSE: TCK  ) , and UTS Energy -- announced that its project costs are running around 50% over budget. That takes the grand total to around C$21 billion (or $19.6 billion in the U.S.), or a per-flowing-barrel cost of C$150,000.

To give you some context, Canadian Natural Resources (NYSE: CNQ  ) is running about 36% over budget at its Horizon project, but the on-stream cost is only about C$84,000 per barrel, per day. It's early yet, but Suncor Energy's (NYSE: SU  ) massive Voyageur expansion, due for completion in 2012, is estimated to come in at just a touch over C$100,000 per flowing barrel.

In comparison with these leading lights, Fort Hills appears to be in trouble. When asked at a recent conference about the crude price at which a new oil sands entrant faces marginal economics, Suncor's Rick George responded that it gets tough around US$80 to $90 per barrel of crude oil. I'm not going to predict the outcome for Fort Hills, but it wouldn't be the first time that Teck Cominco has soured on a project on account of soaring costs. Just last winter, such mining woes forced Teck and partner NovaGold Resources (AMEX: NG  ) to table Galore Creek.

If Fort Hills, or other emerging oil sands ventures, become footnotes, it would be a real blow to the U.S. consumer, who is a prime beneficiary of increasing Canadian crude imports. The winners, naturally, would be the entrenched oil sands ogres left standing -- Suncor and Canadian Natural. Marginalized competitors would spell less pressure on those precious materials and skilled laborers, and improved rates of return on future expansions.

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Fool contributor Toby Shute doesn't have a position in any company mentioned. The Motley Fool has a disclosure policy.


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  • Report this Comment On September 18, 2008, at 11:03 AM, Shillington77 wrote:

    I think it's very unlikely that Ft Hills and other emerging oil sands ventures would "become footnotes", but instead be sold off, or portionately sold off, in order to cut losses and get cash inflow to keep the projects going, to large non-canadian energy companies.

    The only way I could see these projects to cease further development would be in a significant decline in oil price (I'm guessing somewhere around $70 a barrel). If this were the case, then I don't see this being a benefit to Suncor and others. Yes it's true they would have the majority of the supply, but their profit margins would be significantly reduced due to the price decline.

    The counter arguement of this would be, because of the reduced supply then prices would go back up. If that were the case then other oil sands projects would be back in the game again, thus creating more supply.

    In the end, I find it highly unlikely that the large oil sands projects, such as Ft Hills, will fail to continue developing unless the price of oil goes significantly lower, which I don't feel it will.

  • Report this Comment On September 18, 2008, at 12:26 PM, venkytalks wrote:

    I agree with Shillington that if oil prices plunge by even 25% from current levels, Canadian shale oil is going to look like a terrible investment. Maybe the lack of investment from big oil in new oil discovery tells us something - that the experts never believed in oil prices sustaining at such high levels. And that consumption in recessionary times are not going to exhaust even current output, based on 20 year old discoveries. The Cassandras of peak oil are beginning to sound like the Gauls who were afraid of the sky falling on their heads.

  • Report this Comment On September 19, 2008, at 12:30 AM, Statman42 wrote:

    Shillington is only partly right but venkytalks is mostly wrong. First, it's not shale oil but rather tar/oil sands, which are mined and liquified by a new cheaper processe than shale oil, which is usually deeper and more difficult to exact and refine. Second, a 25% drop in oil price to ~$70 will make some oil sand projects closer to break even when one takes into account over run costs due to Canada's greatly increase PPI, but most of the oil sand investments, particular the early ones by Suncor, will still be quite profitable because (a) they are much further along and (b) they access oil sands that are easier to mine and liquify. The failure in most people's understanding is there is a wide range of production costs of oil sands. For Suncor, which built this out with easier oil sands, their production cost is closer to $50 per barrel, making even $70 still quite profitable. Other newer investments based on higher oil prices will suffer much more in the short-term. Combined with Suncor fill the pipes instead of them, this is reason why Suncor will be the "winner", although they will take a hit from an increasing PPI and increased royalties from Alberta, but this hit may be already factored into its price. BTW, even though oil has fall from $147 to $91 recently, this does not imply, by any means, that the peak oil theorists are wrong, as oil is still pretty darned high in a very short period and still very high, considering that we're either in or heading for a global recession. The peak theorists actually predict wild oscillations in the price of oil over a decade as the world oscillates in an out of a recession. Having studied oil for nearly a decade now, I have not seen one good, scientific argument that has convinced me that peak oil is not real and not imminent. The "deep hot biosphere" is neither proven nor does it deter from the fact that reserves are being deplete much faster than they are being discovered and the reserves that are being discovered are either much smaller or extreme hard to extract.

  • Report this Comment On September 19, 2008, at 8:59 AM, venkytalks wrote:

    I appreciate what Statman is trying to say and I am nowhere near an expert or even an oil investor (except in Indian companies).

    But my point may have been missed by Statman. The reason why no new oil discoveries are coming on line may have nothing to do with oil running out, and everything to do with big oil companies not wanting to look for oil. Because the oil companies rightly believe that oil supplies are currently adequate and looking for more oil would not make sense for their shareholders.

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