IMAGE SOURCE: CENOVUS ENERGY.
It's always been a safe bet to assume that investments in oil production will increase as oil prices rise. Placing a specific number on that price has been a more challenging endeavor. Now oil producers such as Canadian Natural Resources (CNQ +2.95%) and Cenovus Energy (CVE +4.01%) have given investors a clearer idea of when to expect increased investments in the Canadian oil-sands region, stating that oil within the $55- to $60-per-barrel range is the key to expanded production.
These comments come shortly after a recent report highlighted the production conundrum that Canada faces. While Canadian oil production is expected to increase by 1.1 million barrels a day over the next 15 years, the current pipeline infrastructure will have to dramatically expand to get that oil to market. With the uncertainty surrounding the future pipeline capacity, are oil companies' investment expectations overly ambitious?
The production increase
Canadian Natural Resources President Steve Laut turned some heads last month when he said the company is prepared to increase spending by nearly $1 billion a year through 2019 if oil prices reach and consistently remain around $60 a barrel. The company is already planning to expand production by 125,000 barrels of oil equivalent per day (BOE/D) through its Horizon oil sands expansion by the end of next year, and the added investment would increase that number further.
Cenovus Energy echoed these sentiments, recently stating that the company will soon make the decision to restart three oil-sands projects that it had delayed at the end of last year. The company feels it can create sustainable production in the region with oil prices at $55 per barrel.
Suncor Energy (SU +2.16%), one of the largest-oil sands producers, was less optimistic about investment, stating simply that it needed to see "strong signals" from oil prices. Keep in mind, though, that Suncor has already invested over $6 billion in the region in the past year, taking a majority ownership in the Syncryde oil venture and a large stake in the Fort Hills oil sands operation. The company expects to increase production from 600,000 BOE/D today to 800,000 BOE/D or more in 2019.
With all of this activity and potential investments in the oil-sands region, it shouldn't have been a surprise that overall production is expected to significantly increase. A recent report by the Canadian Association of Petroleum Producers (CAPP) expects Canada's crude oil output to increase by 1.1 million barrels a day over the next 15 years, reaching 4.9 million barrels a day by 2030. The oil sands will make up a majority of this production.
Can Canada keep up?
It's possible, though, that if these investments pay off and the overall daily production of the Canadian oil sands increases, the companies will have to figure out what to do with it all. The issue, according to CAPP, is that Canada's existing network of oil pipelines are not yet equipped for such high production. With a capacity of 4 million barrels a day, the pipelines ran at near capacity last year and will have to expand by 1 million barrels a day just to keep pace.
While it seems like there is plenty of time to make up ground, Canada has not been kind to the prospects of new pipelines, citing environmental concerns. TransCanada's (TRP +0.63%) Energy East Pipeline, for example, which will carry an estimated 1.1 million barrels of oil a day from Alberta and Saskatchewan to refineries in Eastern Canada, has seen resistance from politicians and citizens during the approval and environmental review process.
Even if Energy East or another pipeline is built, though, it would just barely fill the required capacity of expected production. CAPP expects several pipelines will be required to truly meet demand. If pipelines can't meet the demand, oil-sands producers will have to rely on more expensive forms of delivery, such as trucks and rail. Suncor, for example, has the capacity to ship up to 70,000 barrels per day via rail. This is a far more inefficient method to move oil, though, and lacks the cost-effective expansion capabilities that new pipelines can provide.
Other possible options include expanding capacity in existing pipelines through options such as improving facilities, building extensions, and in some cases building an additional pipeline along a preexisting route. Kinder Morgan is already proposing the latter option by expanding the preexisting Trans Mountain pipeline. Canadian Prime Minister Justin Trudeau is expected to issue his approval or denial of the project by the end of the year.
Additionally, without further options to get the oil to market, there is always the concern that oil sands producers will have to compete with other regions for pipeline space, thereby making Canadian crude less profitable. That scenario played out in 2013 and 2014 when Canadian oil sands producers had to deal with the sudden production boost from the Bakken region. This is a less than an ideal reality for oil producers betting so big on the region.
Investor takeaway
Oil prices have yet to stabilize above $50 per barrel, but oil producers in the Canadian oil-sands region are already developing new sources of future production. Once prices are consistently above $55 per barrel, it seems very possible that these companies will begin to tap entirely new sources of oil that have been unprofitable over the past two years.
Despite the potential issues with pipeline capacity, you should view these investments favorably and take comfort in the fact they mean that companies are bullish on sustained higher prices. I think Canada and its provinces will eventually find common ground with oil companies that satisfy environmental and business concerns to allow the construction of several new pipelines over the next decade, but in the meantime, companies such as Canadian Natural Resources and Cenovus are making smart investments for future growth.
