A recent report from the London-based Carbon Tracker Initiative think tank warns that many oil companies are committing too much money to projects with high breakeven costs, putting them at great risk should oil prices see a sustained decline.
The report argues that policies aimed at curbing climate change, such as energy efficiency mandates and restrictions on greenhouse gas emissions, are likely to significantly reduce future global oil demand, exerting downward pressure on oil prices.
Such a scenario, Carbon Tracker said, would be especially bad for projects with high costs of production in excess of $95 per barrel for Brent crude. It identified Canadian oil sands operations, as well as certain deepwater, tight oil, and other projects, as being especially vulnerable to an extended declined in oil prices.
But before you rush to sell off your holdings in companies focused on the oil sands, there is one very important thing to keep in mind: not all oil sands projects are created equal. While some indeed have breakeven costs as high as $100 per barrel, others are quite economical.
The economics of Canada's oil sands
According to a recent study by Scotiabank, western Canadian oil production is actually more economical, on average, than tight oil operations in major U.S. shale plays including the Bakken in North Dakota and the Permian Basin and Eagle Ford, both in Texas.
After assessing more than 50 plays across North America, Scotiabank analysts found that Canadian oil production has an average full-cycle breakeven cost of $63-$65 per barrel, compared to the U.S. average breakeven cost of $72 per barrel. Scotiabank defines breakeven costs as the West Texas Intermediate benchmark price required for a given project to yield a 9% after-tax return on full-cycle costs.
The report found that the average steam-assisted gravity drainage oil sands project in Alberta breaks even at roughly $63.50 per barrel. Even existing oil sands mining and upgrading projects in Fort McMurray, often characterized as some of the least economical oil projects in the world, yield full-cycle breakeven costs in the range of $60-$65 per barrel.
By comparison, projects in West Texas' Permian Basin require an average price of $81 per barrel to break even, while North Dakota Bakken oil production needs an oil price of about $69 to be profitable and Eagle Ford operations require just over $63.50 per barrel, according to Scotiabank.
Cost disparity between in-situ and new mining projects
However, new mining and upgrading projects in Canada's oil sands have considerably worse economics, requiring a $100 oil price to break even. Indeed, high operating costs are already holding back a number of new oil sands mining ventures. For instance, Total (NYSE:TOT) recently announced that it is suspending work at its Joslyn oil sands mine in northern Alberta due to severe cost inflation.
The project, which Total operates alongside partners Suncor Energy (TSX:SU)(NYSE:SU), Occidental Petroleum (NYSE:OXY), and Japan's Inpex, was estimated to cost $11 billion. At this cost, the project simply wouldn't have generated sufficient margins and operating netbacks to justify the investment, even with currently high Canadian heavy-oil prices.
On the other hand, costs at Surmont Phase 2, a steam-driven in-situ expansion project being pursued as a 50/50 joint venture between Total and ConocoPhillips (NYSE:COP), are highly competitive. According to Conoco, full-cycle finding and development costs for Phase 2, which is scheduled to start up in 2015, are estimated at just $20 a barrel. That's even lower than Conoco's full-cycle costs of $20-$25 per barrel in the Eagle Ford and Bakken, two of the most economical U.S. shale plays.
The results of Scotiabank's study challenge the common assumption that Canadian oil sands operations are some of the least profitable in the world due to extremely high operating and development costs. But there is a massive disparity between operating costs for different projects in Canada's oil sands, as the examples of Surmont and Joslyn highlight. As such, investors should pay special attention to oil sands producers' cost structures as a prolonged slump in oil prices could render several new mining and upgrading projects uneconomical.