Can Canadian Oil Sands Survive Falling Prices?

http://www.businessweek.com/articles/2014-12-22/canadas-oil-sands-are-better-bets-than-shale-oil#p2

Can Canadian Oil Sands Survive Falling Prices?

By Matthew Philips   December 22, 2014

     

As oil prices have crashed over the past six months, a lot of attention has focused on what this means for frackers in the U.S., as well as the national budgets of a lot of large oil producing countries, such as Russia and Venezuela. In short, it’s not good. But what about Canada? The country is the world’s fifth-largest oil producer, and only Saudi Arabia and Venezuela have more proven reserves of crude.

Almost all of Canada’s reserves (and production) are in the form of oil sands, which are among the most expensive types of crude to produce. There are pretty much two ways to do it. one is to inject steam into wells deep underground to heat up a thick, gooey type of oil called bitumen. The other is basically to strip mine large tracts of land and extract a synthetic blend of oil out of the earth and sand.

Taken together, both methods require about 17 percent more energy and water than conventional oil wells and also result in similarly higher levels of carbon emissions. That’s made oil sands a particular target of environmentalists. Now the Canadian oil sands producers have to contend with an even greater opposing force: economics. If Canadian oil sands are more expensive to produce than most other oil, how can they survive in the face of prices that are nearly 50 percent cheaper since June?

A few things play to their favor. The first is that their costs are more akin to a mining operation than conventional oil drilling. Oil sands projects require massive upfront investments, but once those are made, they can go on producing for years with relatively low costs. That’s made oil sands, and the companies that produce them, quite profitable over the past few years.

Suncor Energy (SU) and Cenovus Energy (CVE) are two of the biggest oil sands producers in Canada. Both have profit margins that would be the envy of a lot of major oil companies. At Suncor, earnings before interest, taxes, depreciation, and amortization (Ebitda), a basic measure of a company’s financial performance, have risen from 11.7 percent in 2009 to 31 percent through the first nine months of 2014. Exxon Mobil’s (XOM) Ebitda so far this year is about half that at 14.3 percent.

That cost structure may give oil sands producers an advantage over frackers in the U.S., who operate on a much shorter time horizon. Fracked wells in the U.S. tend to produce most of their oil within about 18 months or so. That means that to maintain production and rates of return, frackers need to keep reinvesting in projects with fairly short lifespans, whereas an oil sands project, once up and running, can continue to chug along, even in the face of lower prices, since its costs are spread out over a decade or more rather than over a couple years. That should keep overall oil sands production from falling and help insulate oil sands producers from lower prices, at least for now.

“They’re safer than the frackers,” says Carl Evans, an oil analyst at Genscape. “The sentiment up in Calgary has very much been that growth will push through this price dip, while U.S. production will start to come off highs.” Evans says the breakeven costs for bitumen oil sands projects that are already up and running can be as low as $10 to $20 a barrel. Right now, the price of Canadian oil in Alberta is about $40 a barrel.

This isn’t to say that future investments won’t get cut if prices stay where they are. But those cuts won’t show up in future production growth for years. A total of 14 new oil sands projects in Canada are scheduled to start next year with a combined capacity of 266,000 barrels a day, according to data published by Oilsands Review. That’s 36 percent more than were started in 2014. Since most of those investments have already been made, those projects are probably safe. Even for projects that are only partially paid for, investors will still probably be loath to stop halfway.

“You don’t stop a project mid-cap-ex,” says Greg Sharenow, a portfolio manager at Pacific Investment Management Company (Pimco) and former senior energy economist at Goldman Sachs (GS). “We’ll see a pause in new investments, but you probably won’t see shut-ins without real distress,” he says.

Oil sands companies have also been pretty good at lowering their costs over the past few years. According to Cenovus’s third-quarter earnings report, operating costs have come down 9 percent and 14 percent per year for two of its biggest projects.

Canada’s falling dollar could end up benefiting its oil sands producers. Over the past 12 months, the Canadian dollar has lost almost 10 percent of its value against the U.S. dollar. That’s bad news for most Canadians since it reduces their buying power, but for oil sands producers, it could end up a net plus. While most of those companies pay their costs in Canadian dollars, they get paid in U.S. dollars because almost all the oil they produce is sold to U.S. refiners. That means their costs have gotten cheaper while their revenues have gained value.

When it comes to the U.S. import market, Canadian oil essentially competes with similar grades of heavy crude from Venezuela, Colombia, and Mexico. Recently, Canadian crude’s been winning big. U.S. imports of Canadian oil have doubled over the past decade, from 1.5 million barrels a day in 2005 to more than 3 million barrels a day. Meanwhile, crude imports from Venezuela have gone in the opposite direction, falling from 1.3 million barrels a day in 2005 to less than 800,000. Not only is Canadian crude cheaper; most refiners also tend to think it comes from a more stable supply.