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Canadian Natural Resources Ltd. (TSX: CNQ) will soon produce the first barrels of oil at Canada’s newest oilsands mining operation. The Calgary-based company’s Horizon Oil Sands Project, located 70 km northwest of Fort McMurray, consumed about five years’ strenuous labour by thousands of workers, and billions of investment dollars. Despite this achievement, COO Steve Laut found himself apologizing. “We are not on time, and we are not on budget,” he declared during a conference call this fall. “Horizon does not meet our criteria for success.”
Exacerbating CNRL’s disappointment, the value of its product has now collapsed. A barrel of West Texas Intermediate (the blend of crude oil used as an international benchmark), which reached a record high of US$147 in July, now changes hands for about two-thirds less. That collapse forced a monumental reckoning in Canada’s oilsands. CNRL and many others responded by slashing capital spending and delaying—or shelving altogether—future expansions. “We’re not going to build in a high-cost environment for a moderate-priced world,” Laut explained.
Such logic is undeniable, and backed by experience. CNRL has weathered three major slumps in oil and gas prices during its 19-year history. Yet, arguably, it and other oilsands developers have already fulfilled half of Laut’s grim recipe: they built in a high-cost environment. If this recession proves persistent, it might well accomplish what the industry’s most aggressive opponents could not: a grinding halt to Canada’s great, mad oilsands rush.
To assess the damage sustained lower oil prices might do to the industry, Horizon’s price tag is a good place to begin. In 2005, CNRL thought the first phase would cost $4.9 billion. The company assured shareholders that cost overruns were something that happened to other oilsands companies, and that it had “achieved a high level of cost certainty.”
Nobody dares repeat that phrase these days.
CNRL was just one of dozens of developers jockeying to construct large mines and in situ projects throughout this decade. If all the proposed projects were completed on schedule, Strategy West, a Calgary-based consultant, recently calculated that production would hit more than 6.3 million barrels a day by 2020. Put another way: that’s more than four times the 1.4 million barrels produced today, which is itself a result of rapid growth. Alberta’s government seemed unperturbed by the mounting social, environmental and practical consequences; it made little effort to contain the frenzy.
With so many companies tripping over each other in northern Alberta’s remote wilderness, costs inevitably rose. Specialized heavy mining equipment, such as trucks and shovels, was in high demand. Despite a rapidly growing population, the region still had nowhere near enough skilled craftsmen and labourers. Developers had to scour the continent for contractors. Overtime became routine as projects fell behind schedule, and more work had to be done in extreme cold weather. Meanwhile, global prices of steel, concrete and other raw materials were also soaring.
These realities nullified earlier cost estimates. Horizon’s first phase wound up at $9.7 billion—nearly twice its original budget. It’s hardly the worst example, though. In September, Petro-Canada (TSX: PCA) and its partners, Teck Cominco (TSX: TCK.B) and UTS Energy (TSX: UTS), revealed that estimated costs for their Fort Hills mining project climbed by more than 50% in just 15 months, to about $21 billion. Strategy West president Bob Dunbar calculates that Suncor Energy’s Millennium project, completed in 2001, cost between $30,000 and $35,000 for each daily barrel of capacity. For Horizon, the figure is $80,000. And Fort Hills? Try $170,000. “We’ve really seen a huge run-up in costs,” Dunbar says.
The industry stoically endured these mounting costs, and only a small handful of projects were axed. Oil prices probably help explain why. They rose dramatically during most of this decade, because of factors such as geopolitical concerns and strong demand from emerging economies like China and India. As the anticipated rewards grew, so did the stakes, and some observers warned of the dangers of overinvestment. “During all oil price booms, it becomes possible to imagine that the industry’s economics have changed forever,” cautioned a trio of consultants from McKinsey & Company in an article written in late 2005. “But history shows that the point when industry observers start to say that things are really different this time around usually marks the top of the cycle.”
The industry finally blinked when oil prices collapsed, forcing a sudden surge in project cancellations and deferrals in recent months. Suncor in October slashed capital spending plans for next year. The following month, CNRL cut its budget and delayed expansion at Horizon. Royal Dutch Shell postponed its Carmon Creek project. Petro-Canada and its partners put off the decision about whether to proceed with Fort Hills. And so on.
David McColl, senior economist at the Canadian Energy Research Institute, says the slowdown is “minor in the grand scheme of things.” Even so, he predicts that it has set back the industry’s production growth between three and five years. That means Alberta’s government can expect less royalty revenues in the near term, and both it and the federal government can expect less income taxes. “There will definitely be some layoffs,” McColl adds.
Future oil prices remain as unpredictable as ever. Merrill Lynch has said they could fall as low as US$25 a barrel, but CIBC World Markets chief economist Jeff Rubin, for one, has predicted oil could reach US$200 within five years. “What’s happening out there is a giant head fake,” he recently told one audience, “that could easily put you running in the wrong direction.”
McColl’s take is similar. “This is a short-term downward blip,” he says. His reasoning is straightforward: at current prices, the industry has no incentive to replace dwindling oil reserves. “We’re out of cheap oil,” he explains. “Even in the Middle East it’s getting expensive to produce, and we’re running out of conventional oil in North America.” New oilsands, offshore and oilshale projects all require oil prices in the US$70–$100 range to be economically viable.
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