Is it game over for the oil sands?
PIERRE FOURNIER
Globe and Mail Update
October 20, 2008 at 6:00 AM EDT
Other than the potential for a severe economic recession, the development of the oil sands is likely the most important economic and political issue for Canada for the coming decade. Based on present expectations, the oil sands will host at least $170-billion of investments during this period. Canada is already the main oil supplier to the U.S., and proven oil resources in Alberta are second only to Saudi Arabia.
The challenges remain daunting. The costs of mining and upgrading the resource have skyrocketed, and the break-even point for new projects is close to $85 (WTI) a barrel, an increase of $20 from just a year ago. Volatile oil prices, coupled with environmental and regulatory risks, and the massive investments required for long-term returns, have led many existing and potential players to adopt a more “prudent,” that is, conservative, approach. Over the last few months, the stock market correction has been particularly devastating for the oil sand players.
Is it game over for the oil sands? More than anything, the future of the oil sands will depend on U.S. commitments to finance their development and buy the oil. In the U.S. presidential race, energy independence has turned into a mantra and a national obsession. There is every reason to believe that the next president will take aggressive steps to diversify sources of energy and stop buying oil from “our enemies.”
U.S. multinationals are no match for the state-owned monopolies from China, Russia and India, among others, who are aggressively seeking to lock up a sizable chunk of the world's scarce oil and gas supplies, with little regard for long-term profitability. The world's top 10 oil producers are state monopolies and account for 77 per cent of total production. The largest U.S. company, Exxon, ranks 12th.
In addition, many oil rich countries are overtly hostile toward the United States. Venezuela has largely expropriated American oil companies, and is doing all it can to avoid shipping its oil to the U.S. Iran is working with its neighbours and China to build pipelines to ship its oil and gas to India and China. Nigeria will remain unstable for the foreseeable future, and Chinese companies are slowly but surely securing the country's resources. Russia is gradually squeezing out foreign producers.
Even “friendly” countries, including some of the Arab states and Brazil, are increasingly aggressive, seeking ownership stakes, ever-higher royalties and taxes and mandating investments in local industries and infrastructure.
This rapid collapse of its ability to secure long term oil supplies has made the U.S. dangerously vulnerable to oil price spikes, and has put a heavy burden on its military, which is at least partly responsible for securing continued access to foreign oil. It would be naive to believe that the world will become a more friendly place for America in the next decade. The opposite is likely.
The strategic interests and the needs of the U.S., coupled with Canada's desire to maximize the benefits of the resource, will lead to the continued and perhaps accelerated development of the oil sands. Balancing the economic, political and environmental stakes will be a formidable challenge.
First, should other foreign players be shut out? It could be argued that multiple investors and buyers would help maximize the value of the oil sands, and that Canada should not be dependant solely on the U.S. markets and U.S. upgraders and refineries – but should instead favour the construction of pipelines to ship some of the supply to other foreign markets. Also would the rejection of large-scale Chinese investments, for example, be viewed as “discriminatory” and contribute to the further deterioration of Canada's relationship with China?
Second, with the private sector unable or unwilling to guarantee the large-scale development of the oil sands in the long run, major multibillion-dollar bilateral agreements between the U.S., Canada and the producing provinces seem likely. The options could include guaranteed long-term contracts at fixed prices, investments in technology to enhance output, reduce costs and carbon emissions, as well as subsidies and various fiscal incentives.
While the oil sands in Alberta and Saskatchewan will produce positive economic impacts in other provinces, their development will be a highly contentious and potentially divisive issue for the country, perhaps eventually posing a threat to national unity.
All of Canada's opposition parties are, to varying degrees, skeptical or opposed to an accelerated development of the oil sands. Central Canada is pushing back on environmental concerns, including restricting the pace of development and adding costs to clear up emissions. Does central Canada really believe they can impose costly restrictions on the oil sands, while at the same time enjoying the economic spinoffs and increasing share of the tax revenues generated? Given its minority status, the Conservative government will find it challenging to reconcile the conflicting visions and interests of the producing and non-producing provinces.
Ultimately, however, the coming U.S. election and the severe correction experienced by oil sands equities – which currently reflect a long-term oil price of less than $50 a barrel – will undoubtedly present opportunities for the investor. Harsh geopolitical realities and the need for energy independence will trump all other considerations in realizing the potential of Canada's oil sands.
