Exploring the top 10 opportunities and risks in Canada s oilsands

Transcription

1 Exploring the top 10 opportunities and risks in Canada s oilsands

2 About this report This report consists of insight and perspectives from Ernst & Young s Calgary Oil & Gas team, which has extensive experience helping oil and gas companies in Western Canada achieve their potential. The research is drawn from the team s own conversations and experience advising international, national and local oil companies. All monetary figures are in Canadian dollars unless otherwise specified. Key findings In this report, our oil and gas team has uncovered a number of ways companies can turn today s challenges and opportunities into results. One of the top trends we re seeing today is the rising number of joint ventures and partnerships in the industry, which is helpful for oilsands as it allows for sharing of resources, costs and skills. The industry is investing more in technology, and is collaborating on its use and research. With the rise of globalization in the economy, it s becoming more and more important for Canada s oil and gas market to break into new markets around the world rather than solely relying on the US for trade. With the rise of concern from stakeholders and the community, and with government regulations, companies are focusing more on ways to curb their greenhouse gas emissions. Due to the perceived negative environmental effects of oil and gas production, companies are working on their own public relations management. It is important for the government to support these efforts by coming up with a federal energy strategy. In the wake of the global recession and crude price volatility, companies are taking a fresh look at their strategies and improving their internal business operations. 2 Exploring the top 10 opportunities and risks in Canada s oilsands

3 Oilsands geography Oilsands, also known as tarsands, are a mix of bitumen, sand and water. They are considered a type of unconventional petroleum deposit, since the process to extract oil from the sands is different from that used to extract the free-flowing hydrocarbon mixtures of crude oil traditionally produced from oil wells. Oil is extracted from oilsands through in-situ methods such as steam-assisted gravity drainage (SAGD) during which lowpressure steam is continuously injected into horizontal wells to heat the oil and reduce its viscosity. Another more expensive form of extracting oil from the sands is surface mining, using large trucks and excavators. Surface mining is performed when the bitumen is covered by little overburden, which consists of water-laden peat bog over top of clay and barren sand. The oilsands are typically 40 to 60 metres deep, sitting on top of flat limestone rock. After excavation, hot water and caustic soda are added to the sands to separate the oil. The oilsands in Western Canada s Sedimentary Basin are located in three major deposits in northern Alberta: the Athabasca-Wabiskaw oilsands deposits of northeastern Alberta, with the bulk of oilsands companies located in the town of Fort McMurray; the Cold Lake deposits in the northeastern part of the province; and the Peace River deposits of northwestern Alberta. Together, these three regions cover 225,308 square kilometres and hold proven reserves of 1.75 trillion barrels of bitumen. The area contains at least 85% of the world s reserves of natural bitumen, but they are the only deposits concentrated enough to be economically recoverable for conversion to synthetic crude oil at current prices. In fact, Canada s oilsands reserves are ranked third in the world for proven oil reserves behind Saudi Arabia and Venezuela. Alberta oilsands properties Athabasca- Wabiskaw Deposit Fort McMurray Peace River Deposit Cold Lake Deposit Peace River Athabasca- Wabiskaw Deposit In-situ projects Mining projects Cold Lake Exploring the top 10 opportunities and risks in Canada s oilsands 3

4 The top 10 emerging opportunities As Canada s economy recovers from the global economic recession, its oil and gas industry is gaining strength at a fast pace entering a boom cycle. During the recession, exploration, development and many capital projects were put on hold, and now the industry is facing a growing global demand for resources a demand that oil and gas companies are scrambling to take advantage of. This increasing demand has been a driving force in Canada s recovery, and we believe it will remain so well into the future. Demand for Canada s oil resources is particularly evident in Alberta s unconventional oil region, which plays an important role in the country s oil and gas sector. The oilsands hold great resource potential, and there are a growing number of projects on the rise that consist heavily of an oil-focused mix. The region has generated interest from foreign (notably Asian) investors and partners as these countries look to secure their oil supplies to fuel rapidly expanding populations. To many, Canada offers a stable business environment that weathered the economic storm well, political stability, strong and transparent regulations, and the development of leading-edge technology and expertise in the oilsands. The oilsands sector is evolving quickly. Risk continues to dominate the business agenda, but competition in a global marketplace is becoming a dominant feature. Market volatility, pricing pressure, variations in market performance and demanding stakeholders have all contributed to an economy that encourages competitive drive. And with that drive comes opportunity. After taking into account the many lessons learned from the recession, and the boom period from 2005 to 2008, oilsands companies are better equipped to succeed today than ever before. The following are the top 10 opportunities we see emerging in the industry. 4 Exploring the top 10 opportunities and risks in Canada s oilsands

5 Global demand is growing The demand for oil around the world remains crucial to the viability of oilsands as a resource. The International Energy Agency forecasts continued growth and demand for fossil fuels of 36% between 2008 and 2035, with 36% of the increase coming from China. The US is also an important customer of Canadian oilsands production, accounting for approximately 22% of the world s oil and gas consumption. The agency also predicts that coal, oil and natural gas will remain prominent sources of energy into 2035, and that Canadian oilsands and 1Venezuela heavy oil will dominate production mix in the future globally. 2The oilsands are economically important to Canada Canada s oilsands play a significant contributing role in the oil and gas industry, and in giving Canada a global competitive edge. Canada s current oilsands production is disproportionate relative to its large reserves base owing to high capital costs, restrictive regulatory requirements and the long lead times needed to bring oilsands production online. Exploring the top 10 opportunities and risks in Canada s oilsands 5

6 Here are some key numbers from the government of Alberta that highlight how the oil and gas industry contributes to the Canadian economy. The economic impact to Canada generated from the oil and gas sector is $1.7 trillion per year (GDP); 90% of this comes from Alberta. Reserves base Canada has a huge resource base of oilsands reserves comparable on a world scale to countries like Saudi Arabia and Venezuela. Another measure of government share or revenue from the development of the oil sands is to measure the direct and indirect revenues. This involves measuring the direct royalty and taxes paid, as well as the taxes paid by those supplying goods and services to the oilsands projects and paid by their employees. A Canadian Energy Research Institute (CERI) study, titled The Economic Impact of Alberta s Oil Sands, October 2005, quantified the measure of government revenue over the 20 year period from 2000 to 2020 and found Canada s governments in aggregated collected $123 billion, which was divided up as follows: Government revenue from oilsands $ in billions $123 billion by jurisdiction 14% Municipalities 9% Provinces other than Alberta 36% Alberta government 41% Federal government 0 Source: CERI Economic Impacts of Alberta s Oilsands, Oct World oil reserves Accessible oil reserves State owned or controlled 78% Accessible 52% Canada s oilsands % Other accessible reserves Billion barrels Includes 170 billion barrels of oilsands reserves Saudi Arabia Venezuela Canada Iran Iraq Kuwait Abu Dhabi Russia Libya Nigeria Kazakhstan Qatar China United States Source: Oil & Gas Journal, December Exploring the top 10 opportunities and risks in Canada s oilsands

7 3 Oilsands are playing a more prominent role in the oil production mix Supported by several oilsands assets in either operations or construction, and future growth plans both in-situ (drillable) and mining related, production is expected to grow through 2025, according to the Canadian Association of Petroleum Producers (CAPP). Production growth mainly fuelled by oilsands is expected to strengthen the energy relationship between the US and Canada. In fact, CAPP expects oilsands production to grow from 1.3 million barrels/day in 2009 to 2.2 million barrels/ day by 2015 and 3.5 million barrels/day in Canadian oilsands and conventional oil production forecast ( ) 5 Actual Forecast 4 Atlantic Canada Million barrels/day In-situ Mining Conventional heavy Pentanes/condensate Conventional light Source: Canadian Association of Petroleum Producers Exploring the top 10 opportunities and risks in Canada s oilsands 7

8 4 Canada is an attractive place to do business Looking at the major global projects against the economics and political risk in Canada indicates SAGD oilsands and mining oilsands projects compare well on a global scale. Canada provides a politically stable economy and has a strong legal and business system in which to operate. Canada s vast oilsands reserves and proximity to the US make it an ideal market for wealthy international and national oil companies. Major oil and gas projects evaluated by size and political risk Typical well economics (after-tax return rate) 60% 50% 40% 30% 20% 10% 0% Australia LNG Low SAGD oilsands Hebron Deepwater GOM Mining oilsands Political risk GOM: Gulf of Mexico LNG: liquefied natural gas SAGD: steam-assisted gravity drainage Tupi oil field Papua New Guinea LNG Libya redevelopment Iraq redevelopment High Source: Company reports and CIBC World Markets Inc. Asian investment in Canada topped $10.9 billion in While Norway, France, the US and other international countries are heavy investors in Canada s oilsands resource plays, Asian countries are showing a significant interest. In fact, the number of inbound oilsands-focused transactions from Asia tripled in 2010, as resource demand from China, Japan, Thailand and South Korea continues to grow. According to DBRS Limited, a globally recognized provider of credit rating opinions, consumption by non-organisation for Economic Co-operation and Development countries grew by 12.5 million barrels/day from 2000 to 2010 as a result of rapid industrialization and economic development. In particular, China s consumption growth averaged 6.6% per year since 2000, and it s expected to remain as robust going forward. Demand is growing as many Asian countries are actively seeking to secure natural resources around the world to support their population growth. Asia Pacific has experienced significant growth with imports increasing by more than 30% over the decade, according to DBRS. This growth has primarily been led by China and India, whose imports increased 23% and 65%, respectively. Some examples of Asian investments and partnerships in Canada s oilsands include the following: July 2011: CNOOC announced a $2.1 billion deal to acquire OPTI Canada. June 2011: Petronas announced a joint venture with Progress Energy for $1.07 billion. January 2011: China s Sinopec Corp. is one of the investors in its proposed $5.5 billion Northern Gateway pipeline with Enbridge. November 2010: Statoil Canada entered a US$2.28 billion joint venture with Thailand s PTT Exploration and Production Public Company Limited. May 2010: China s main sovereign wealth fund entered into a partnership with Penn West Energy Trust to develop oilsands assets. April 2010: Sinopec purchased a 9% stake in Syncrude Canada Ltd. February 2010: State-run PetroChina Company Limited closed its agreement to purchase a majority stake in Athabasca Oilsands Corp. It paid $1.9 billion for a 60% working interest in Athabasca s MacKay and Dover assets. April 2005: CNOOC Limited acquired a 16.7% stake in MEG Energy Corp. 8 Exploring the top 10 opportunities and risks in Canada s oilsands

9 5Increased crude prices expected The West Texas Intermediate (WTI) and Brent exchanges continue to show evidence that the market is uncertain over oil and gas prices. The current forward strip certainly appears to support oilsands, but it also makes it difficult for those companies to plan and forecast accurately especially recently with significant price volatility caused by the S&P downgrade of the US credit rating. Forecasts reflect increased optimism over crude pricing, with most analysts expecting levels to stay above $80 per barrel in the long term. Higher crude prices are favourable for oilsands production as previous uneconomic assets and costly projects suddenly become possible. The risk comes in when oil prices drop below the costs of extracting oilsands, which is more expensive to produce than conventional oil production methods. Companies with deep pockets and low cost of capital can be expected to handle the lower crude prices and take advantage of potential short-term lower material and labour costs. West Texas Intermediate forecasted prices As of 30 June (US$/bbl) High forecast Investment banks Reserve engineers Low forecast Source: Ernst & Young LLP 6 The US as a key customer is evolving The US continues to be a very important customer of Canada s crude oil production. Canada is the world s sixth-largest crude oil producer, providing 21% of US imports. Canada has been able to double production since 1980, and its share of US imports compared to Saudi Arabia, Venezuela and Mexico is expected to increase. Most Americans strongly value Canada s role as a secure, stable and friendly supplier of oil to meet the needs of US families and businesses, according to a poll conducted by Harris Interactive for CAPP and the American Petroleum Institute. Americans naturally want to reduce dependency on imported oil, but to the extent that the US continues to rely on supply from other countries, Canada is very well regarded, said Dave Collyer, President of CAPP. Among Americans, Canada is seen as a friend and ally, with positive environmental values and a commitment to democracy, social justice and human rights. Exploring the top 10 opportunities and risks in Canada s oilsands 9

10 However, reliance on the US is not without its challenges. US dependence on imported oil fell below 50% in 2010 for the first time in more than a decade thanks in part to the weak economy and more fuel-efficient vehicles, the US Department of Energy (DOE) has said. The DOE s Energy Information Administration said it expected the moderating trend in US oil-import dependency to continue through the next decade due to improvements in energy efficiency and even higher fuel economy standards. Therefore, Canada needs to focus on diversifying it s oil and gas customers by building relationships globally. Such relationships are being formed with Asian countries and Canada is opening up many new opportunities by securing its position in new markets. 7 Project activity increasing in a controlled way At Ernst & Young, we re seeing renewed project activity in all facets of the oilsands sector. Projects that were shelved over the last few years are now coming back on stream. CAPP sees an increase in 2011 of $2 billion in capital spend in the oil and gas industry compared to Some examples of this include the Sunrise Project Husky Energy s joint venture with BP; Suncor Energy Inc. s Firebag expansion stages three to six and the second stage of Mackay River; and Cenovus Energy Inc. s oilsands expansion project at Foster Creek and Christina Lake. Compared to the early 2000s, we are noticing some key differences in terms of project growth. These include fewer megaprojects with 100,000+ barrels of oil/day production, more cross ownership and collaboration, and smaller average project size. Collaboration between companies is helping them better control risk and deliver faster project results it s easier to get a smaller number of skilled resources to complete a project, rather than having to manage massive teams. CAPP sees an increase of $2 billion over 2011 in capital spend in the oil and gas industry. Industry capital spending ($ in billions) Northern Canada Oilsands Western Canada East Coast offshore $34 billion Source: Canadian Association of Petroleum Producers, January $42 billion (forecast) $44 billion Exploring the top 10 opportunities and risks in Canada s oilsands

11 In 2010, crude oil pipeline capacity was 3.3 million barrels/day compared to 2.5 million barrels/day in Infrastructure development continues Canada has well-established oil and gas production infrastructure that has been built up over many years. This includes pipelines that supply the US and the potential to export to Asia, politically stable government, skilled workers who are experts in oilsands production, respect for contracts and low corruption levels. Future infrastructure development projects like TransCanada s Keystone XL have the potential to further support export growth and security of demand for production. The tightening of differentials in the past few years has influenced the expanding pipeline capacity. In 2010, crude oil pipeline capacity was 3.3 million barrels/day compared to 2.5 million barrels/day in Once it s built, Keystone will initially transport 435,000 barrels/day, and Enbridge s Northern Gateway will transport 525,000 barrels/day. Canadian and US crude oil pipeline proposals Enbridge pipelines, AB Clipper and connections to the US Midwest Kinder Morgan Express Kinder Morgan Trans Mountain TransCanada Keystone Proposed pipelines to the West Coast Existing/proposed pipelines to PADD III Expansion in existing pipeline Source: Canadian Association of Petroleum Producers Exploring the top 10 opportunities and risks in Canada s oilsands 11

12 9 Smaller players create diversification We are starting to see signs of a shift in industry emphasis and dynamics in a few areas. First, there are a greater number of SAGD projects moving forward compared with new oilsands mining projects. This is partly due to the lower breakeven points of SAGD projects (approximately $42/barrel) versus an upgraded mine project, which may require $90/barrel to break even. We re also noticing that mining projects are more labour intensive, and therefore face higher cost issues in a tight labour environment. SAGD projects are less labour and capital intensive, more environmentally friendly, easier to manage and seem to have a better track record of being on time and budget compared to mining. The changing business model has allowed the emergence of smaller players like MEG Energy and Athabasca Oilsands Corporation, which are focused on SAGDtype projects and operations with smaller production, high degree of control and no upgrading capacity. Recently, MEG was ranked the top oilsands producer in the industry by Oilsands Review, and announced in April 2011 that its first quarter results had increased based on strong production at Cristina Lake. The lower barriers to entry are helping to build a more diverse Canadian oilsands industry with smaller, more nimble players. 10 The increasing role of technology Technology and innovation continue to play an important role in supporting enhanced oil and gas recovery, and in reducing the environmental impact of production. Some examples of innovative technologies being implemented, and those to watch over the coming years include the following: Different processes for using solvents together with SAGD production, improving recoveries and reducing greenhouse gas (GHG) emissions. The solvent-assisted process co-injects solvents such as butane and propane, reducing the need for large amounts of steam, which decreases the steam-tooil ratio. Technologies to process produced bitumen that remove the heaviest hydrocarbon components, facilitating transportation direct to refineries and eliminating the need for a separate upgrade step. Wedge wells, which involve drilling incremental horizontal wells between existing well pairs to harness incremental production. Toe-to-heel air-injection could help dramatically decrease costs using combustion technology and the vertical injection of air, creating a high temperature that burns the oil and reduces the viscosity of the remaining oil. The electro-thermal dynamic stripping process (ET-DSP) combines heat transfer mechanisms. Privately held E-T Energy Ltd. is getting support from Total E&P Canada Ltd. to fund its patented ET-DSP technology for producing heavy oil and bitumen from oilsands. Total will provide financial and technical support for field testing as E-T prepares for its proposed 10,000 barrel/day phase one commercial development at Poplar Creek. Working with E-T Energy is an excellent opportunity for Total to help advance innovative extraction methods that continue to build on the development of environmentally sound practices in Canada s oilsands, said Jean-Michel Gires, President and CEO of Total E&P Canada Ltd. 12 Exploring the top 10 opportunities and risks in Canada s oilsands

13 Combustion overhead gravity drainage uses combustion instead of steam to heat the reservoir. Thermal-assisted gravity drainage inserts an electric wire into the well and heats the resevoir over a one-year period, avoiding the need for steam. Non-aqueous extraction technologies that have the potential to eliminate the need for water and the net for wet tailings ponds. Here are some additional examples of companies that are leveraging new technology to enhance in-situ oil recovery. Together with Saltworks Inc. Technologies, Cenovus Energy recently invested $6.3 million in energy and environmental technology, developing efficient ways to convert saltwater to freshwater through desalinization. The technology removes salt from seawater and underground saline water by harnessing low-temperature heat. The heat is created by solar energy and waste heat from a power generator, which produces mechanical and electrical energy. Cenovus is also working with General Fusion Inc. to find ways of combining hydrogen atoms that generate energy. The byproducts are considered safe for the environment and don t emit GHGs. Imperial Oil is piloting new steam flooding techniques for late-life wells in which it will drill new steam-only injector wells and continue to produce from existing wells. The company has also commercialized laser technology, in which solvent is added along with steam in mid-life wells, improving both recovery and GHG intensity levels with no additional steam input. Over about two cycles, recovery is up about 35% compared to a typical cyclic steam stimulation well, and GHG emissions are down approximately 25%. Exploring the top 10 opportunities and risks in Canada s oilsands 13

14 The top 10 risks With rapid growth and prosperity in Canada s oilsands region, the industry is also facing many challenges and risks. Like many others today, the oil and gas industry as a whole is dealing with changing regulations and compliance, new laws around transparency and reporting, environmental and climate change pressures from the community, government and stakeholders, and price volatility in the market as people are still uncertain about the state of the global recovery. With the fast pace of change in the economy today, those companies that will succeed are nimble and can adapt quickly, innovate and come up with new ways to enter emerging markets. With the rise of global demand the industry will need the support of Canada s government for continued success and growth in the face of today s challeges. The following are the top 10 risks we believe the industry is dealing with today. 14 Exploring the top 10 opportunities and risks in Canada s oilsands

15 1Cost inflation The markets in general are starting to see early signs of a cost-inflation issue, which is accentuated in the oilsands due to the higher lifting costs per barrel of oil equivalent and break-even points. We see multiple factors at play in terms of driving costs depending on the oil or gas mix shown in the graph below. Here are some of the challenges companies are facing from a cost perspective: Fear of making short-term cuts that impair the company s long-term growth Governing a company that tells existing operations to cut costs, while project teams are spending Difficulty for rapidly growing (and sometimes very large) organizations to know exactly how to manage costs more effectively Fear of losing suppliers to a competing project in a seller s market The traditional boom and bust mindset when companies are forging ahead on long-term investments The paradigm that a company can t be low cost and grow at the same time Cost inflation key drivers Oil price volatility Escalating OPEX Profitability Sustained low gas prices CAPEX spend increasing, which is usually a sign of cost challenges New regional players reducing WCSB demand (Utica shale, United States) Commodity prices increasing (e.g., steel) Accelerating use of alternative energy sources (includes gas) Total shareholder return Gas oversupply (shale) Drilling rig use high, driving daily service costs up Lifting cost $/BOE of oilsands higher than conventional sources Future demand sources (NGVs, power generation) uncertain Labour shortages (talent increasing again, driving service costs up) Capital allocation Growth Uncertain global economy/ geopolitical influences North Africa and Middle East Oil Gas Trend up, down or stay Negative trend Positive trend No change WCSB Western Canadian Sedimentary Basin NGV Natural gas vehicle Source: Ernst & Young LLP Exploring the top 10 opportunities and risks in Canada s oilsands 15

16 There are a number of trends, statistics and indicators supporting the reasons we think cost will become an important issue for oilsands companies, including the following: A) Operating costs for oilsands went from $19.6/barrel of oil equivalent in 2006 to $25.5/barrel of oil equivalent in Development and operating costs for oilsands remain on the high end of the global scale. The CERI report Canadian Oilsands Supply Costs and Development Projects ( ) estimates that capital costs have declined by 3.6%, but operating costs have risen by 5.8%. CERI s supply-cost model assumes a three-year construction period for oilsands projects with construction beginning this year. Over the construction period ( ), construction and operating costs are expected to rise by 19%. B) General and administrative costs are increasing, which is evident in the graphs below. Operating cost per unit of production Traditional oil and gas only 20 Cost ($ per barrel of oil equivilant) Operating cost sensitivity to varying rates of cost inflation 10% 5% 2% Focus period Forecast Source: Canadian Association of Petroleum Producers, ARC Financial Corp. 16 Exploring the top 10 opportunities and risks in Canada s oilsands

17 Operating cost per unit of production Oilsands only Operating cost sensitivity to varying rates of cost inflation 10% 5% Cost ($ per BOE) % Focus period Forecast Source: Canadian Association of Petroleum Producers, ARC Financial Corp. General and administrative costs Total industry; per unit of production Cost ($ per BOE) Focus period Forecast Source: Canadian Association of Petroleum Producers, ARC Financial Corp. Exploring the top 10 opportunities and risks in Canada s oilsands 17

18 C) Labour costs Alberta was the only province in Canada with increased employment in February According to Statistcs Canada, in June 2011, Alberta, Ontario and Nova Scotia had employment gains of 22,000 growing by 3.5% between June 2010 and June At the same time, average hourly wages have continued to increase yearly. Since 2006, Alberta has had the highest average hourly wage rate in Canada. With increasing labour costs and the increasing difficulty of hiring strong talent now that baby boomers are retiring, oilsands operators will need to be more creative with their hiring plans, such as considering more talent from other countries around the world, and ensuring they have strong knowledge transfer, training and integration programs in place to bring new workers up to speed on processes as quickly as possible. Operating costs are susceptible to inflation, and labour and energy input costs are the primary drivers. Hourly wage rates in Alberta 26 Average hourly wage ($) Source: Government of Alberta Employment and Immigration Alberta weekly wage earnings Mining, quarrying, oil and gas extraction 2,200 Weekly average earnings ($) 2,000 1,800 1,600 1,400 1,200 1, Focus period Source: Statistics Canada 18 Exploring the top 10 opportunities and risks in Canada s oilsands

19 D) Project costs We continue to see signs of project-cost overruns, partly driven by higher labour costs, service costs (including drilling) and commodity costs, such as for steel and other raw materials. For example, the first phase of Imperial Oil Ltd. s new Kearl oilsands mine in northern Alberta will now cost $10.9 billion onethird more than the company first estimated at $8 billion. Imperial attributed the cost increase solely to a reconfiguration of the project, but some analysts suspect costs may increase further as a result of cost inflation. Overall, the per-unit cost of steel, which is the primary material input for oilsands projects, is up almost 30% from the 2010 average, but it is still significantly below the 2008 high. As crude prices increase, usually steel prices will follow. Oilsands capital cost increases Global, not just local Capital cost of 100,000 bbl/day project $3.3 billion $9 10 billion Capital $/bbl/day (upgraded) Millennium Shell/ Albian Aurora 2 & UE 1* Nexen - OPTI Long Lake CNRL - Horizon Shell Muskeg & Scotford PCA/UTS Fort Hills Production start date * Syncrude includes base plant quality improvements and power Source: Canadian Association of Petroleum Resources The per-unit cost of steel, which is the primary material input for oilsands projects, is up almost 30% from the 2010 average. Exploring the top 10 opportunities and risks in Canada s oilsands 19

20 Correlation between steel prices and oil prices Hot-rolled steel imports (US$/short ton) 1,500 1,400 1,300 Steel 1,200 Crude 1, June 01 June 02 June 03 June 04 June 05 June 06 June 07 June 08 June 09 June 10 June WTI price (US$/barrel) Current: US$763/short ton 2011 YTD avg. US$690/short ton 2010 avg. US$597/short ton 2009 low US$335/short ton 2009 avg. US$453/short ton 2008 high US$1,138/ short ton Current vs high: down 33% Current vs low: up 128% Current vs avg.: up 28% Source: Bloomberg 20 Exploring the top 10 opportunities and risks in Canada s oilsands

21 E) Drill rig use The year 2011 is shaping up to be robust in terms of rotary rig counts compared to 2010 a sign that there is service activity in the industry, which will most likely drive up service costs at a certain point. The following graphs show that there was less drilling activity during the recession in , but that activity in 2011 is returning to pre-recession levels. In fact, the Petroleum Services Association of Canada s revised forecast for 2011 is a total of 13,250 wells drilled (rig released) across Canada, representing a 5.7% increase in total wells drilled compared to last year. The Petroleum Services Association of Canada s revised forecast for 2011 is a total of 13,250 wells drilled (rig released) across Canada, representing a 5.7% increase in total wells drilled compared to last year. Canada rotary rig count Total active rigs Active rigs Rotary rig count Crude oil Crude oil prices US $/barrel (January May 2011) Sources: Baker-Hughes, Energy Information Administration (DOE), WTRG Economics F) Commodity price volatility Volatility in the commodity market is being driven by uncertainly in the global and local North American economy, especially during times of unsettlement in North Africa and the Middle East. It s also being driven by supply and demand imbalances, the influence of the Organization of the Petroleum Exporting Countries, S&P s downgrade of the US credit rating, and inventory for oil storage and spare oil production capacity. These drivers are making it very difficult for oilsands companies to manage their costs. Exploring the top 10 opportunities and risks in Canada s oilsands 21

22 Skilled labour shortages Unemployment rates continue to decline in 2011, edging towards levels when service costs escalated out of control in the industry. We expect labour availability will become an issue again, which will drive costs up in the coming year. With the large population of babyboomers retiring in the coming years, many of the skilled and qualified experts will be leaving the industry. A perfect demographic storm is developing in Alberta leading to severe worker shortages for many years to come. Thomas Lukaszuk, Alberta s Minister of Employment and Immigration, said the province is already starting to see labour shortages in some sectors, and his 2government expects to see a shortage of 77,000 workers in the next decade. Canadian unemployment rate 9.0 Unemployment rates continue to decline in Percentage of total work force Source: Statistics Canada 3The need to break into new markets Currently, the US is the largest market for Canada s oilsands. But long term, as the US begins to look for more energy self-sufficiency and renewable sources of energy, it will be important for Canada to consider other sources of demand in Asia and Europe. Being dependent on a single market is a risk as it leaves the country unprepared if its largest customer turns to a new supplier or is able to use a new product instead. A recent survey by the Asia Pacific Foundation of Canada identifies China as the second most important economy for Canada after the US. In fact, a majority of Canadians believe that the global influence of China will exceed that of the US in 10 years. Asia is leading the global economic recovery, with most Asian economies buoyed by strong exports and vigorous domestic demand. And by 2040, China will be the largest economy in the world. It is for these very reasons that we cannot underestimate the importance of this region the future prosperity of our country may depend on it. In order to supply more product to existing and new customers around the world, the industry will need to develop the proper infrastructure and access to global markets. Here are some of the challenges to consider around future demand: 22 Exploring the top 10 opportunities and risks in Canada s oilsands

23 In the US New pipeline capacity is needed from Canada to the US: Suncor Energy Inc. President and CEO Rick George says he believes energy security will be the key to the US government s decision to approve the proposed Keystone XL pipeline that will carry Canadian crude to the concentration of refineries on the US Gulf Coast. He said the crude that would travel down TransCanada Corp. s proposed Keystone XL pipeline would displace heavy crudes from Mexico, Venezuela and Saudi Arabia. 1 Large inventories in the US could mean less demand for Canadian crudes: Inventories of WTI, the US crude benchmark, continue to rise in Cushing the delivery point of the NYMEX crude oil futures contract. This is pushing down the price due to lack of transportation options from the region to the large concentration of refineries on the US Gulf Coast In Asia New pipelines and long-term contracts are needed if Canada wants to export to Asia: It s important for Canada to build long-term contracts with Asia in order to secure future demand. Canada will also need to run crude pipelines to its West Coast in order to increase its supply to Asia. Although, there is some resistance from First Nations around these proposed opportunities because of concerns that tankers off the coast could harm the habitat. The map below compares the distances for oil tankers to transport their product from various ports. Canada s West Coast is an attractive target for Asian countries because the exporting distance from its West Coast to Asia is shorter than it is from the US or the Persian Gulf which makes it cheaper for transportation. Competitive travel distances for Canadian supply Prince Rupert/Kitimat Persian Gulf South Korea China Japan Taiwan ~ 4,500 N miles ~ 8,600 N miles ~ 1,400 N miles Los Angeles ~ 1,790 N miles Santa Cruz San Jose/ La Cruz ~ 5,400 N miles ~ = approximate N miles = nautical miles Far East Target markets US West Coast Source: Enbridge Pipelines 1 Source: Reuters and Daily Oilpatch Bulletin Exploring the top 10 opportunities and risks in Canada s oilsands 23

24 4 CAPP expects oilsands production to grow from 1.3 million barrels/ day in 2009 to 2.2 million barrels/day by 2015 and 3.5 million barrels/ day by Large upfront capital investment CAPP expects oilsands production to grow from 1.3 million barrels/day in 2009 to 2.2 million barrels/day by 2015 and 3.5 million barrels/day by The capital required to achieve this production is approximately $100 billion, not including sustaining capital to maintain operations and production. Many analysts note that the annual sustaining capital and maintenance spend in the oilsands is greater than the capital for new projects. There are several challenges around capital investment affecting the industry, including the fact that oilsands development is expensive, especially in mining, where heavy equipment is used, and with in-situ horizontal drilling. Input costs are also high with the great need for water and natural gas for production. In order to upgrade extracted bitumen and turn it into synthetic crude, companies are required to use expensive upgraders for processing. Such high costs are the reason some companies, such as Canadian Oilsands Ltd. and MEG Energy are not building large, integrated projects. Instead they are keeping projects smaller, lowering the execution risk and considering the upgrader at a later point. To help save costs, many oilsands companies extract the bitumen and then ship it to another country, such as the US, for upgrading and refining. But in the longterm, this process isn t beneficial to Canada as we are exporting much of our resources for processing rather than retaining the value and associated jobs. The industry is converting US refineries to take Alberta heavy oil. These challenges may require new sources of capital from companies around the world, such as Asian national oil companies. 24 Exploring the top 10 opportunities and risks in Canada s oilsands

25 5 Changing policy and regulations Policies and regulations around fiscal, labour, environmental and export issues can be complex and overwhelming to many companies. It is not always clear to the industry where the federal and provincial government stand on items of importance, and the industry does not always have clear performance management metrics and targets. The government needs to set the direction while collaborating with industry. Recently, there have been some changes in policy that have fundamental impacts on the industry. For example, the government changed its position on income trusts, which were phased out in January It introduced a more burdensome fiscal regime under the New Royalty Framework (NRF), and the government restructured the NRF to provide incentives for companies to use new technologies. The Alberta government has created an integrated plan for oilsands environmental monitoring. The plan will be carried out in collaboration between provincial, territorial and academic scientists, and includes provisions for monitoring air and water quality in the oilsands region. The plan will give the scientific foundation the government and industry needs to ensure environmentally sustainable development of the oilsands resource. 6Complexity of tailings ponds Creating and dealing with the politics around tailings ponds, which hold waste water from oilsands processing methods, remain a challenge for the oil and gas industry. The public has been concerned over the environmental impact of such ponds. There is also emotive interest involved when wildlife is unable to survive in these areas, which has become a prominent news feature in the past. The ponds consist of a mixture of water, clay, sands and residual bitumen used to settle solids and recycle water 80%+ recycle ratio. Unfortunately, historically there hasn t been a great deal of collaboration within the industry to deal with the environmental aspects and concerns, or to return the areas to their natural state after the ponds are no longer used. At the same time, we are seeing considerable investment and research going into recycling and reducing pond size, and sharing this technology between companies will be key to ensuring the ponds are returned back to normal. Here are some of the current technologies: Consolidated tailings co2 treatment (Canadian Natural Resource Limited) Thickeners, paste/dry tailings Tailings reduction (Suncor Energy Inc.) Atmospheric fines drying (Shell Canada) Centrifuge (Syncrude Canada Ltd.) Exploring the top 10 opportunities and risks in Canada s oilsands 25

26 7Large water requirements Oilsands production requires a considerable amount more water than conventional oil extraction. This is mainly due to the viscous nature of the bitumen and the process-intensive steps required to produce synthetic crude. Despite the comparison to conventional oil, the actual usage needs to be put into context. For mining, the oilsands currently uses only 0.5% of the annual flow of the Athabasca River. In comparison, this is one-third of the amount that the City of Toronto uses. About 80% 90% of the water used by the industry is recycled, and according to the Royal Society s 2010 report, there is no impact on Athabasca water quality or its ecosystem, and no evidence of impact on human health in downstream communities. With in-situ drillable oilsands production, companies use non-potable (saline) from sub-surface aquifers. About 90% 95% of the water is recycled, and most new projects are using 100% saline for steam. 26 Exploring the top 10 opportunities and risks in Canada s oilsands

27 8 Greenhouse gas emissions One of the major challenges around GHG emissions in oilsands production is that the targets vary depending on the federal or provincial level. Without clear and aligned targets, it s difficult for the industry to make improvements. The other challenge lies in public belief. It is widely thought that oilsands production creates more GHGs than other industry, which has a negative impact on Canada s reputation. For example, it is popular public belief that oilsands production creates more pollution than coal-fired power stations in North America, but, in actual fact, this is not true and is evident in the map below. We believe this perception could be out there because oilsands production is fairly new. Managing and refining this perception will be key to profitable future growth and help companies get the social lisence they need to operate. GHG emissions from Canadian and US coal-fired power plants and oilsands operations, 2007 ~ 1,400 N Miles Legend 150 megatonnes 50 megatonnes 10 megatonnes US coal-fired power plant emissions, by state, 2007 Canadian coal-fired power plants emissions, by province, 2007 Canadian oilsands and upgrader emissions, by province, 2007 Source: Canadian Association of Petroleum Producers Exploring the top 10 opportunities and risks in Canada s oilsands 27 Source: Natural Resources Canada

28 Clearly, oilsands production does produce GHGs, but, in our opinion, much of the public s perception about the level of emissions released is not always based on fact. For example, Canada contributes only 2% of global emissions all together, according to CAPP. Of other emission-producing industries in Canada, the oilsands produces the lowest percentage of GHGs. According to the chart below, this number is 5% of the 2% of global emissions. Global emissions Canadian emissions China 21% US 20% OECD Europe 15% Non OECD Europe Other fossil fuel Conventional oil and and Eurasia 10% 5% gas production 32% Service industries Japan 4% India 5% 8% Residential 7% Oilsands 5% Canada 2% Australia/ New Zealand 2% Other 21% Agriculture 10% Transportation 22% Electricity 16% Manufacturing and heavy industry 15% GHG emissions from oilsands: 5% of Canada s GHG emissions Less than 1/10,000 of global GHG emissions Chart does not equal 100% due to rounding Source: Canadian Association of Petroleum Producers On average, oilsands GHG emissions are comparable to those produced from other sources of oil. While increased production in the oilsands is increasing GHGs in absolute terms, the use of new oilsands technology since 1990 has reduced the GHGs produced by 39%. The graph below shows that most emissions are in fact generated in the consumption stage rather than in production. Common US imported crude oils 120 g CO 2 e/mj gasoline Saudi Arabia Mexico Iraq Venezuela Nigeria Imported weighted avg. US Gulf coast California heavy Oilsands avg. Range of common US imported crude oils On a lifecycle basis, oilsands have similar GHG emissions to other sources of oil. Full cycle emissions, or wells to wheels, is the appropriate measure to use in setting carbon policies. GHG emissions from production and refining GHG emissions from gasoline consumption Source: Jacobs Consultancy, Life Cycle Assessment Comparison for North America and Imported Crudes, June Exploring the top 10 opportunities and risks in Canada s oilsands

29 9 Public relations and perception issues Many Americans are unsure of how much oil the US imports from Canada, according to a survey by CAPP. About 56% of Americans feel that currently more than four million barrels/day should come from Canada. The most common guess by Americans is that Canada provides less than 100,000 of the eight million barrels the US imports every day. The reality is that roughly 20 times that amount, or about two million barrels/day, are imported into the US. With a stronger focus on public relations, companies can better communicate the realities of the industry s GHG emissions, their effects on Canadian forests and Canada s important relationship with the US. Increasing transparency and making the public more aware of the oilsands and their significant resources are key to company and industry success. As the policymakers debate important questions about our energy security, Americans polled overwhelmingly want the administration to support greater use of Canada s abundant resources, said Jack Gerard, API President and CEO. 1 1 Source: API Newsroom Exploring the top 10 opportunities and risks in Canada s oilsands 29

30 10 Land disturbance and reclamation In cases in which companies create open-pit mines for bitumen extraction or in-situ, they clear land to build well pads and related facilities in vast boreal forest areas. There are many concerns over the impacts of this development. But after they have completed their development and production, oilsands companies are required to return the land to its original state. Today, the proportion of reclaimed land in the oilsands regions is smaller compared to the surface area disturbed through surface mining and tailings ponds, which suggests there is a lot of work to be done as the industry is still in the many stages of reclamation. There are several producers that are addressing the importance of reclamation, such as ConocoPhillips, which is piloting an aggressive reclamation processes on land used for SAGD production. Oilsands mining footprint and reclamation process Square miles Tailings ponds Surface mining Reclaimed land 0 Source: Cambridge Energy Research Associates Forecast Forecast 30 Exploring the top 10 opportunities and risks in Canada s oilsands

31 According to the map below, a total of 4,802 square kilometres of land are impacted by the mining practice, in relation to the total boreal forest area of 3.2 million square kilometres. Canadian landscape Canada s boreal forest (3,200,000 km 2 ) Land covering the oilsands (142,200 km 2 ) Land that could be impacted by mining (4,803 km 2 ) Land mined over the last 40 years (*662 km 2 ) 11% of land mined has been reclaimed * How big is 662 km 2? Area(km 2) Inner city Greater metropolitan area Source: Canadian Association of Petroleum Resources Edmonton Toronto Chicago Oslo ,418 7,125 28,164 8,900 Exploring the top 10 opportunities and risks in Canada s oilsands 31