Oil sands producers settle into a new price paradigm
Rising prices are good, until they're not
Illustration by Anthony Tremmaglia
This spring, with Canadians grumbling about gasoline prices that had risen to $1.50 a liter and more in some locales, Industry Minister Tony Clement of the normally pro-business Conservative government announced he was going to bring in oil refiners, distributors and retailers to explain why gas prices were so high. “At a time when household budgets are already tight,” Clement said at the time, “Canadians want and deserve answers about high gas prices.”
It was tough talk that amounted to little more than political posturing by Clement. After all, gas prices were rising because a barrel of West Texas intermediate (WTI) crude oil was hovering between US$100 and $110 as the markets fretted over political unrest in the oil-rich countries of North Africa and the Middle East. Refiners, distributors and retailers had little control over the events of the so-called Arab Spring and the Tory cabinet minister knew it.
Clement’s bluster aside, there is little doubt the high price of black gold has given the Canadian oil patch a needed boost after it endured a difficult 2008 and 2009 during the recession. But continued escalating prices for oil might not be in its best interest. “I think people in the oil industry probably do worry that if you have really big increases in oil prices, it could very well dampen demand and encourage a shift into biofuels and renewable energy,” says Patricia Mohr, a Scotiabank economics and commodity markets specialist.
What constitutes the optimum price of oil – one that generates acceptable rates of return for the industry but also isn’t so high that it encourages a switch to other fuel sources – can vary depending on the region in which a company operates and the type of play in which it invests. But this “sweet spot” has been going nowhere but up since 1998.
A look at historical spot prices for WTI deliveries at Cushing, Oklahoma, from 1978 to 2007 shows that producers had to be content with prices in the US$20 range from 1986 to 1998. However, since that time the price has gradually edged upward to where $50 or $60 oil seems cheap. In Canada, Mohr thinks US$90 to $100 is the latest sweet spot. “At the $90-per-barrel mark, most of the Alberta oil sands projects are economic, although that depends a great deal on technology,” Mohr says.
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With prices currently sitting at that level and organizations like the U.S. Energy Information Administration (EIA) forecasting oil prices to reach US$125 per barrel by 2035, Canadian oil production projections are increasingly robust. The Canadian Association of Petroleum Producers’ (CAPP) 2011 Crude Oil Forecast and Market Outlook predicts Canada will pump out 4.7 million barrels per day by 2025 compared to 2011 production of 2.9 million barrels per day. Of the 4.7 million barrels, 3.7 million is expected to come from the oil sands.
But the rub is that while high oil prices can dampen demand and stall economic growth, they are also a necessity if production in Canada is going to reach the levels predicted by CAPP. That’s because there is little “easy” oil left to extract in the Great White North. Growth in oil production hinges on increasing the haul from technically difficult and expensive resources – Alberta’s oil sands, heavy oil and “tight” oil trapped in old Western Canadian Sedimentary Basin (WCSB) reservoirs.
In CAPP’s recent forecast, it predicts production from conventional sources will be one million barrels per day in 2015 and will still be sitting at 700,000 barrels per day by 2025. Yet wringing that many barrels from conventional plays like the Bakken, Cardium and the Shaunavon requires using unconventional extraction techniques that weren’t in vogue in the WCSB even five years ago – namely horizontal drilling and hydraulic fracturing. “That horizontal multi-frac drilling does require a higher oil price because there are higher upfront costs,” says Canaccord Genuity energy analyst Kyle Preston. “Anything over $80 still generates a very strong return in most of these plays. But if you get down to the $50 or $60 level, some of the economics on these wells might be questionable.”
While the U.S. banking crisis had much to do with the financial meltdown that gripped the globe in 2008 and 2009, volatile oil prices that got as high as US$147 per barrel in July of 2008 also played a part in the economic collapse. The recession ultimately shelved much of industry’s grand development plans for the oil sands. But the high price of oil has resulted in those plans being dusted off once again. Yet there are signs the upward spike in the price of oil is threatening the global economic recovery, particularly in the U.S. – the largest crude oil market in the world.
Scotiabank’s Mohr says petroleum consumption has slowed in the U.S. as consumers in states like California, New York and Massachusetts cut back on discretionary driving in the face of gas prices between US$3.70-$3.90 per gallon. In June, the EIA reported that the average price of gasoline was US$0.91 higher than it was at the same time last year. How high does the price have to rise past the current sweet spot to send economies into another economic tailspin? “As oil prices move higher and all sorts of other products become more expensive, there does come a time when you do see some kind of demand destruction,” Preston says. “But where that number is – $120 or $140 – is tough to predict.”
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