Over a barrel

Andrew Nikiforuk
Canadian Business magazine
February 12, 2007

Within 10 years, Alberta's tarsands could become the single largest source of new oil in the world. Given rising political unrest or aggressive state capitalism in Russia, Nigeria, Venezuela and the Middle East, the tarsands have simply become the globe's safest oil investment. Even a U.S. congressional committee recently called the oilsands "a new force in the world oil market" and concluded that they offered two investment rarities: large volumes and "secure access."

Boasting reserves (174-billion barrels) second only in size to Saudi Arabia, the tarsands have placed Canada in the remarkable position of holding nearly 60% of the investable oil reserves in the world. This explains why Imperial, ExxonMobil, Shell, Total and other energy multinationals have committed nearly $100 billion in a feverish rush to build as many as 51 projects in the sands over the next decade. Not surprisingly, stocks in 10 major firms with key tarsand investments gained a whopping 370% in value between July 2003 and April 2006. "In the big picture, deepwater oil and the oilsands are the only game left in town," says CIBC chief economist Jeffrey Rubin.

As a consequence, this powerful industry now produces nearly half of the nation's oil supply, provides the U.S. with nearly 16% of its oil imports--and will soon crown Canada as the world's fifth- or even fourth-largest oil producer. In the process, the tarsands will generate nearly $51 billion in income for the federal government and $44 billion for the province of Alberta between 2000 and 2020. No wonder Prime Minister Stephen Harper happily refers to Canada as an "energy superpower" and U.S. Energy Secretary Samuel Badham contentedly reports that "the hour of the oilsands has come."

But how long will that hour last? Certainly, the world's largest capital project will not only alter the course of Canada's economy, but will dominate business news for years to come. And yet, as global interest in the resource heightens, investors and taxpayers alike have begun to ask hard questions about costs, carbon emissions, infrastructure and other hidden liabilities. The following key issues may dramatically alter or slow the pace and scale of the tarsands.

The World's Most Expensive Oil

Although industry marketers prefer the term oilsands, bitumen is not oil. This heavy, viscous hydrocarbon, which according to the Book of Genesis helped glue the Tower of Babel together, is really tar trapped in sand and clay. As a heavy chain of carbon-rich atoms that are high in sulphur content, bitumen takes a lot of money and energy to upgrade to synthetic oil. In fact, raw bitumen can't even be moved in pipelines without using expensive light oils as a transport fuel. "You know you are at the bottom of the ninth when you have to schlep a tonne of sand to get a barrel of oil," says the CIBC's Rubin.

The cost of extracting the gooey stuff continues to unsettle rational economic minds. Neil Carmata, Petro-Canada's senior vice-president for oilsands, recently opined that the price tag for an open pit mine plus an upgrader climbed from $25,000 to between $90,000 and $110,000 per barrel in the past decade. Given that investors used to spend no more than $1,000 on infrastructure to remove a barrel of conventional oil a day, Houston-based energy investment banker Matthew Simmons of Simmons & Co. International observes that "energy's pricing committee" has truly flunked in the tarsands.

Chronic labour shortages combined with persistent government failure to sequence projects, has led to staggering cost overruns. When Shell Canada admitted last July that its $7.3-billion expansion plans for its Athabasca project (it currently produces 155,000 barrels a day) could swell to $12.8 billion, U.S. energy analyst Bob Gillon of John S. Herold, Inc. responded with a "My Lord in Heaven....we are getting these things back to where the economics...are going to get skinny in a hurry." Estimates for Petro-Canada's Fort Hill's project--a planned 170,000-barrel-a-day mine plus an upgrader--now range as high as $19 billion. Given that the richest tarsands leases are already being exploited, the Petroleum Technology Alliance Canada, a Calgary-based research group, warned last year that declining quality of the resource means "capital intensity is likely to continue to increase."

Yet cost overruns (like carbon intensity) define the character of unconventional oil. Rubin even advises investors to get used to persistent markups. He argues that the development of non-conventional oil just means spending more money. (Gulf of Mexico drilling comes with 400% increases, for example.) "What investors have to remember is that in a world of depleting conventional supply, higher costs and delays simply equate to higher crude prices," he says.

The Infrastructure Deficit

The Alberta government has approved one tarsands project after another with nary a thought about public infrastructure in the past decade. As a result, the city of Fort McMurray and the Regional Municipality of Wood Buffalo (RMWB) face an alarming $1.9-billion infrastructure deficit. The region not only reports a dangerously critical shortage of health care and police services, but also unaffordable housing, rampant social problems and water-treatment woes. Rents are so high that most hospital staff require subsidized housing. "Our quality of life is deteriorating," Bill Newell, RMWB regional manager, reported to the oilsands Multi-stakeholder Committee, a government-appointed group examining policy options for the oilsands, last fall. While former Alberta premier Peter Lougheed calls the social chaos "a mess," John Lau, CEO of Husky Energy Inc., has repeatedly warned that the infrastructure deficit has become an impediment to further investment. "The government has not really put a thinking cap on how and what they are going to do," Lau told the Calgary Herald.

Short of a moratorium, a recession or staggered project approvals, the region's infrastructure crisis will simply accelerate. After approving another $4-billion project last December, Alberta's Energy and Utilities Board, the industry regulator and the government of Canada warned that "growing demands and the absence of sustainable long-term solutions must weigh more heavily" in future decision-making.

Reclamation Liabilities

The tarsands lie in deep and shallow deposits underneath roughly 23% of the province of Alberta. About 20% of these reserves (3,000 square kilometres, or three times the size of New York City) can be strip-mined with shovels and trucks, but the vast majority of deposits require thermal operations that drill and inject steam or heated solvents deep into the ground. The area currently leased for underground operations will create "an industrial sacrifice zone the size of Vancouver Island," according to the Pembina Institute, a Calgary-based energy watchdog.

To build a strip mine, a company must cut down hundreds of thousands of trees, uproot wildlife, change entire watersheds and drain fens and bogs. According to Alberta law, these industrial wastelands and accompanying tailings dams must be reclaimed or restored into some semblance of the original forest. But it's a policy fraught with uncertainties, unknowns and growing risks.

Although mining operations have already disturbed 42,000 hectares of land and have been active for 30 years, not one hectare has been certified as restored to its original state by the Alberta government. Incredibly, the province hasn't updated its oilsand reclamation graphs since 2003, and says its guidelines and policies are still "currently under development and review."

Nor can companies talk about reclamation without employing Orwellian rhetoric. Chris Jones, the chief operating officer of Albian Sands Energy Inc., owner of the 155,000-barrels-per-day Muskeg River Mine north of Fort McMurray, told a public meeting last year that his firm hoped to restore its moonscape to "maintenance-free, self-sustaining ecosystems with a capability that is equivalent to pre-development conditions. This does not mean that every hectare will be identical to pre-disturbance conditions."

The fact remains that no one has ever remade a boreal forest before. Even the National Energy Board doesn't know "if land reclamation methods currently employed will be successful." A 2003 scientific workshop on "Creating Wetlands in the Oilsands," held in Fort McMurray by a largely industry-based stakeholder group (the Cumulative Environmental Management Association) complained that this "entire mining process" was being allowed "to proceed with little real knowledge...of how it will be reclaimed." Alberta's Mining Liability Management Program remains a draft document, and criteria for managing mine waste still haven't been established. Last November, Alberta's Energy and Utility Board (AEUB) acknowledged that the current security program for toxic tarsands waste "does not require a deposit or the posting of security with respect to total project liabilities and that work is underway to address shortcomings of the existing program." (For more than $100-billion worth of investments, the Alberta government holds only $356 million in reclamation bonds.) The AEUB, in a joint review panel with the government of Canada, also described reclamation as a "key regional issue with uncertainties that require adaptive management for resolution." In plain English, tarsands reclamation is one big experiment, with no guarantee of success.

Production Hype

Just about everybody, from Uncle Sam to the Chinese, has bet on the tarsands to offset conventional declines. On its energy website, the Alberta government even highlights an optimistic Time magazine article boasting that the oilsands "could satisfy the world's demand for petroleum for the next century." Cold reality, however, does not support such claims.

Consider a series of popular production forecasts now being seriously hampered by the region's infrastructure backlog. Canada's National Energy Board predicts that oilsands production could jump from 1.1 million barrels a day to three million barrels a day by 2015. Prime Minister Harper is even more bullish and predicts "nearly four million" by 2015, while some Alberta groups are talking about three times that amount--or 12-million-a-day output by 2030. Both the Canadian Association of Petroleum Producers and the Canadian Energy Research Institute believe four million barrels a day might be possible by 2020 if environmental and labour challenges don't tar up the works. That's still only 4% of the world's forecasted oil supply in 2025.

At a recent Boston meeting on peak oil, Dave Hughes, a Calgary-based energy specialist with Natural Resources Canada, argued that none of these forecasts will live up to the hype due to the complex and energy-draining process of turning tar into oil. He defined the big stumbling block as a delivery problem. While noting that the oilsands are a "Great White Hope of a panacea to support business as usual," he added that "forecasts do not live up to the hype."

Given existing investment levels of $90 billion, Hughes told Canadian Business that he'd be very surprised if oilsands production could exceed 2.8 million barrels a day. To reach four million barrels a day would likely require an additional $110 billion in investment. "The oilsands should be viewed as a marginal interim supply that serves as a bridge to prepare for a less energy-intensive future," warns Hughes.

Since 1850, the world's population has increased fivefold, while per-capita energy use has increased eight times, says Hughes. The world now uses 43 times the energy used in 1850, and nearly 90% of it comes from non-renewable sources, such as oil, gas, coal and uranium. "Those levels can't continue," says Hughes.

Even the U.S. Congress has its doubts. In its 2006 report on the tarsands, chaired by Jim Saxton (Republican, New Jersey), it acknowledged that the resource can't be developed rapidly enough to achieve real energy independence for North America. Just to replace Persian Gulf imports alone would require sucking up all of Canada's projected crude production by 2016: 3.8 million barrels. "North American energy independence thus would require a dramatic ramp-up in oilsands production far beyond any of the current projections," concluded the report. Yet last January, an oilsands Experts Group Workshop directed by Natural Resources Canada and the U.S. Department of Energy supported a "fivefold expansion" of the oilsands within a "relatively short time."

The Royalty Ruckus

Ever since oil prices catapulted beyond US$50 a barrel, oil-producing nations have either raised their royalties or nationalized the resource. But not Alberta. In 1996, the provincial government introduced a standard 1% royalty regime that predictably resulted in an explosion of industry investment and corresponding infrastructure woes. The bargain-basement royalty regime, which has been roundly criticized by citizens but defended by industry, remains at 1% until a project has recovered the cost of construction. Cost overruns also delay any increases.

Even the Canadian Association of Petroleum Producers, a defender of low royalties, ranks the tarsands regime in competitiveness as 79th out of 324 world royalty regimes. (In contrast, Alberta's conventional oil royalties rank somewhere between 209 and 258 out of 324.) The CIBC's Rubin doesn't think Alberta's royalty giveaway can last much longer. He points out that Venezuelan president Hugo Chavez "had a similar subsidy for the Orinoco tarsands," but quickly abandoned it given the economics of oil prices.

Alberta's current payout also applies to bitumen rather than upgraded oil. The general price for bitumen (a product with an ill-defined market value) is generally half of that posted for West Texas Intermediate, a fact most Albertans don't recognize. "Small wonder we are seeing so many oilsands companies proposing upgraders," Ian Urquhart, a University of Alberta political scientist, noted at a public meeting on the tarsands last year. "They will pay royalties on bitumen and then sell the final product at roughly twice the price."

Although Alberta's generous royalty system has increased corporate income at an annualized rate of 42% between 1999 and 2006 for a total increase of 440%, it has not enriched provincial coffers. According to the Pembina Institute, Alberta tarsand royalties declined by 32% between 1996 and 2005.

Alberta's new premier, Ed Stelmach, has promised a full and transparent review of the outdated royalty regime this year. And few doubt that the province will eventually insist on a higher and fairer share of tarsands wealth. "But even with a more aggressive royalty structure, Alberta remains company-friendly," says Rubin. "The companies have no other place to go."

The Natural Gas Pit

At one time, the oilpatch used one barrel of conventional oil to find 100 more--a tidy energy profit ratio. The tarsands, a thoroughly unconventional product, make a mockery of such accounting and boast a net energy intensity two to three times that of conventional heavy oil. As a consequence, it now takes the energy equivalent of one barrel of oil to create two barrels of oil from the tarsands.

Much of this energy comes from natural gas, a relatively clean fuel used to steam up the tar or upgrade the carbon-heavy pitch into a marketable product. According to a 2005 report by the Pembina Institute, the industry daily consumes more than half a billion cubic feet of natural gas, or "enough to heat 3.2 million Canadian homes per day." (In 2006, industry consumption actually surpassed a billion cubic feet daily and partly accounted for falling gas exports to the U.S.) By 2012, the tarsands will burn enough natural gas each day to heat every home in Canada.

Given that experts say Canada has only a nine-year supply of proven natural gas reserves left (undiscovered and unconventional reserves might extend that timeline, but with large environmental costs), former Alberta premier Peter Lougheed has described the natural gas addiction in the tarsands as a waste of a "valuable resource." Houston investment banker Simmons, author of Twilight In The Desert (a look at Saudi Arabia's dwindling oil reserves) is even more blunt: "If I were a Canadian, I'd make it illegal to use precious natural gas and potable freshwater to turn gold into lead in the tarsands." His recommendations for policy-makers are equally stark: go slow, charge for water, cap tarsands production and "find some other way to produce this atrocious resource other than using scarce natural gas....To get more addicted to the tarsands doesn't make any sense to me."

Although alternative sources of energy are being developed (such as burning bitumen or coke to create gas as a fuel source), most are more carbon-intensive, with the exception of nuclear energy. To replace natural gas use in the tarsands with nuclear power would require nearly a decade of planning, hellish political controversy and as many as 16 Candu 6 reactors. Yet Gary Lewis, a tarsands engineer and member of Fort McMurray-based Environmentalists for Nuclear Power, argues that such a change would "reduce CO¸ emissions in accordance with Kyoto and not harm gas and oil production in Alberta."

The Water Wall

The tarsands drink water unlike any other petroleum resource in the world. It currently takes two to five barrels of water to wash two tonnes of sand and clay in order to make one barrel of oil. Each year the industry withdraws enough water from the Athabasca River to service two cities the size of Calgary. That consumption could soon double, with significant consequences for the entire Mackenzie River Basin, a region already experiencing accelerated drying from climate change. Shell's Albian Sands project, for example, needs 55 million cubic metres of water every year--the equivalent of about 30,000 Olympic-sized swimming pools--and will "contribute to reductions in available fish habitat," according to the federal Department of Fisheries and Oceans. Even the National Energy Board, an agency not know for its environmental rhetoric, has repeatedly warned that the limited amount of water available in the Athabasca River "could be a constraint on future expansion plans." After seven years of study, the Alberta government has failed to establish how much water the threatened river needs to support fish.

Nearly 90% of the water withdrawn from the Athabasca River ends up in toxic tailings ponds the size of small lakes in Ontario's cottage country. These toxic lakes currently cover 50 square kilometres of forest and could fill Lake Erie up to a depth of 20 centimetres in toxic waste. Until China completes its Three Gorges dam in 2008, the world's largest dam (in volume) will remain Syncrude's Tailing Dam, the U.S. Department of the Interior reports. It holds 540 million cubic metres of water, heavy metals, bitumen and sand. It's also an 18-kilometre-long holding tank for such fish killers as naphthenic acids and polycyclic aromatic hydrocarbons. The National Energy Board calls the management of these toxic lakes "daunting," while the Alberta Chamber of Resources, a group representing mining and logging interests, has concluded that "current practices for long-term storage of 'fluid' fine tailings pose a risk to the oilsands industry." Even the business-friendly Petroleum Technology Alliance Canada calls the large tailings ponds "a major concern for the long-term protection of the Athabasca River and downstream water users." Aboriginal groups representing scores of First Nations communities downstream have repeatedly called for a moratorium on further water withdrawals.

The Carbon Cauldron

A variety of analysts and critics have called climate change a pirate ship in the fog for the tarsands industry. In 2000, the tarsands produced 23 megatonnes of greenhouse-gas emissions. (The mines smoked out 80 pounds of carbon per barrel, while underground thermal operations produced up to 160 pounds per barrel.) By 2015, the industry will likely produce 108 megatonnes. According to the Pembina Institute, the oilsands currently represent the fastest-growing point source of carbon emissions in Canada. By 2020, emissions could rise as high as 141 megatonnes. "I think the CO¸ issue will be the real issue for these guys at the end of the day," says CIBC chief economist Rubin.

Thanks partly to rapid tarsands development, Canada has the third-most-energy-intensive and fourth-most-carbon-intensive economy in the 25-member Organization for Economic Cooperation and Development (OECD). In 2006, the environment commissioner, in the office of the auditor general, found widespread confusion, uncertainty and "inadequate leadership, planning and performance" in Canada's climate-change response. The program to reduce pollution among 700 companies, including tarsands operators, the so-called Large Final Emitters System, has so far failed to reduce overall emissions let alone report in a "real, measurable and verifiable" manner, said the environment commissioner. As she noted, Canada's carbon clouds are 26.6 larger than than they were in 1990, and fall way below Kyoto targets. Even the U.S. Energy Information Administration concluded in its "2006 Country Analysis Brief" that Canada's carbon-loving ways are a political liability and have "led to serious environmental concerns, primarily regarding air pollution and climate change."

Oil exports driven by tarsands production have also played a major role in rising carbon levels, Environment Canada reports. Between 1990 and 2004, oil exports grew by 513%--or almost 10 times the rate of growth of oil production. As a result, the amount of carbon due to net oil or gas exports grew from 22 megatonnes in 1990 to 48 megatonnes in 2004.

Alex Farrell, an energy expert at the University of California in Berkeley, notes that the transition from conventional sources to increasingly lower-grade products such as what is produced from the tarsands ultimately comes with "increased risks of environmental damage, as well as other risks." Farrell calculates the tarsands produce anywhere between 30% to 70% more carbon emissions than conventional oil. In the absence of any policy to control those emissions, he says, petroleum buyers may soon ask: "Are we responsible for those emissions, and do we want to buy that fuel?" In fact, Republican Gov. Arnold Schwarzenegger, in the trend-setting state of California, is already demanding low-carbon fuels.

For the world's newly emerging low-carbon marketplace, tarsands companies plan to bury carbon in old oilfields, as well as trade emission credits overseas. Shell's Albian Sands project has already announced that it will reduce carbon emissions by 50% by 2010. Nuclear power is also seen as a carbon-reducing tool. But in a carbon-restrained world, Rubin, like other analysts, asks who will profit most: "The shareholders of tarsand companies or the owners of emission credits?"

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