Oil sands catches break from recession

Shawn McCarthy
Globe and Mail
Friday, Jul. 17, 2009

The current slowdown could prove a boon for Canadian oil sands producers, driving down construction and operating costs and giving time for the development of infrastructure needed for the industry's growth.

Signs of a thaw are already appearing, half a year after several companies shelved their most ambitious expansion plans amid diving crude prices and a breakdown of financial markets.

Smaller oil sands companies, including Canadian Oil Sands Trust (COS.UN-T27.230.220.81%) and Petrobank Energy and Resources Ltd. (PBG-T35.020.471.36%), have been able to raise debt and equity financing to finance their operations.

And larger companies are taking advantage of the hiatus to re-engineer their projects in order to drive down costs and incorporate the latest environmental technologies.

The latest vote of confidence in the industry comes from U.S.-based rating giant Moody's Investor Services, which six months ago cited large increases in debt and declining oil sands economics in downgrading Nexen Inc. (NXY-T21.85-0.60-2.67%) and Suncor Energy Inc. (SU-N31.71-0.04-0.13%).

In a report yesterday, Moody's said the oil sands sector will prosper but at scaled-back and more sustainable levels. Moody's also expects smaller, financially weaker companies to be acquisition targets, as the industry is set for further consolidation.

"The way development was going on there, at such a breakneck pace, was not sustainable," Moody's vice-president Terry Marshall said in an interview yesterday.

"So we've had this big pullback and a lot of projects deferred or cancelled; but I think that enables the industry to step back, take a harder look at what they're doing and move forward on a much more measured basis. So we'll have a more steady growth over a longer period of time."

Oil sands producers faced increasing bottlenecks in accessing pipelines and a lack of refining capacity at the height of the boom last year. A moderate development schedule will allow time for pipeline companies to complete their expansions, and refiners to reconfigure their plants to handle the Alberta bitumen.

Suncor expects its capital costs to decline by as much as 20 per cent from the peak of 2008 when it resumes oil sands expansion after its merger with Petro-Canada, which is expected to close this fall.

"Material costs are down - steel for sure," Suncor spokesman Brad Bellows said. "And labour costs are easing. If there is a continued slower pace in the industry, then that takes some of the overtime out of the equation, and productivity will also increase."

Despite uncertain economics and the prospect of burdensome environmental regulations, investors will continue to value oil sands companies because they offer massive, long-life reserves in a stable political climate with close proximity to the largest market in the world.

Moody's expects further consolidation in the industry.

"Low oil prices, steep declines in stock valuations and limited capital for oil sands development have created a ripe environment for mergers and acquisitions [M&A]," its analysts said in the report.

However, companies will approach M&A opportunities cautiously, given the volatile nature of the commodity and financial markets.

Greg Stringham, vice-president at the Canadian Association of Petroleum Producers, said Moody's outlook is consistent with CAPP's own cautiously optimistic view of oil sands development.

At the height of the boom, CAPP said oil sands production would grow to 3.5 million barrels a day by 2015. It has since revised that forecast to between 1.9 million and 2.2 million barrels a day.