There’s been some surprising talk over the past week about oil sands costs. Following a Bank of Montreal report, the Financial Post reported that oil sands were, “now more competitive than they used to be,” when judged against other global sources of oil production. A little further into the article comes the real kicker: The Bank of Montreal report “pegs supply costs for oil sands projects in the range of US$50 to US$90 per barrel.” Against three-digit world oil prices, these costs may seem competitive, but a look at some historical figures reveals why investors may remain nervous about oil sands cost inflation.
In October 2000, the National Energy Board published a market outlook for oil sands (pdf) to 2015. Included in their analysis was a discussion of supply costs. They reported that, “industry analysts anticipate that continuing improvements in technology and operating methods may bring operating costs [in dollars of the day] for integrated mining/upgrading plants down to $10 per barrel as early as 2004, with further improvement to the $8 to $9 per barrel level by 2015.” At that time, it seemed new oil sands plants would generate a reasonable return on invested capital as long as oil prices remained at around U.S.$18/bbl. In fact, with oil prices increasing only with inflation from $18/bbl in 2000, the NEB expected total oil sands production to reach 1.6 million barrels per day by 2015.
In 2004, as the oil sands boom started to heat up, the NEB updated their results (pdf). Costs back then were still low by today’s standards, but the integrated mining operations were seeing operating costs of $12-18/bbl and new projects needed $U.S. oil prices of $20-$30 to generate reasonable rates of return. Coincidentally, the light oil price forecast of the day had also crept up, to U.S.$24/bbl plus inflation, with oil sands production expected to reach 2.2 million barrels per day by 2015.
Jump to 2006, and the NEB was back at it (pdf). Operating costs for integrated mining and upgrading projects had jumped to $18-$22/bbl, and the NEB reported that, “integrated mining and SAGD operations are estimated to be economic at U.S.$30 to $35 per barrel WTI.” (SAGD stands for Steam-Assisted Gravity Drainage; WTI for Western Texas Intermediate, a crude oil price benchmark.) Again, the crude oil price forecast was updated to U.S.$50/bbl plus inflation, and the oil sands production forecast had been updated to 3 million barrels per day in 2015. The boom was in full swing.
By 2009, the NEB pegged the break-even price for new oil sands projects at a U.S.$55-70/bbl WTI price, and the expected quantity had been scaled back largely due to the financial crisis, to less than 3 million barrels per day by 2015. Oil price forecasts were getting still more bullish, with the NEB expecting oil prices to rise at rates faster than inflation, from — you guessed it — a little over U.S.$80/bbl.
When the NEB’s 2011 look at Canada’s Energy Future was released, oil sand production costs had risen again. It wasn’t a huge jump for in situ projects, which were still expected to earn a reasonable rate of return at WTI prices of $55-65/bbl. The break-even for mining projects, though, had climbed to $85-95/bbl if the project included an upgrader, a facility that turns bitumen into synthetic crude oil. Of course, this change yet again coincided with an expectation of increases in oil prices, which were now forecast to be $90/bbl and also outpace inflation through 2035. The growth forecast was still well below 3 million barrels per day by 2015.
The NEB has yet to release its semi-annual report for 2013 (it will likely come out in November), but the Bank of Montreal report and other recent studies cited above have shown that this trend continues. A May 2013 report from the Canadian Energy Research Institute estimated that new oil price break-even requirements would be, “$77.85/bbl for SAGD projects; $103.16/bbl for integrated mining and upgrading projects; and $99.49/bbl for stand-alone mining projects.” Oil prices were forecast to be about $95/bbl plus inflation.
If you want to know what the break-even price for new oil sands projects is (at least for the marginal project), look at the forecast of future oil prices. The break-even price will always be at or near this level as long as open-access to the resource is allowed — it’s basic economics. As world oil prices increase, the oil sands become more valuable and, all else equal would generate much higher returns. The problem, of course, is that all is not equal. High-grading means that newer facilities generally must work with lower quality, higher cost resources. Also, higher profits often translate (as they did in Alberta) into higher royalty rates. And that’s not all of the story.
In an open access market, capital will flow in as long as there are attractive returns to be had. In such a situation, resource rents are dissipated to whatever factor of production is scarce. In Alberta, that’s been primarily labour and housing. That’s not all bad of course, especially if you happen to be in a position to benefit from wage inflation in Alberta. However, consider that if operating costs had simply risen with inflation, we’d be talking about $14/bbl Alberta oil sands production today. Instead, operating costs for the same facilities that were hoping to see costs decline to $12/bbl (in today’s dollars) by 2015 are seeing costs well above U.S.$40. The answer to whether oil sands operations are more competitive than they used to be looks slightly different when you think about it that way, doesn’t it?