Friday, November 23, 2007
Athabasca has a problem.
In terms of proven reserves, Canada's tar sands, which hold 179 billion barrels of oil, rank second only to Saudi Arabia, with 262 billion barrels. In fact, Canada's reserves could grow to more than 300 billion barrels, surpassing the kingdom's oil fields.
But oil producers can reach just 7% of the reserves by mining, the traditional means of extracting bitumen. In other words, at best, Canada's minable proven reserves only equal the total reserves of Argentina – about 2.1 billion barrels.
The other 298 billion barrels need to be pumped out. But trying to pump thick, tarry bitumen is like trying to suck Crisco through a straw. So, you see the problem...
Fortunately, tar sands, again like Crisco, melt in heat. So tar-sands producers have taken to pumping steam into their wells to draw out liquid bitumen.
The solution may sound simple, but it's not cheap. Tar-sands production requires about three thousand cubic feet (mcf) of natural gas to generate a barrel of upgraded bitumen. With natural gas prices at roughly $8 per mcf, tar-sands producers spend about $24 on natural gas for each barrel of bitumen. Natural gas is their single-largest cost. But that's not all...
Alberta's provincial government has just jacked up taxes on energy companies operating there. At $14 oil prices, nobody really cared about tar sand. To lure companies into the region, Alberta set up an attractive royalty system: 1% royalty on oil production until a company recouped its capital investment, then 25% afterward.
All that recently changed.
Tired of seeing oil companies "raking in" cash, Alberta's premier created a new royalty regime... Now Alberta will charge royalties on a sliding scale. When oil sells for $40 a barrel, the royalty equals 1%. It climbs steadily until it reaches 9% at $120. Once an energy company recoups its capital costs, another sliding scale kicks in, this one beginning at 25% (when oil is $40 a barrel) and ending at 36% at $120 a barrel. While a few percentage points doesn't sound like much, it can greatly affect a company's capital budget.
Now, here's the kicker...
The natural gas industry will take the hardest hit, with royalty rates ranging from 5% up to 50% when natural gas prices hit $17.50 per mcf. In fact, oil sands giant Canadian Natural Resources said it would cut 40% of its natural gas drilling for 2008 because of the increase.
That means even higher prices for tar-sand companies that depend on natural gas to pull oil out of the ground. All this is adding up... Canada's National Energy Board estimates that capital costs for tar-sands projects have risen by 40%-50% over the past two years.
I see high costs and Alberta's harsh new legislation having two effects: First, they will create a moat for established oil sands producers. Investment will slow when new players see that they have an extra 5% or so in costs to recoup... Second, they will add another "push" to find oil in other unconventional areas, like in deepwater deposits and unsavory countries.
As one of my friends in the oil business remarked the other day, "Haiti isn't looking so bad..."
Yen and Euro rally... Japanese yen and euro ETFs hit new 52-week highs.
Semis follow the market down... AMD, Applied, and Altera at new lows.
Airlines sink... New lows for AirTran, JetBlue, US Airways, ExpressJet.