Oil Sands
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OTTAWA (Dow Jones Newswires), Apr. 28, 2009

Costs in Canada's pricey oil sands are starting to fall but nervous developers are still leery of giving the green light to stalled projects.

Last week, Husky Energy Inc. (HSE.T) said estimated costs for its proposed Sunrise oil sands development -- a joint venture with BP PLC (BP) -- had nearly halved to C$2.5 billion, from earlier projections of C$4.5 billion. The company is the first to provide hard numbers but there is plenty of informal chatter of cost savings within Alberta's oil sands following the wave of project cancellations and delays at the end of last year.

"We're hearing anecdotally that costs are down 20%, 25%," but Husky's new estimates provide a concrete point of reference, said Steve Fekete, a Calgary-based senior principal at consulting firm Purvin & Gertz.

Until recently, oil sands companies were pursuing projects with swollen, multibillion-dollar budgets, confident at turning a profit with crude prices above $100 a barrel. Inflation soared as companies flocked to exploit Alberta's massive crude reserve -- the biggest outside Saudi Arabia -- and by last summer, analysts reckoned that the costs for a typical oil sands project had more than quadrupled since 2003.

But when crude oil prices collapsed, so did project economics and nearly C$200 billion ($164 billion) worth of proposed developments have been affected, according to recent estimates by Merrill Lynch. Fewer projects mean less competition for a limited pool of labor, while global steel prices have slumped more than a third from last year. But most companies still need $80 a barrel crude to push ahead with new projects, and the speed of the oil price plunge is likely to render company executives much more cautious at restarting developments even after prices recover.

"There's going to be some hesitation," said Justin Bouchard, an oil sands analyst at Raymond James.

The example of Long Lake, a joint development between Nexen Inc. (NXY) and OPTI Canada Inc. (OPC.T), is the "worst-case scenario," Bouchard said. Building at the peak of the oil sands boom, the C$6.1 billion project - like nearly all others - saw several delays and cost overruns, only to start production after crude prices had crashed below $50 a barrel. The partners have since pushed back a decision to double output to after mid-2010.

Sticky Costs

And some costs are "stickier" than others. Labor was the main culprit for escalating inflation during the boom years, as companies fought over a limited pool of experienced workers and as inexperienced staff dragged down productivity rates. Costs are coming down but the savings aren't in cutting labor rates. Flint Energy Services Ltd. (FES.T), for example, is stripping out perks such as retention bonuses, while the bigger local pool of skilled labor removes the need to bring in workers from elsewhere. This will cut costs by 10%, Flint's chief executive Bill Lingard said last month, and productivity gains will save another 10%.

But persuading workers to take lower wages is tricky, and any changes in labor rates certainly haven't matched the dramatic decline in commodity prices.

Enbridge Inc. (ENB) Chief Executive Pat Daniel noted on a recent conference call that labor rates "have not changed, and generally...don't tend to come down all that much."

He added: "We have seen a fairly significant change in productivity...[as inexperienced people] have been pushed out of the workforce."

However, these cost savings can only benefit companies if projects go ahead. Imperial Oil Ltd. (IMO) -- majority-owned by cash-rich supermajor ExxonMobil Corp. (XOM) -- is still keen to proceed with plans for its Kearl oil sands mine, unlike many of its competitors.

Other companies are hoping to lock in lower prices by renegotiating and rebidding contracts during the downturn. Suncor Energy Inc. (SU), among others, has noted greater bargaining power with contractors that have seen work suddenly dry up. But these savings may evaporate if companies restart projects at the same time, kicking off the inflationary spiral once more as too many developments compete for too few workers.

"There are so many projects waiting to be built...and everyone is very aware of how tight labor is," Raymond James' Bouchard said. "That's going to put a damper on how quickly these projects get going again."

In the meantime, companies with existing output are focusing on lowering operating costs. Suncor has already seen costs fall and is targeting further cuts of up to 15%, CEO Rick George said last week.

"For the oil sands in general, operating cost reductions are largely achieved by improving reliability," said Chris Feltin, a vice president at Tristone Capital Corp. "That's what Suncor is aiming for - ensuring that they're running their operations as smoothly as possible."  

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