One of the biggest challenges the oilfield services (OFS) sector must face in the short and medium term is adjusting to the reality that construction of new or “greenfield” major oil sands exploitation projects has all but ground to a halt. This has been a major driver of investment, employment and expansion for OFS and a myriad of support industries for over a decade. Having this important element of Canada’s economy in general, and OFS in particular, disappear will force painful adjustments. It is hard not to feel the jar is at least half empty.
But if you study the figures, the jar is also half full. As global capital expenditures on new oil and gas supply plummet worldwide, production of oil sands will grow by a third over a five-year period from 2.3 million barrels per day (b/d) last year to almost 3.1 million b/d in 2018. While the party appears to be over for Fort McMurray, Bonnyville, Cold Lake and other major bitumen mining and thermal bitumen support centers – and major fabrication and distribution hubs in and around Edmonton like Nisku, Leduc and Sherwood Park – there are many oil producing communities across North America who would love to have “Fort Mac’s” problems. Take Williston, North Dakota for example, which has gone from boom town to ghost town.
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Growth in oil sands output for the next few years is based on multi-year projects currently underway or near completion. Esso Kearl’s 100,000 b/d phase two, for example, came on stream earlier this year. Suncor’s massive Fort Hills project will be done in late 2017 and is designed to contribute 180,000 b/d to 2018’s output. Conoco-Phillips at Surmont started injecting steam this year and this expansion will add 118,000 b/d when fully operational. Husky Sunrise began producing this year and it will contribute another 60,000 b/d. Canadian Natural Resources Limited’s next expansion at Horizon which is currently underway will ramp up output well beyond the 137,000 b/d the first phase has already achieved. Related: The End Of The Oil Major?
To an industry grown accustomed to big bucks, big numbers and a “pick a number” supply chain that has had things really good for a long time, this doesn’t mean much. Everybody’s too busy feeling sorry for themselves to understand what this really means. I’m really thirsty. The jar is half empty. What now?
The reality is, the half full portion of the jar is going to quench the thirst for economic activity for a lot of people and companies. These are big numbers. The 756,000 b/d in scheduled oil sands output growth is greater than the recent output of OPEC members Ecuador, Libya and Qatar. This is substantially more than the total daily production of any of Canada’s largest producing companies. Any Canadian exploration and production (E&P) company reaching 100,000 b/d – the output of just one of the larger projects – is considered very successful.
As Canada’s oil sands ramps up to over 3 million b/d, the OFS support sector to keep it all running must expand as well. The Canadian Association of Petroleum Producers recently released its 2014 E&P operating cost (OPEX) statistics and, for the fourth consecutive year, oil sands led the way as the largest recipient of revenue spent by producers to keep production on stream.
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In 2014, oil sands operating costs were about $24 billion and this is expense is not included in capital expenditures (CAPEX). In the past 17 years, oil sands OPEX has risen over 1,500 percent from $1.65 billion in 1998. OPEX includes expenses for operating company-owned facilities (there is no third-party field processing of mined or thermal bitumen), E&P production staff and major inputs like natural gas. There is no granularity provided on how much of this massive pie goes into the pockets of third party OFS vendors. However, oil sands have high cost production meaning more money is spent per barrel than most other crude types. While this may not be great for the producer, it’s good business for the support infrastructure.
Go to any of the communities supporting oil sands production and you’ll find hundreds of companies and thousands of workers employed by oil sands producers to keep the operations going, the oil sands flowing, and the lights on.
With commodity prices down, vendors can expect pricing pressure from clients to help them manufacture a margin from existing production. But unlike OFS companies supporting drilling operations, this business has not disappeared entirely. In fact, with producers determined to slash operating costs as much as possible, vendors with good ideas to help their clients work more cost-effectively by outsourcing essential functions they currently perform themselves will likely be met with open arms. The percentage of OPEX revenue available to efficient third party contractors is likely to grow under current market conditions.
The OPEX pie will grow as well. With output rising by one-third and even with market-driven vendor price reductions and continued low natural gas prices, it is not unreasonable to see oil sands OPEX heading for $30 billion a year by 2018.
3 Reasons Oilfield Services Are Strong in Oil Sands
There are three other positive elements to oil sands production nobody talks about enough which are significant assets to the myriad of companies supporting this massive industry.
The first is production decline rates. Whatever the oil sands may or may not be in a world increasingly concerned with the carbon footprint of its energy sources, oil sands output is flat relative to high-decline oil production such as light tight oil (LTO). Most oil sands projects will have the same output in 10 or 20 years as they have today. In fact, with efficiency gains and technological advancements, output could rise from the same plant. This “debottlenecking” has taken place at Suncor and Syncrude which have enjoyed increased output at lower costs from their legacy assets for decades.
Without continued drilling, LTO producers are going to be liquidating their asset base at an alarming rate. They are producing whatever they can to stay in business and service debt but many don’t have sufficient profit on every produced barrel to drill the next well to sustain production and reserves. Oil sands producers don’t have to do that. Obviously many have balance sheet constraints and all have equity capital servicing obligations, thus they would like to make more money. But most oil sands production is owned by larger producers with deep pockets. Many of the small, capital constrained outfits that have tried to play the oil sands game started having financial problems long before world oil prices collapsed.
The second is oil sands plants are not easy to shut-in, even temporarily. This was evident in the 1980s when Suncor and Syncrude lost money on every barrel they produced which forced them to examine every facet of their operations to cut costs while waiting for prices to recover. Nobody is happy producing high cost (relatively speaking) oil sands at or near current low oil prices. But they’re not going home either, meaning OFS has a chance to work with clients to find ways to create win-win long-term business relationships. Obviously North America’s low natural gas prices will likely protect oil sands producers from price pressure from this major input expense. Related: Can The Oil Industry Really Handle This Much Debt?
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The third is sustaining CAPEX, money required to maintain facilities and de-bottleneck existing operations. The CAPEX declines and project cancellations we read about are primarily for greenfield projects, not money spent to sustain or enhance current operations. In a research note to clients on September 1, 2015, ARC Financial VP Research Jackie Forrest wrote, “Even if the construction of greenfield oil sands facilities slows to a trickle, expenditures on sustaining capital projects should remain robust. By the end of the decade, oil sands production is expected to reach as much as $13 billion a year of sustaining capital spending. While this is a markdown from recent spending levels it is still a considerable sum and greater than all of the oil and gas capital spending in British Columbia and Saskatchewan combined”.
Adjusting to the new realities of low oil prices, intense competition, reduced capital spending, capped market access by pipeline and as-yet unknown Alberta royalty and climate change policies, is painful for all in OFS and will prove terminal for some. The OFS pie is shrinking significantly for some time and no area will be hit harder that the supply chain for building greenfield oil sands projects.
If the price of oil spiked tomorrow producers would be back drilling LTO as quickly as they could capitalize and mobilize. Even if oil prices rise significantly, the challenges for new oil sands projects are much more complex, more uncertain and will take much longer to resolve.
But as the world’s oilpatch licks its wounds after what will soon be a year of collapsed prices, there are much worse places to be operating than Alberta’s oil sands. Quit feeling sorry for yourself, take a sip of that half full glass and retool your operation to make the best of it.
(Suncor Energy Inc. last week announced an unsolicited, $6.6 billion, all-share bid for all the shares of Canadian Oil Sands Ltd., the largest partner in Syncrude Canada Ltd., the oil sands mining consortium. While the value of Suncor’s bid will be the subject of significant discussion and negotiations in the days and weeks ahead, it demonstrates tremendous confidence in the future of the oil sands industry. It also signals that at least one major player – Canada’s largest oil company Suncor – believes oil markets are at or very near the bottom of the cycle.)
By David Yager for Oilprice.com
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