Oil sands project delays could be boon for US refiners

by Hyun Young Lee

The wave of project delays in Alberta's massive oil sands could benefit US refiners at the cost of the provincial government's ambitions.
Oil sands developers -- from start-up firms to international energy giants -- have pushed back multibillion-dollar projects as oil prices plunged off record highs and the global economy ground to a halt. Most of the delays have centred on upgraders, high-cost facilities that process the sludgy oil sands bitumen into a lighter, more valuable synthetic crude.

In recent weeks, Norway's state-owned StatoilHydro has scrapped plans for a C$ 16 bn upgrader while Petro-Canada said it could cancel its facility altogether, potentially saving more than C$ 10 bn. Yet these are the very projects Alberta's government is trying to encourage, to create more jobs and more value from oil sands development.
In December, it released a widely panned energy strategy that included the goal of developing a "world-class hydrocarbon processing cluster" of upgraders, refineries and petrochemical facilities. Details remain scarce.

But Alberta's loss could favour refiners across the border. The US refining industry has faced rapidly weakening demand for its products while struggling to manage huge volatility in oil prices, which traded over a $ 115 range during 2008.
Canada is the top crude supplier to the US and oil sands producers have already formed lucrative partnerships with US refiners, all in the Midwest due to existing pipeline capacity constraints.

But TransCanada and ConocoPhillips's new Keystone link will soon connect Alberta with the US Gulf Coast, the heart of the country's refining capacity. Much of this can already handle oil sands crude, which could easily replace declining output from traditional US Gulf supplier Mexico, and several refiners plan to boost this capacity further with major conversion projects.
And as Keystone comes into service over the next several years, oil sands producers may prefer to sell their unprocessed bitumen on the spot market or sign supply deals with refiners instead of building an upgrader, even when the economy recovers. Developers that are fuzzy about their proposed upgraders are largely still pushing ahead with bitumen production plans.

"The Alberta government can talk about value-added [development]...but that's not what the market is demanding," said Steve Fekete, a Calgary-based senior principal at Purvin & Gertz.
"The economics to produce the bitumen is still there long-term and the demand is still there long-term, but building an upgrader's only going to give you a marginal return. It's not strong enough given the capital cost you need to put in."

Due South
Even those with upgrading plans in Alberta are keeping their options open. In July 2007, Royal Dutch Shell, one of the biggest and most established producers in the oil sands, started the regulatory process to build a C$ 27 bn upgrader next to its existing Scotford upgrading and refining complex near Edmonton, Alberta. Ayear later, however, Shell said it could scrap this plan and ship the crude to be processed at its Martinez, California, and Deer Park, Texas, refineries instead.
"The North American upgrading strategy is still being considered -- we're looking to integrate our oil sands into our downstream as efficiently as possible," said Paul Hagel, Shell's senior oil sands spokesman. "But we're still going to pursue the regulatory option (for the Alberta-based upgrader) to ensure that we have viable options down the road."

Meanwhile, companies without Shell's far-reaching operations are looking for partners. A number of cross-border deals have already been signed, kicked off by EnCana and ConocoPhillips in late 2006, but these involved asset swaps -- a stake in oil sands production for part-ownership of a refinery.
New deals are more likely to involve long-term supply contracts instead, as producers grow more protective of their oil sands assets. Others, such as Petro-Canada, are mulling US refinery acquisitions.

Last summer, Canadian Natural Resources, Canada's second-biggest oil and gas producer, said it had agreed to supply "a major US refiner" for 20 years via the Keystone pipeline. Several observers reckon the partner is Valero Energy, the biggest independent refiner in the US, which has also made long-term commitments to Keystone.
Analysts think Canadian Natural could also be a good partner for Sunoco. The US's second-biggest refiner wants to form a joint venture to run more Canadian heavy crude at its Toledo, Ohio, refinery, and says it is already in talks with Canadian producers.

"Plenty of room"
Retooling a refinery is still a major capital expense, however. Few refiners expect the gloomy outlook for oil demand to brighten anytime soon, and have pared back 2009 spending plans as a result.
In October, Marathon Oil said it was delaying a $ 1.9 bn project to equip its Detroit refinery to handle oil sands crude. The Houston-based company announced the project in mid-2007, after acquiring a 20 % stake in Shell's Athabasca oil sands development.

But Canadian producers won't have difficulty finding homes for their crude, as some very big projects are still underway, said Neil Earnest, vice-president of Muse Stancil, a Dallas-based consultancy. Shell and state-owned Saudi Arabian Oil Co., or Saudi Aramco, plan to more than double their Port Arthur, Texas, refinery in a $ 7 bn project to handle the "nastiest crudes." BP is upgrading its Whiting, Indiana, refinery to run almost wholly on Canadian heavy oil.
"There's already an enormous heavy sour [crude] capacity on the Gulf Coast," Earnest said. "That's not going to go away -- there's plenty of room."

Difficulty and opportunity
The trend of upgrading oil sands crude in the US will reduce competition, possibly benefiting upgrading facilities still planned for Alberta. A couple of private companies plan to build independent upgraders in the province, which wouldn't have any oil sands production themselves but would source their bitumen entirely on the market or through long-term contracts. The problem is, they haven't been built yet, and the credit crunch is making it increasingly difficult to do so.
North West Upgrading has halted construction on the first C$ 4.2 bn phase of its facility, which it had hoped to bring onstream by early 2011.
"We're ready to go but it's a question of money -- the markets are in terrible shape and have been for some time," said Chief Financial Officer Rob Pearce. "The markets have hit us and for development stage companies without cash flow, it's particularly difficult."

Alberta's government is pressing ahead with plans to accept bitumen in place of energy royalty payments, in a bid to encourage the upgrading industry to stay within the province. It's a positive step, Pearce says, though others reckon producers would still find it cheaper to ship bitumen to the US instead of building a new upgrader in Alberta.
"The deferral and cancellation of upgraders is a concern because that adds a huge amount of value," Pearce said. "But less activity means construction costs will be better controlled. And it means more upgrading opportunities for us."