Bitumen in Canada

After declining from $50 a barrel earlier (as we predicted) in the year due to OPEC’s unwillingness to commit to steeper production cuts and US shale oil production continuing to ramp up due to lower operating costs from improving technology and opportunistic hedging, the price of oil has rallied back up ~8% over the last week as crude inventories in the US have fallen and traders start to cover their shorts.

In addition, market watchers saw rig counts and production decline in the US, and anticipate possible stabilization of supply and demand. Shale oil, unlike the bitumen-rich oil sands in Canada, is a short-cycle (quick start and high decline) business, meaning that given unfavorable economics (as the market is assuming right now), shale supply can be cut rapidly, resulting in a spike in oil prices. Conversely, bitumen production cannot be turned off due to extremely high startup costs (and time) and low variable costs. If production costs exceed revenues, oil and gas companies such as Li-Ka Shing’s Husky Energy just have to draw on their lines of credit and ride out the pain.

Interestingly enough, the historical relationship between oil and the Canadian dollar (Canada being a net exporter of oil and oil being a USD-traded commodity) has decoupled – with the oil price decline being met with Canadian dollar strength as hawkish Bank of Canada interest rate policy speculation has overshadowed the fall in oil, and the recent rebound seeing the Loonie give up some of those gains.

Given this recent action, we figured we would pen a post regarding Canada’s unconventional bitumen production, which would be useful for anyone interested in oil and gas or working in Calgary in addition to our comprehensive oil and gas primer.

Canada has the third largest hydrocarbon reserve in the world after Saudi Arabia and Venezuela – a large part of that is due to new technologies for shale and the oil sands. Shale is not unique to Canada and although there are very economic plays in Canada, the oil sands are a resource that is uniquely Canadian (oil sands exist elsewhere but Canada has by far the largest deposits).

Oil sand extraction is considered unconventional extraction – traditional oil production (artificial lift methods) have been declining in Canada, and oil production in Canada was declining until a ramp up in oil sand production. The commercial oil sands are almost exclusively in Alberta (deposits in Saskatchewan may be large but are largely untested).

Oil extracted from the oil sands is viscous (thick), making it difficult to pull out of the ground and refine for commercial use. Technology has advanced and certain periods of high oil prices has yielded two go-to methods of extraction in Alberta – mining and in-situ (where there are a variety of methods). As technology improves, in-situ projects will move towards using solvent instead of steam, as it is less energy intensive (and thus more cost efficient).

Oil sand production profiles are very different from conventional oil production (and shale) with oil extraction being extremely long-lived with constant production per day.

Oil Sands Mining

Mining entails large shovels (from Caterpillar or Komatsu) digging bitumen (the thick, practically solid oil found in much of the oil sands) from the surface after clearing the overburden (plants and rocks that need to get out of the way before the bitumen that has seeped to the surface can be shovelled easily).

This is more of a legacy extraction method – although there are new prominent oil mines (Suncor/Total/Teck Fort Hills), mining is very expensive and requires the price of oil (WTI) to be over US$100 to be NPV positive at a shareholder friendly 15% rate of return. This has not been the case lately, with Fort Hills being impaired and Total selling off some more of their ownership to Suncor.

Previously, with very high priced oil, bitumen was upgraded at an “upgrader”, a facility that breaks down the long hydrocarbon chains of bitumen and makes lighter synthetic crude that can be transported through a pipeline easily. The large capex requirements and expensive specialized labor have made them uneconomic, with Suncor most recently canceling their Voyageur Upgrader project.

In-Situ Production and Steam-Assisted Gravity Drainage (SAGD)

In-Situ bitumen means “in-place” bitumen – which means the oil is far enough beneath the ground where mining would be uneconomical – but a reservoir exists where oil can be pumped up through traditional methods. However, the bitumen, as mentioned earlier, is too thick to be pumped up through artificial lift, so the oil must be more “oily” before extraction is possible.

Currently, the most popular and economic method is steam-assisted gravity drainage (known in the oil patch as SAGD). Water is jetted into the in-situ oil reservoir as steam (it is heated – natural gas is burned to generate the electricity to heat the water), making the oil more fluid and it is piped out in a separate tube. Without the same heavy machinery required for mining, SAGD is economic these days on average at US$68 per barrel (again, assuming a 15% IRR). As technologies improve (less steel used on well infrastructure like pads, more efficient centralized processing facilities and increased automation) and the amount of oil recovered rises, this economic threshold will fall.

Oil sands producers are moving towards using a solvent to dilute and make the oil flow better instead of steam (heat) – a low steam-oil ratio (SOR) is a measure for low cost for a producer, and solvent lowers the SOR. This should lower costs because less energy is used to generate the steam and cleaning or treating the solvent is cheaper than cleaning or treating the water that is recovered. Also, solvent is more easily recovered.

Bitumen in Canada