July 07, 2006
Oil Sands Cost Explosion
As we know, the oil sands and oil shales of Canada are put forward as one of the reasons why oil isn’t running out, why there is still a century or more of supplies to use. So this doesn’t look good:
SHELL is facing a cost explosion in the expansion of the Athabasca Oil Sands Project, a mining venture that extracts oil from bitumen deposits in the Canadian province of Alberta.
The first phase of expansion, intended to add 100,000 barrels daily to the current 155,000 barrel per day output was budgeted at C$7.3 billion (£3.6 billion) only a year ago. It is now expected to cost as much as C$11 billion, according to estimates published by Western Oil Sands, Shell’s partner in the project.
However, before the peak oil crowd start crowing about how it shows that the process will never make sense, will never really amount to much, it’s worth looking at what (well, at least what Shell say) is the problem. It isn’t the process itself, isn’t something wrong with the whole idea. It’s simply a result of an overheated market:
The Dutch oil giant is the leading player in an overheated market where the high price of steel, cement and a chronic shortage of skilled labour is weighing on investors.
Make of it what you will.
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So a process which is generally thought to be no solution due to its expense turns out to be more expensive than originally thought and you say this isn't a problem with the idea? You wouldn't accept this excuse in a government programme.
Posted by: Matthew | Jul 7, 2006 11:47:46 AM
I was in Rifle, Colrado that day in May 1982 when Exxon pulled the plug on its $5 billion oil shale project on the Colorado Western Slope. As I understood the decision at the time the reasoning was that the high oil prices of the 70s appeared to make oil extraction from shale in Colorado economically viable. However, the high oil price had - short term - the effect of making the materials and capital goods necessary for that extraction very expensive (a combination of high input costs and supply shortages translating into even higher input costs). These costs made the profitability of the extraction increasingly marginal. What bust the project was the collapse in oil prices which made the whole thing uneconomic even with a prospective decline in input cost.
It appeared that the effect of high energy cost causing economic turndowns made the Western Slope or similar projects permanently uneconomic. The "solution" to this conundrum is consistently high oil prices and ones which don't trigger an economic turndown of early 80s proportions. It seems this may have arrived with oil prices bouncing around at $70/barrel and no (immediate) slump in prospect. Of course the world has changed in the last 25 years so Matthew's pessimism might not be justified. In a government programme BTW the taxpayer is forced to cover extra "unforeseen" expense usually caused, not by secular movements in economic variables, but by the sheer incompetence (or disingenuousness) of those running governmental projects cf London 2012.
Posted by: Umbongo | Jul 7, 2006 4:01:15 PM
Shareholder response to the news of higher up-front costs has inflicted immediate pain on the value of Western Oil Sands' stock causing it to delcine 12%. While this stock drop doesnt necessarily mean that the overall oil sands reclamation process is bankrupt, it does suggest that somebody will have to explain what is going on or he/she/they will likely continue to be punished financially for the error. How do you punish a bureaucratic bumble of similar magnitude? The difference is that market oversight can be swift and painful.
Posted by: dkidd | Jul 7, 2006 4:07:29 PM
The tar sands operations are actually much closer to open pit mining than the traditional oil industry. Given that I have recently worked on the feasibility study for a large open pit mining operation, maybe I can shed some light.
The big working cost items in open pit mining are explosives, fuel and tyres. Now the tar sands boys don't do a lot of blasting, but running trucks on tar sands burns fuel at a prodigious rate since the going is akin to porridge. So any cash flow prediction will have taken a big knock thanks to the high diesel price (haul distances are long since the deposits are flat and wide which makes diesel an even higher cost component than normal).
Turning to tyres; the oil in the tar sands eats rubber faster than John Prescott eats pies. The market for tyres that fit 240 and 300 ton trucks (the size typically used in the tar sands mines) has gone haywire in the last two years with demand far outsripping supply and no prospect for increased production for at least 24 months. We have seen the cost of tyres double in the last 12 months.
Add to that the fact that nearly all commodities (iron, copper etc) have increased in price recently, pushing up the capital cost of mining machinery and processing plant and it is quite possible that a revised cashflow for a marginal mining venture (tar sands falls into this category) may well become less attractive than the original estimates. Especially if the study was done based on economic estimates from a couple of years ago. I had a look at our forward price projections from 2003 the other week and they are laughable compared to today's reality.
Please note: The Remittance Man is available for all mining consulting work at very reasonable rates. He will even consder giving courses in mining and resource economics if the price is right.
Posted by: The Remittance Man | Jul 8, 2006 12:19:51 AM