However, in order to feed growing US energy demand, increased oil production and the development of non-traditional sources of supply are required. Developments in technology make it possible to utilize fuels that were once thought to be economically unfeasible.

While significant strides have been made towards the development of alterative forms of power generation, such as fuel cells, solar and wind power, energy produced from these sources is insufficient to meet the expected growth in US energy demand. New sources of petroleum products are therefore required.

One of the most attractive means to increase crude production from secure supply sources is the further development of the Canadian oil sands industry, which is primarily located in the Province of Alberta in western Canada.

Over recent decades, Canadian oil sands production has grown from relatively modest test-well quantities to volumes in excess of 1 million barrels per day. Oil sands are also beginning to make a significant contribution to Canada's total oil production - which averaged approximately 2.6 million barrels per day in 2005. As Canada’s traditional oil field production matures and declines, oil sands production will continue to increase and offset the decline in conventional crude oil production, ultimately becoming Canada's foremost source of oil.

According to the Alberta Energy and Utilities Board (EUB), total raw bitumen production - the petroleum product directly obtained from oil sands - exceeded total conventional crude oil production in the Province for the first time during 2001. In 2005, Alberta oil sands production has been approximately equal to Alberta’s light and heavy conventional crude production. One million barrels of daily oil sands production is being upgraded to approximately 650,000 barrels of synthetic crude per day with the remaining 339,000 barrels being marketed as bitumen.

In 2005, crude oil derived from oil sands and associated bitumen accounted for approximately 50% of Canada’s crude oil output, and it is expected to increase to 77% of Canadian crude production by the year 2012. Over the next decade, forecasts estimate that the amount of synthetic crude produced from Alberta's oil sands will reach 1.5 to 1.7 million barrel per day. The amount of bitumen shipped to the market is also expected to more than double its current volume of approximately 350,000 bbl/d.

A favorable regulatory environment and increasing oil sands production has resulted in greater oil sands derived revenues, in the form of royalty payments from operating leases, paid to the Canadian government. During the 2004 - 2005 fiscal year, these revenues amounted to $10.2bn, two and a half times the revenues raised from the industry in 1998. Estimates for 2005 - 2006 industry revenues are currently approximated at $14.7bn.

There are approximately 1,800 oil sands lease agreements in place with the Province of Alberta totaling 12,350 square miles of developable territory. Alberta’s Department of Energy asserts that close to 80% of the Province’s potential oil sands areas are still available for lease, exploration and development. While not all of these open leases will yield significant oil sands opportunities, the sheer number still available and the increasingly favorable economics behind their development continue to offer the potential for favorable investment opportunities.

Understanding oil sands

The Province of Alberta has three well-known large oil sands regions:

• Athabasca;
• Cold Lake; and
• Peace River.

Approximately 75% of the Province’s current oil sands production is derived from the Athabasca region while roughly 23% comes from Cold Lake. Currently, only 2% of daily production, approximately 23,000 barrels, is produced in the Peace River region of Alberta.

Advances in technology have made the production of bitumen from Athabasca’s vast fields economically feasible. Once extracted, bitumen can be further upgraded into Synthetic Crude Oil (SCO), a blend of hydrocarbons similar to light crude oil. SCO is an input for refineries, where it is further processed into light consumer products such as gasoline and aviation fuels. Bitumen can also be used directly for the production of asphalt, an important material for road construction and repair. The process of upgrading will be elaborated on in subsequent chapters of this study.

Technology-assisted extraction methods have made it possible for oil sands to be reclassified as proven reserves - currently measuring approximately 175 billion barrels. Estimates suggest that reserves could be as high as 2.5 trillion barrels of bitumen, five times more than the conventional oil reserves in Saudi Arabia and enough to supply the world’s current demand for oil for roughly 15 years. Indeed, Alberta’s oil sands reserves dwarf existing conventional oil reserves in the Canada and the US.

This vast oil sands resource has proven itself as a viable and reliable source of synthetic crude and other petroleum products. As of result, numerous projects are either under development, expansion, or operation, throughout the Province.

Definition of oil sands

Oil sands are naturally occurring mixtures of several organic materials including:

• Bitumen;
• Water;
• Sand; and
• Clay.

A typical sample of oil sands contains approximately 12% bitumen by weight. Samples with bitumen content greater than 12% are classified as ‘rich’, while those with bitumen contents of less than 6% are classified as ‘poor’ and are generally not considered as being worth extraction and development unless they can be blended with higher-grade sand. The figure below shows the unique composition of oil sands, a sand particle surrounded by both a water envelope and a layer of bitumen.

Bitumen is a black, naphthenic-based viscous hydrocarbon with a density greater than 960 kilograms per cubic meter, an API gravity of about 8 and a sulfur content of 4 to 6%. However, the quality of bitumen produced from oil sands located in Athabasca, Cold Lake and Peace River can vary slightly and when processed, yielding differing quantities and specifications of refined product. An analysis of the properties of bitumen extracted from Athabasca and Cold Lake, shown below in Table 1, illustrates these variations.

Historic developments

The commercial development of Alberta's oil sands resources started in the late 1960s when Great Canadian Oil Sands (now Suncor Energy) built a mine and upgrading facilities north of Fort McMurray, Alberta.

In the 1970s, the Syncrude consortium also built a plant in the area. Both of these facilities have been modified and expanded on an incremental basis to enhance their production capabilities with each currently producing around 250,000 bbl/d. In the 1980s and 1990s other oil sands developments were established in the Cold Lake and Peace River regions.

Advances in technology, such as the use of steam to enhance accessibility to oil sands reserves that are too deep to mine economically, and the development of a favorable business climate within the Province (and Canada as a whole) have created an atmosphere where the number of operations or projects under construction has grown to well over thirty - not including proposed or theoretical projects under development.

Development drivers and challenges

Drivers

There have been a number of drivers behind the development of the oil sands industry in the Province of Alberta. These factors have directly contributed to a noticeable increase in oil sands project investment and development in recent years. They include:

• Increasing demand for upgraded synthetic crude oil from both US, Canadian and world refiners;
• Amendments to the provincial royalty and tax systems to encourage greater investment; and
• The implementation of new technology that has reduced operating costs and lessened the potential negative environmental impact of oil sands extraction activities.

While these represent a number of positive fundamentals for the Canadian oil sands industry, there are also a number of uncertainties and potential drawbacks that must be evaluated in order to properly judge the risks involved in any investment in the industry.

Challenges

Oil sands development has been seen as an economic ‘golden goose’ for the region and a conveniently located alternative source of crude oil for US markets. However, several concerns surround the industry’s further development, including the availability of natural gas and water needed to separate the bitumen. As much as 20% of Canada’s annual natural gas production might be required to operate the growing number of Albertan oil sands projects. This trade-off between continuing oil sands development and the production and sale of natural gas for local consumption and export could hinder the development of the industry unless suitable alternatives can be utilized.

Furthermore, Canada’s oil sands, estimated at approximately 180 billion barrels, still require the development of new technologies in order that they might be fully exploited in a cost effective manner. Extracting synthetic crude from these reserves is economically viable when the market price of crude oil is above $20 per barrel, well under the April 2006 NYMEX price of around $70 per barrel, should the price of crude oil fall back to below $20 per barrel, an extremely unlikely event, the industry could be crippled. This constraint can be attributed to the main drawback of oil sands production, namely that the energy requirements for extraction are considerable when compared to conventional oil production. In addition, returning the mined area to its natural state once extraction and production has been concluded in any given area requires still more energy, effort and money.

Table 2 shows forward NYMEX crude prices on an annual basis to until the year 2012. From this we can infer that the crude oil market has long-term strength, thus strengthening the economic case for further oil sands investment and development.

Another factor to consider is the opportunity cost of investment in oil sands projects. The expected rates of return from such projects must be compared against returns expected from other potential investments. Should other investments (conventional production, LNG, gasification or nuclear) surface that offer the potential for even greater profits, interest in Alberta oil sands development could well decline.

Additionally, changes in regulatory policy, both in Canada and internationally, such as the Kyoto protocol, are also ‘unknowns’ that could have a dramatic impact on oil sands development.

While these concerns present real challenges, oil sands should still be considered as a partial solution to reducing overseas energy dependence, but by no means will the emerging industry, by itself, solve the problem of US dependence on imported crude oil.

Extraction of oil sands

The two approaches or methods employed in general commercial operations to extract bitumen from oil sands are:

• Mining operations; and
• ‘In situ’ (in place) production.

The type of oil sands reserves found at any given site dictates the extraction method that must be used and while each method has a different cost profile, they are roughly equivalent.

Mining operations

Where oil sands deposits are relatively close to the surface, open-pit mining and hot water processing methods can recover bitumen. Surface mining is used in the production of Athabasca oil sands.

In-situ production

In-situ extraction techniques are used in all three oil sands regions. Mining operations expose the oil sands by stripping the ‘overburden’ - comprised of grass, soil and rock - from the sand/bitumen mixture. The oil sands are then removed using relatively low-tech truck and shovel mining methods. Once the oil sands are collected, an extraction process removes the sand by adding warm water (and other solvents) and then agitating it to separate out the bitumen.

Deeper deposits require ‘in-situ’ methods such as steam injection through vertical or horizontal wells; this separates the bitumen from the sand in its underground reservoir prior to the liquid being pumped to the surface for collection and further processing.

There are several types of in-situ processes currently being used. These will be explained in detail later in subsequent sections of this study.

Benefits of in-situ production vs. open pit mining

By utilizing in-situ technology there are numerous large oil sands reserves that can now be economically developed. These reserves were previously thought to be too deep to exploit using traditional mining methods.

• The implementation of in-situ production is also better suited for ‘staged project development’ in which projects are developed in smaller increments relative to large-scale mining operations. This smaller, phased approach places less stain on a company’s cash flow during the development and initial production stages of a project and is generally perceived to be a better method to manage risk relative to full-scale mining operations.

   

• In-situ operations also have a smaller environmental production footprint. Production generally uses recycled water in a closed system for steam generation. As a result, no additional surface or ground water is required and no tailings (residue) ponds need to be created to manage production bi-products.

   

• There also appears to be greater potential to reduce bitumen production costs further by using in-situ methods, while additional efficiency gains from mining operations appear to be difficult to realize.

Oil sands reserves

At the end of the 1990s, proven oil sands mining reserves within the Province of Alberta grew significantly, almost doubling in size. The Canadian Association of Petroleum Producers has confirmed that, despite increased production, oil sands reserves continue to grow substantially as new reserves are discovered and technology gains allow for increased yields of oil from existing sources. In 2004, 217 million barrels of oil sands were produced from mining operations and additions to official reserves totaled 332 million barrels. The figure below shows oil sands reserve growth, by production type, for an eight-year period ending 2004.

Oil sands production

As of 2002, mining extraction methods accounted for over 65% of oil sands production, approximately 450,000 bbl/d. By the end of 2005, mining production had increased to 665,000 bbl/d.

In situ oil sands production has more than doubled over the last six years and now stands at just over 440,000 bbl/d (including cold primary production). The figure below illustrates the increases in bitumen produced from oil sands deposits using each of these production techniques relative to 1996 levels.

Overall, production is expected to grow to nearly 2 million barrels per day by 2010, 2.5 million barrels per day in 2015 and reach 5 million barrels per day in 2030.

Estimated value of investment

Between 1996 and 2002, the oil sands industry spent an estimated $19.4 billion on new projects, in addition to an estimated $3.1 billion on sustaining capital. According to the Alberta Economic Development agency, the oil sands industry could spend as much as $63.5 billion on new oil sands projects between 2005 and 2015. Another $16.5 billion could be spent on sustaining capital and another $1.3 billion could be spent on co-generation, pipeline, and other associated projects.

While not all of the currently proposed projects will come to fruition, the scale of current and planned investment shows a substantial commitment to ongoing oil sands industry expansion. The figure below shows the growth in oil sands capital spending. In 1996 the level of investment was approximately $1.3 billion, by the end of 2005 spending had surged to $8 billion.

Current forecasts call for capital spending within the Alberta oil sands sector to reach an apex of $10.8 billion during 2009. However, the development of additional projects in the coming years should delay the forecasted decline in investment currently expected in 2010 and beyond.

Investment difficulties

A combination of high development costs, growing environmental concerns, and high natural gas prices resulted in a few firms delaying, downsizing or re-evaluating oil sands projects in 2003, but investment rebounded in 2004 and continued to climb in 2006.

The extraction of bitumen, particularly through in-situ production techniques, requires significant amounts of natural gas and water. Natural gas is used not only to generate steam, which is injected into the ground to melt the bitumen, but also to generate electricity to power equipment used for pit mining operations. Some analysts predict that if all the proposed oil sands projects were realized, companies would require up to 2 billion cubic feet of natural gas per day, a commodity that is currently in tight supply in Canada.

Canada’s December 2002 ratification of the Kyoto Protocol also has the potential to raise costs since companies would most likely have to invest in emission reducing technologies or acquire carbon credits to offset the emissions resulting from production.

Conclusions

While there are potential obstacles that could hinder further development of Alberta’s oil sands, industry, participants have been actively working to overcome such challenges. Such efforts have considerably reduced production costs and aided in the development of innovative ways to transport and market bitumen and synthetic crude to end users in both Canada and the US.

The proximity of oil sands to the high demand US energy market, favorable market fundamentals and a supportive government and regulatory environment create a promising atmosphere for further Alberta oil sands investment and development.

Recommendations & conclusions

Should current demand growth for oil and the commodity’s high price persist, and it is likely that it will, development opportunities within Alberta’s oil sands sector remain promising. The resource benefits from being abundant and located in a politically and economically stable country. Oil sands also have a proven track record of production with existing technology that is constantly being improved and made more efficient; and an infrastructure designed to inexpensively transport the product to nearby markets.

Utilis Energy believes that continued investment in Alberta’s developing oil sands assets has the potential to be very worthwhile. To better ensure more profitable investments, the following courses of action should be considered by involved parties.

• Develop projects with sufficient scale
• Integrate upgrader operations
• Use risk management tools to lessen price risk
• Enter into term sales and marketing contracts
• Develop further markets for synthetic crude

The Canadian oil sands industry has made great strides in its 40 years of commercial development. With proven reserves of 175 billion barrels, this resource will continue to make its impact felt as a means to meet the world’s growing demand for fossil fuels. It is the opinion of Utilis Energy that there are real opportunities available for continued and profitable investment in this sector and that interested parties should consider committing resources towards finding, evaluating and developing such opportunities.

Utilis Energy has recently published a new study “Oil Sands - Alberta 2006: projects, participants & market opportunities” - the third edition of Utilis Energy’s extensive research report – taking a detailed look at the rapidly growing Albertan oil sands industry.

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