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Motley Fool: Shell Shocks the Oil Sands

By Robert Aronen
March 27, 2006
While Americans turned their attention to March Madness last week, Canadian papers were plastered with headlines about Royal Dutch Shell (NYSE: RDS-A) and its latest move in the oil sands.
The headline-grabber up north was that Royal Dutch had paid $465 million Canadian (about $400 million U.S.) for leases on 10 parcels of land in an area known as the Grosmont formation. The size of the deal is impressive and makes for one of the largest lease sales in recent history. Furthermore, Royal Dutch is making this investment through its subsidiary Shell Exploration & Production in the Americas, not through Shell Canada.
The industry is somewhat baffled by the investment, because the Grosmont formation is an almost untouched area of oil sands, with no proven technology to develop the resource. This is a big bet — but it's one that has left the players in the oil patch scratching their heads.
The intrigue
How big is this deal? If successful, Shell Exploration & Production will have squatter's rights for about 219,000 acres of the Grosmont formation, which is estimated to hold 300 billion barrels of oil, although the amount actually recoverable is uncertain. Even though the company has not purchased rights to the entire formation, 300 billion barrels of oil would be higher than Saudi Arabia's current reserves of 259 billion barrels. And if Shell has an economically viable technology, the purchase will boost its shrinking reserve base by billions of barrels.
The fact that Royal Dutch used its American subsidiary, instead of Shell Canada, for this purchase also raises questions. Shell Canada is the major partner in the Athabasca Oil Sands Project, along with Chevron (NYSE: CVX) and Western Oil Sands. Under this partnership agreement, Shell Canada must allow Chevron and Western Oil Sands to participate in any expansion within the region. Shell Exploration & Production in the Americas is not under the same sharing obligation, which may explain why Royal Dutch decided to use it instead of Shell Canada for the Grosmont leases.
While this aspect of the story is interesting, I doubt that Shell Canada's partners are too upset. After all, for the foreseeable future, the Grosmont formation will likely be a money pit, sucking up hundreds of millions of research and development dollars, with no known payback. Even Shell claims that any project will not begin producing until the next decade.
A different kind of oil sand
Investing in the Grosmont formation is risky because the oil is locked in limestone, unlike the profitable oil sands currently under development that extract hydrocarbons from a mixture of heavy oil, sandstone, and dirt. Hydrocarbons in sandstone are extracted from the oil sands via mining operations or through in situ (in place) thermal recovery methods, with a current production cost of about $15 a barrel, according to alternative-energy superstar Suncor Energy (NYSE: SU).
To date, however, the Grosmont formation has proved unwilling to yield to in situ technologies and lies too far beneath the surface for mining operations. The resource has been considered economically unviable, with very little interest in the site. So why did Shell spend almost half a billion dollars, and how does it plan to produce any oil?
An ace up the sleeve?
Shell might just have an ace up its sleeve with an experimental technology it has developed for the oil shale formations of Colorado. Shell announced last year that it has an in situ thermal recovery method that would be commercially viable in oil shale at $30 a barrel. My guess is that Shell is looking at some variation of this method for the Grosmont formation.
At a minimum, Shell has staked a claim on a huge resource. The company undoubtedly remembers that the first movers, like Suncor, grabbed the most promising properties in the other oil-sands formations. If oil prices continue at current levels or rise in the coming years, this bold purchase in the Grosmont formation will likely prove to be a pivotal moment in Shell's corporate history.
Robert Aronen recommends a trip to Fort McMurray for anyone who doesn't believe in the oil sands story. Please feel free to share your comments with him at [email protected].
He does not own shares in any company mentioned. The Motley Fool has an ironclad disclosure policy.

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