Royal Dutch Shell Plc .com: Fears Athabasca oilsands costs have spiralled out of control

The Vancouver Sun
James Stevenson, Canadian Press

Fears growing in wake of expected 50% cost increase at Shell oilsands plant 

CALGARY (CP) – Fears that cost pressures have spiralled out of control in the northern Alberta oilsands spooked investors Thursday in the wake of news that Shell Canada’s (TSX:SHC) Athabasca oilsands project could potentially pay upwards of $11 billion to generate an extra 100,000 barrels of oil a day.

Even in an industry that has seen its share of multibillion-dollar cost overruns to build megaprojects, word that Athabasca’s first major expansion could cost 50 per cent higher than the current $7.3 billion pricetag hit oilsands producers hard on the stock market.

Bob Gillon, an energy analyst with John S Herold in Connecticut, said the Athabasca expansion would now cost six times what the original project did, on a daily flowing barrel basis.

“It’s not a knock on Shell or this project, everybody’s facing it,” Gillon said in an interview Thursday.

“But my Lord in heaven. If you’re talking about something that cost you six times as much as it did six or eight years ago, even with the move we’ve had in oil prices, we’re getting these things back to where the economics . . . are going to get skinny in a hurry.”

Western Oil Sands (TSX:WTO), a pure-play oilsands producer with a 20 per cent minority stake in the Athabasca development, bore the biggest brunt from nervous investors, dropping $3.70 or nearly 12 per cent to $27.30 in trading of nearly 3.6 million shares on the Toronto Stock Exchange on Thursday.

Shell Canada, which owns 60 per cent of Athabasca but also has a diversified energy portfolio with large natural gas operations throughout Canada and a national gasoline station network, lost nearly two per cent or 81 cents to $40.99.

Gillon said at $11 billion, the company is paying twice as much for 100,000 barrels of oilsands crude as it would by buying conventional production.

“Now, it lasts forever and it doesn’t decline, and supposedly once you get it running you don’t have the maintenance capital to stay in position. But that’s not so sure either – sometimes they break, they catch fire.”

Gillon said the dramatic cost escalations could ultimately put an end to oilsands companies drawing the largest investment dollars in the energy industry.

A long list of new projects that have not yet begun development might be dropped off the list, said Gillon. While projects that have already been built or are well underway, such as those owned by Canadian Natural Resources (TSX:CNQ) or Nexen Inc. (TSX:NXY) might even attract greater market interest.

Other industry observers didn’t expect the latest cost overrun announcement to stop growth in the oilsands, which has been receiving international attention as one of the few oil producing regions expecting large production growth in the future.

“We don’t believe that the market’s going to stop, we don’t believe even that the rate of production addition is even going to slow down,” said Steven Paget, an oilsands analyst with FirstEnergy Capital in Calgary.

But Paget said the soaring costs to develop oilsands reserves were “rationalizing” which projects ultimately go ahead.

Though there are a few smaller, junior oilsands companies looking to build smaller projects involving steam technology and not open pit mines, the oilsands is mainly a game for larger producers.

In the past year, large international companies like Royal Dutch Shell (NYSE:RDS.A), Chevron Corp. (NYSE:CVX), and French energy company Total SA have all bought major land positions or unveiled plans for massive projects.

Both Shell and Western said that further updates on the planned Athabasca expansion would be provided by the end of July.

But Paget said he highly doubted that the project would be halted.

“In some sense, it looks like a bargain. Look at the cost – you could buy a basket of large-cap shares on the open market for about the same price, but these companies are fighting to replace declines every year and they’ve also got international risk and exploration risk.”

“Perhaps it makes sense to spend more money on oilsands.”

In a research report, Merrill Lynch analyst Andrew Fairbanks in New York said the cost increase would mean that the Athabasca project would require at least $50 US per barrel oil to make a 10 per cent return on investment.

“If this is the new upper bound for capital costs, it will not be likely to deter major industry players from expanding oilsands capacity,” wrote Fairbanks.

“We may lose some smaller, less well capitalized projects, but in general we foresee the industry marching on despite this latest cost challenge.”

The Athabasca announcement sent shock waves through the market Thursday, affecting other oilsands producers and those currently involved in building new projects.

Calgary-based Suncor Energy, (TSX:SU), one of the first oilsands producers in northern Alberta, lost 92 cents to close at $92.32.

EnCana Corp. (TSX:ECA), a major gas producer also involved in oilsands development, fell 45 cents to $57.88, while Nexen dropped $1.31 to $63, a decline of more than two per cent.

The big partners in the Syncrude oilsands venture also took a hit on the TSX. Canadian Oil Sands Trust (TSX:COS.UN) fell $1.29 to $33.95, while partner Imperial Oil (TSX:IMO) dropped 58 cents to $40.25.

Meanwhile, Canadian Natural Resources, which is building the Horizon oilsands project, fell $2.52 to $59.60, a drop of more than four per cent.