Oil Crisis to the South, But Oil Opportunity to the North

In the aftermath of the Deepwater Horizon explosion and the ongoing oil blowout in the Gulf of Mexico (GOM), risk factors have changed for fossil fuel energy developments.

We need to consider what it means for our future investment strategy — indeed, there are more lucrative opportunities if you look in the right places.

Certainly in the U.S., and doubtless the world over, the GOM disaster will spark tighter restrictions and higher costs for deep-water development. So let’s look at what’s going on with deep water and then compare it with what’s happening far from the sea, in the interior of the North American continent, up in Canada’s oil sands country.

The bottom line is that the GOM oil disaster will benefit energy development in Canada — and you can profit. But this gets ahead of the discussion…

Declining Support for Deep-Water Development

First, the BP (BP: NYSE) oil well blowout caused a decline in public support for deep-water development. The political forces simply are no longer aligned for strong growth in U.S. deep-water development, at least for the next few years. In other parts of the world, things may be better for offshore development. But even that is yet to be determined. We’ll have to watch, on a country-by-country basis.

Second, the U.S. government has just closed down the GOM, one of the world’s great oil provinces, to further drilling. We have a “six-month moratorium” on U.S. deep-water development, hastily enacted by the Obama administration. It’s already the subject of fierce litigation in federal court, but these things typically don’t play out quickly or smoothly. Thus, the moratorium will likely prove to be long. We’re already seeing upstream oil operators declaring force majeure and breaking contracts with drilling companies for GOM-based rigs. That kind of drastic legal remedy wouldn’t occur if people thought the moratorium were going to end anytime soon.

Third, the GOM blowout and oil spill will surely lead to stronger, more adversarial and more expensive regulatory scrutiny. Everything will take more time. Everything will cost more to accomplish. This will include industry having to obtain more permits. We’ll see more frequent, and more intrusive, inspections. Overall, there will be much more stringent environmental control.

Altered Risk-Reward Profile

The long and short of it is that deep-water energy development — in the GOM, and possibly worldwide — will face increased costs and extended project timing. We’ll see this at every step, from the regulatory approval process for new drilling to project construction, commissioning, operations and decommissioning.

In the U.S. for sure, the entire risk-reward profile for the deep-water GOM has altered dramatically. And in this world of mobile capital, we’re sure to see capital shift to other locales where the resource potential offers a better return. That new balance favors Canadian oil sands.

There’s “Peak Oil,” and Then There’s Canada

That term “Canadian oil sands” is truly loaded. Some people hear it and go ballistic, ripping into the amounts of water and natural gas and environmental impact there is in recovering “bitumen” — the correct term — from the frozen north. Other people hear the same term and smile at the geological fact that there are a lot of other hydrocarbon molecules out there in the rest of the world besides conventional crude oil.

Which gets us to another point. For as much as the term “Peak Oil” has made it into the common language, we need to keep in mind what we’re really discussing. The global energy production curves show conventional crude oil output peaking in many parts of the world. U.S. crude oil output, in fact, “peaked” in 1970. But you need to understand that the oil output that’s peaking is the old-fashioned kind of oil, like what Col. Drake was drilling back in 1859.

That is, the light, sweet, easy-flowing oil is getting harder and harder to find, certainly in significant quantity. It’s one big reason why the energy industry has moved offshore into deep water. That’s where the big new oil finds are.

But in addition to deep-water oil resources, the onshore world has immense amounts of unconventional, “heavy” hydrocarbon molecules. See the graph on the facing page from oil services giant Schlumberger that shows the world’s heavy oil and bitumen resources.

Canada has about 400 billion cubic meters of bitumen — most of it in Alberta (with some in Saskatchewan). That number translates to something like 1.4 trillion barrels of oil equivalent. How much is that? About SEVEN times the total oil reserves of Saudi Arabia. In other words, the Canadian oil sands may be the single largest hydrocarbon deposit anywhere on earth.

Reevaluating Oil Sands Risk

So yes, there are a lot of hydrocarbon molecules up in Canada. But these molecules are harder to get out of the earth than conventional oil. To produce bitumen from the oil sands requires large investments of capital, technology, energy, water and labor.

Thus, in recent years, Canada’s oil sands developers have faced increased public scrutiny. Much of it has to do with the perception of “dirty” oil, particularly the water usage and carbon dioxide (CO2) output required to extract oil from oil sands.

Then again, with the GOM disaster, and oil washing into sensitive environments along the Gulf coast, peoples’ viewpoint of “dirty” oil will likely change.

The fact is that the total CO2 emission profile for the entire Canadian oil sands operation — from one end of Alberta to the other — is about the same as the CO2 footprint for one large world-class city, such as London. And the water usage? Recent technical advances allow each barrel of water to be recycled and reused up to 19 times, for a 95% efficient process. It’s almost a closed system.

The bottom line is that obtaining bitumen from Canadian oil sands is not nearly as “dirty” as the opponents would like you to think. For investors, the environmental downside is a diminished risk factor.

Then there’s the issue of geologic risk tied into development. If you drill a well in deep water, for example, you may or may not find oil. By comparison, the oil sands resource is well established. The oil sands are well mapped. There’s really no real risk there. When you acquire an oil sands claim, you know what you’re getting. And the technology has progressed to the point that you can predict with great accuracy what you’ll ultimately recover from the ground.

Further along these lines, the experience with offshore projects is that the high-productivity wells last for only a few years at best. Then the wells and oil fields begin to enter conventional decline. In contrast, oil sands projects offer flat, stable production profiles over many decades. The historical record is that some surface-mining oil sands projects have reserve lives well north of 50 years.

For underground projects (called in situ projects, using steam-assisted gravity drainage or cyclic steam stimulation), the record is that projects can run at design rates for 20–40 years.

Thus, it’s time for investors to reevaluate the prospects for Canada’s oil sands. For many years to come, Canada’s oil sands are and will be a dominant contributor to future growth in global oil production.

Until we meet again,
Byron King
Whiskey & Gunpowder

July 21, 2010

The Daily Reckoning