Oilsands delays likely

October 10, 2008 OTTAWA --Oil sands producers may start looking to pause multibillion-dollar projects as crude prices slump below the sector's comfort zone.

Just three months after its meteoric rise above $145 a barrel, crude oil has plunged 46% to below $80 a barrel as demand fears gather pace. But Alberta's oil sands developments are now more expensive than ever and analysts reckon new developments will need sustained oil prices of $90 a barrel, or even $100 and beyond. Funding them will prove a major challenge as credit dries up and global markets continue to freefall.

"We're well below the marginal cost of a new Canadian oil sands project," said Jeff Rubin, chief economist at CIBC World Markets. "Oil sands stocks are getting particularly pummeled because they're not profitable at today's (crude price) levels, even existing projects. It's wiped out their operating margins."

Major producers such as Suncor Energy Inc. (SU) and Royal Dutch Shell PLC (RDSB) maintain that they don't base investment decisions on "short term volatility" as oil sands developments produce steadily over decades.

However, analysts reckon that companies are already considering rejigging project sizes or timelines, especially those that have yet to put a shovel in the ground. As a result, the sector's output forecasts are likely to have to be scaled back yet again. This could have big implications for the U.S., which already sources a fifth of its crude imports from Canada and will be increasingly reliant on the oil sands to replace declining production from Mexico and Venezuela.

"Although the focus (in the oil market) has been on demand destruction, people should be looking at supply destruction," Rubin said. "Companies are going to find it difficult persuading their boards to sanction projects if they're not going to make any money."

One victim could be the massive Fort Hills integrated oil sands project in northern Alberta. Last month, the Petro-Canada-led (PCZ) consortium announced cost estimates had jumped by more than half to around C$24 billion, potentially making it one of the priciest developments in an already pricey sector.

The project will need oil to stay at $96 a barrel to generate returns of 8.5%, estimates UBS Securities' analyst Andrew Potter. Some economists reckon oil prices have a long way to go down yet - $60 could be the oil market floor, according to Deutsche Bank - and even if crude tracks back up again, the Fort Hills partners may be forced to put the project decision on hold until it does. Benchmark crude prices settled down more than 10% at $77.70 a barrel Friday, the lowest settlement since Sept. 10, 2007.

Petro-Canada still intends to make the go-ahead decision at the end of the year as planned, and the oil price slump "won't impact" the project's schedule, company spokeswoman Andrea Ranson said.

"It's kind of a short-term volatility that we're seeing now but the oil sands is a long-term investment that will be producing over decades," she added.

Even projects that are already producing or close to doing so may be affected. While oil sands output will provide some steady cash flow, expansions are often significantly more expensive than earlier phases due to soaring inflation. Nexen Inc. (NXY) and OPTI Canada Inc. (OPC.T) will start producing high-quality synthetic crude from the first 60,000 barrel-a-day phase of its Long Lake project this month, and plan to add equal-sized chunks of production up to 360,000 barrels a day.

The next phase, which could cost up to C$9.6 billion, could now be put on hold until markets stabilize.

"With recent economic and financial market instability, we may not be in a position where we feel comfortable with the near-term sanctioning of phase two," OPTI's chief financial officer David Halford said at a London conference earlier this week.

If the expansion is delayed, oil sands output growth may slow again. Production is currently expected to more than double to 2.8 million barrels a day in 2015, a more modest estimate than a year ago, as regulatory delays and vague environmental rules take their toll.

The Canadian Association of Petroleum Producers, the industry group that produces the widely watched forecasts, hasn't yet indicated if it expects a further downgrade.

© 2008 Dow Jones & Company, Inc.