Oil sands pain points to long-term gain

Jeffrey Jones, July 15, 2009, Moody's-- Canada's oil sands developers will emerge from the economic downturn smaller in number and ready to advance projects at a more measured pace than during the boom, a debt rating agency said on Wednesday.

Moody's Investor's Service said today's slowdown should be a boon for the sector overall as high-cost plans get scrapped and development costs drop. Since last autumn, companies have deferred or canceled more than C$90 billion ($81 billion) worth of Alberta oil sands projects.

In addition, financing difficulties that have plagued the smaller, pure-play oil sands companies may lead to more merger and acquisition activity, the agency said in a report.

"For the industry as a whole, on a longer-term basis, it's a positive development because it's a pullback from the breakneck pace of development that was going on out there," Terry Marshall, vice-president and senior credit officer for Moody's and lead author of the report, said in an interview.

Before last year, when oil fell to below $40 a barrel from a record above $147, companies such as Petro-Canada (PCA.TO), Royal Dutch Shell (RDSa.L) and Canadian Natural Resources Ltd (CNQ.TO), suffered spiraling costs due to an overstretched labor pool and inflation in prices for materials such as steel.

Oil is currently above $61 a barrel.

Developers were forced to rethink plans as the credit crunch and shaky energy markets made investing massive amounts of capital impossible.

"I think they just move forward on a more manageable basis over time," Marshall said.

Last month, the Canadian Association of Petroleum Producers, cut its oil sands production forecast for the third time in a year, blaming project deferrals.

It now expects 2.2 million barrels a day by 2015, down from a December estimate of 2.4 million. Current output is about 1.2 million, an 80 percent jump in just seven years.

Suncor Energy Inc's (SU.TO) pending C$22 billion takeover of Petro-Canada is a prime example of how the industry will be able to advance its best projects first, Marshall said.

Suncor had deferred its C$26 billion Voyageur expansion project early this year, and Petro-Canada had delayed the C$23 billion Fort Hills development to find ways to cut costs.

"You'll have one company that can pick and choose and take the most economic piece and move that forward," he said.

"And the other important point from our standpoint is it benefits the ratings of these companies as some of these costs come down and become more manageable as they spread their capital spending out over a longer period."

One aspect of oil sands production that may not be revived in Alberta is construction of the multibillion-dollar upgrading plants that turn the tar-like bitumen into refinery-ready crude, Moody's said.

Those don't earn healthy returns unless the spread between light and heavy oil prices is wide. Also, many U.S. refiners have added upgrading capacity at their facilities.

Meanwhile, takeover activity among smaller developers is expected to pick up due to depressed stock prices and a lack of cash flow from other operations, Moody's said.

"You become highly dependent on capital markets on a periodic basis, which may or may not be there for you, and it's very expensive in today's environment," Marshall said. "It's more of a hand-to-mouth existence,"

Already this year, Total SA (TOTF.PA) made a hostile bid for UTS Energy Corp (UTS.TO), although it proved unsuccessful. Opti Canada Inc (OPC.TO) was forced to sell 15 percent of its interest in the Long Lake project to partner Nexen (NXY.TO).

($1=$1.11 Canadian)