The stranding of Canada’s oil assets

Low oil prices and stricter environmental regulations are pushing energy companies and resource-rich governments to confront the possibility that some fossil-fuel resources will remain in the ground indefinitely. Once considered a safe bet, Canada’s oil sands look like a prime candidate for possible abandonment.

François-Xavier Chevallerau | March 3, 2017

While U.S. tight oil producers rush to boost production, oil majors still have to deal with the consequences of the oil price crash of the last couple of years. Exxon Mobil Corp., the largest of the world’s Big Oil companies, recently announced it had written down its proven oil reserves by a massive 19.3%, the deepest reserves cut in its modern history. As of the end of 2016, Exxon had 20 billion barrels in proven reserves, compared with 24.8 billion a year earlier. The equivalent of about 3.3 billion barrels of untapped crude was removed from the so-called proved reserves category in Exxon’s books, as low energy prices made it mathematically impossible to profitably harvest some of its North American assets within five years. The U.S. Securities and Exchange Commission (SEC) indeed requires producers to use the 12-month average trailing price for oil and natural gas to book the value of their reserves and mandates that proved undeveloped reserves, or PUDs, be developed within five years or be deleted from the reserves numbers.

Exxon’s reserves write down  includes the erasure of all 3.5 billion barrels of Exxon’s proven oil sands reserves at Canada’s Kearl field in Alberta. Last year’s low oil prices made it uneconomical to drill at Kearl, which had been at the core of Exxon’s growth strategy. In addition, for the second straight year, Exxon failed to replace all the reserves it pumped -in 2016, it replaced just 65% of its produced reserves. In 2015, it replaced just 67%. Prior to these years, Exxon had replaced at least 100% of its production every year since 1993. The replacement failures of the last two years and the 2016 write down punched a hole in Exxon’s vaunted 10-year reserves replacement average – which plunged to 82% in 2016, from 115% a year earlier.

Exxon’s writing down of its proven oil reserves is far from an isolated move in the industry. A new era of low crude prices and stricter regulations on climate change is indeed pushing energy companies and resource-rich governments to confront the possibility that some fossil-fuel resources will remain in the ground indefinitely. Once considered a safe bet, Canada’s oil sands look like a prime candidate for eventual abandonment. The country’s vast heavy oil or bitumen deposits are indeed emerging as a prominent case of reserves being stranded by a combination of high costs, low prices and tough new environmental rules. During most of the past decade, giant oil companies spent billions of dollars in Canada as part of a global quest for new sources of supply and in order to replenish their reserves of oil and gas. The oil price drop since 2014 has however altered investment priorities away from high-cost opportunities in the Arctic, ultradeep waters and the oil sands and towards projects that require lower upfront investment and bring faster returns.

Canada’s oil prospects are victim, in particular, of the unexpected resilience of the U.S. tight oil industry, which is ramping up production and attracting investment again after the ‘oil price war’ of the last couple of years. Canada indeed seems to be the major victim of an ongoing reallocation of capital toward the U.S. shale fields. One region in particular seems to be attracting capital more than the others: the Permian Basin of West Texas and southeast New Mexico. Private equity groups have begun injecting an increasing amount of capital into the Permian, and major producers are refocusing their operations around the basin, which is widely considered the cheapest per-barrel play of any oily shale field in the U.S. Part of the appeal for Permian operators is the layered nature of the basin, which boasts successive stacks of resource that can be drilled from a single well and results in a lower break-even price than other U.S. shale oil plays. The region is also well endowed with a competent labour pool and plenty of pipeline capacity to meet growing production demands.

Production in the Permian is expected to reach 2.5 million barrels per day (bpd) by the end of 2017, up from roughly 2.1 million bpd today, and could reach three million bpd by the end of 2018 – a nearly one million bpd jump in two years. Permian production growth could according to some hamper the oil price recovery that is expected from OPEC’s output cut agreement signed late last year. A major victim of this increased focus on Texas and New Mexico could be Canada, where oil plays require more investments and longer-term developments, and where major producers are now selling oil and gas assets and writing down reserves.

Canada was once thought to hold the world’s third-largest trove of crude, largely due to the oil sands in northern Alberta. Today, only about 20% of those reserves, or about 36.5 billion barrels, are capable of being profitable, according to energy consultancy Wood Mackenzie. Capital investment in the oil sands fell about 30% in both 2015 and 2016 and is expected to slide another 11% this year, according to the Canadian Association of Petroleum Producers.

That Canada’s oil sands look like a prime candidate for possible stranding should not come as a surprise. The energy return on investment (EROI) of oil sands – i.e. the ratio of energy output (returned) over energy input (invested) in the extraction process –  is significantly lower than that of conventional oil (Brandt et al, 2013, Poisson et al., 2013) or even than that of other unconventional resources such as U.S. tight oil.

The ongoing stranding of Canada’s oil reserves is however a major problem for a country that has made its economy increasingly dependent on fossil fuel extraction over recent decades. It’s fairly well known that Canada is, amongst industrialized countries, the largest single emitter of greenhouse gases (GHG) on a per capita basis. Climate change analyst Barry Saxifrage even argues that Canada has become one of the world’s largest ‘extractors of climate pollution’ per capita. Canada, he says, has built “an economy that must dig up and sell extremely high levels of climate pollution per capita – in the form of fossil fuel carbon — just to function properly.” The fossil fuels dug from the ground last year in Canada contained 32 tonnes of CO2 (tCO2) per capita – twice as much as Americans, five times as much as the Chinese, and ten times as much as the European Union. That, says Saxifrage, is how much climate pollution Canada now needs to be able to sell each year for its economy to function properly.

co2-extracted-per-capita-1

It was not always that way, though. Back in 1990, Canadians extracted only slightly more carbon pollution per capita than Americans. Since then Americans have reduced their CO2 extraction and Canadians have dramatically increased how much they dig up – by an additional 10 tCO2 per capita.

co2-extracted-per-capita-2

Canadians are supersizing their CO2 extraction and with it their climate impact and their carbon dependency. Canada is even planning gigantic increases on top of that. The Canadian government’s most recent National Inventory Report to the United Nations projects dramatic and ongoing increases in CO2 extraction per capita, up to around 36 tCO2 in 2030 – with all the increase expected to come from a massive surge in bitumen extraction (i.e. bituminous sands or ‘oil sands’). This surge may never happen, as oil sands reserves now seem destined to be abandoned by oil majors. Should it happen, however, it would convey significant risks to the stability of Canada’s climate and economy. Despite these growing risks, though, Canada’s leaders don’t seem to have any “Plan B” so far.

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