June 28, 2020

Canada’s Oil Sands: Recent Troubles And Prospective Challenges

By Matthew McIntosh

COVID-19’s impact on state lockdowns and reduced travel combined with the Saudi-Russian oil price war – which flooded the global market with oil from these respective states – resulted in lessened global oil demand in the first four months of 2020, causing oil prices to consequently decline in this time period (Varcoe, 2020). The oil price drop in Western Canada has been severe, as the monthly average price of Western Canadian Select (WCS) – which is the benchmark oil blend of the Canadian oil sands – declined by 90.49% from US$36.82/bbl in January 2020 to US$3.50/bbl in April 2020 (AB Gov, 2020b).

The oil price drop has taken a heavy toll on Canada’s oil sands, which are located almost exclusively in the province of Alberta, accounting for 96% of Canada’s oil reserves and 64% of Canada’s oil production in 2018 (Varcoe, 2020; NRCAN, 2020). As of May 8th, 2020, oil sands companies have announced reductions in capital spending of at least CDN$8.5 billion (Orland, 2020). While these statistics provide a brief insight into the negative impact of the oil price collapse on the oil sands in the first half of 2020, the future prospects of the oil sands must be considered through a detailed analysis of the various challenges faced by this subsector.

This report argues that the Canadian oil sands will likely continue to be challenged for the remainder of 2020 and into 2021. The report supports this assertion by identifying the uncertainty regarding future global oil prices, the lack of a unified governmental response to the oil sands troubles, and the challenging recovery process based on an uneasy compromise of oil ambitions and environmental responsibility.

Prior to explaining these points of support, the report will first explain the financial and environmental reputation challenges that are currently faced by the oil sands. Second, the report will consider the response to the crisis from both the Alberta Provincial Government and the Canadian Federal Government. Third, the report will then reflect upon the current challenges to the oil sands and the governmental responses in order rationalize its main points of support for the assertion that the oil sands will likely continue to be challenged for the rest of 2020 and into 2021.

Understanding the Financial Damages to Canadian Oil Sands Companies

The ongoing struggles for the oil sands companies are particularly severe due not only to financial damages from the economic and energy crises, but also due to environmental reputation issues. Beginning with the financial damage, oil sands companies are under financial duress in part because of the low relative price/bbl of oil sands oil and also due to its steep production costs.

First, the oil from the oil sands is valued less in comparison to other global benchmark oil blends. Indeed, from January to April in 2020, the average of monthly prices of global benchmarks of Brent crude (US$42.43/bbl) and West Texas Intermediate (WTI) (US$38.46/bbl) exceeded the same price average of WCS ($US20.11/bbl) by considerable margins.

The low price of oil from Alberta’s oil sands is the result of three key variables. First, oil coming from the oil sands has a high density (hence the use of the term ‘heavy’ in the phrase ‘Canadian heavy oil’), meaning that it is comparatively more challenging and more expensive to refine as compared to WTI and Brent, which are both ‘light’ or less dense oil blends (Alberta Energy, 2015; OSM, 2018). Second, the oil from the oil sands is marketable to practically only US refineries, as the US is one of the world’s largest importers and refiners of crude oil and Canadian refineries are relatively simple and are typically at capacity (Ibid.,). In essence, limited marketability means that demand for oil sands oil is not as strong as other oil blends, thereby lowering the price (Ibid.,). Third, there are transportation logistics, as Canadian heavy oil is most often destined for the US Gulf Coast, yet the pipeline network to the Gulf has traditionally been limited, resulting in high transportation costs (Ibid.,). In contrast, Brent crude, located in the European North Sea, can be easily accessed to coastal ports and can be transported cheaply due to low costs to move oil in light tankards (Alberta Energy, 2015). The Canadian Association of Petroleum Producers contends that the lack of pipelines has caused the decline in oil sands investment since 2014, with an average CDN$21.5 billion decline in annual investment in the oil sands from 2014-2017 (CAPP, 2019).

These interdependent variables make WCS, for instance, cheaper than WTI and Brent crude – the likes of which are lighter oil blends and are easier to refine, have higher marketability to that of WCS, and can be transported more ably and cheaply than WCS (Alberta Energy, 2015; OSM, 2018). This explains why the average annual prices of WCS from 2010-2019 was US$54.93/bbl, which is significantly less than the average annual prices in the same time period for both WTI (US$72.47/bbl) and Brent crude (US$79.58/bbl).

The second financial factor to consider is that Canadian heavy oil production cost is also high, making this type of oil very cost-ineffective for oil sands companies in 2020. As explained by Wood Mackenzie, oil sands producers require US$45/bbl Brent, on average, to cover the cost of production before capital expenditure (2020). Therefore, with Brent crude’s average monthly price being US$18.38/bbl for the month of April, Alberta’s oil sands producers lost, on average, US$26.62 for every barrel of oil produced in April (USEIA, 2020a).

Yet, even now with greater travel through lockdown restrictions being loosened and the OPEC+ deal helping to steer oil prices slightly upwards through agreed production cuts, oil sands companies are still losing money through oil production (Healing, 2020). For instance, even with Brent being US$41.18/bbl on June 10th, oil sands producers still consequently lost, on average, $US3.82 for every barrel of oil produced on June 10th (USEIA, 2020a).

The low price and high production costs – in addition to COVID-19 forcing companies to limit projects and spending to prevent the virus’ spread – helps to explain why many oil sands companies have made cuts to budgetary expenditures for 2020. Overall, by May 8th it was reported by BNN Bloomberg that Canadian oil and gas producers, pipeline operators, and service companies had announced plans to cut as much as CDN$11.4 billion in capital expenditures in 2020 (Orland, 2020). Such a reduction would amount to more than the whole CDN$10.7 billion that was invested in oil sands production in 2019, meaning that the recent spending cuts across the Canadian energy sector have effectively eliminated all the of new capital that oil sands growth was expected to acquire in Alberta in 2020 (Ibid.,).

Furthermore, if Brent were to average US$35.00/bbl for 2020, it is anticipated that corporate cash flow from the oil sands, as a subsector, would be US$17 billion in the red – the likes of which is a very real prospect considering that the average of monthly prices for Brent from January to May 2020 is US$39.82/bbl (Wood Mackenzie, 2020; USEIA, 2020a). Ultimately though, financial losses are not the only issue that has hamstrung oil sands companies this year, as environmental concerns about the oil sands continue to be raised.

The Negative Environmental Reputation of the Oil Sands

Indeed, the oil sands are also troubled by ongoing environmental reputation issues. Canadian heavy oil (oil coming from the oil sands) is mostly made up of Bitumen, which is often buried deep into the earth, requiring in-place (or in-situ) extraction process) (Leahy, 2019; Stenhouse et al., 2019). With 80% of oil sands extraction being in-situ, the extraction method for in-situ facilities is steam-assisted gravity drainage (SAGD), which consists of forcing steam into sub-surface oil sands deposits to heat the bitumen locked in the sand, allowing it to flow well enough to be extracted (Stenhouse et., al 2019; Lloyd, 2018). This use of steam causes greenhouse gas (GHG) emissions (Leahy, 2019). Only 20% of Alberta’s bitumen reserves are close enough to the surface to be mined, which typically is responsible for fewer GHG emissions in the extraction (via mining) process but still leaves tailing streams and higher water usage (OSM, 2020).

The key thing to consider though is that the emissions of carbon dioxide for bitumen development and pre-processing are about 110 kg per barrel, which is triple the amount for a barrel of conventional crude (Stenhouse et al, 2019). In-situ extraction operations account for about half of this – the likes of which is 60 kilograms of carbon dioxide per barrel of bitumen (Ibid.,).

With the growing knowledge of the oil sands environmental impacts, an April 2019 Environment Canada report outlined that four major mines – run by Suncor, Syncrude, and Canadian Natural Resources Limited – released an average of 33% more carbon dioxide per barrel of oil than what had initially been reported for 2013 (Weber, 2019). As such, while oil sands companies have not only lost investment in the last five years through limited pipeline access to the US market, the growing doubt over environmental credibility and the knowledge of the oil sands emissions have also swayed away environmentally conscientious investors in 2020.

On February 12th, BlackRock – the world’s largest asset manager – claimed that one of its fast-growing green-oriented funds would stop investing in companies that create revenue from the Alberta oil sands (Flavelle, 2020). Armando Senra, head of BlackRock’s iShares Americas funds, said that the oil sands and coal are “the worst offenders, if you want, from a climate perspective” (Ibid.,). Then, on May 13th, the Norwegian central bank excluded Canadian Natural Resources, Suncor Energy, Cenovus Energy, and Imperial Oil from its $1-trillion sovereign wealth fund (SWF) (Global News, 2020). These four Canadian oil and gas companies were omitted from the world’s largest SWF for their excessive production of greenhouse gases, making this the first use of carbon emissions as a criterion to blacklist energy firms (Ibid.,). This decision came after Kommunal Landspensjonskasse (KLP), Norway’s largest pension fund, decided in early October, 2019, that it would stop investing in companies deriving their income from oil sands (Klesty et al., 2019). Jeanett Bergan, KLP’s head of responsible investment, expressed the decision was made due to the high emissions resulting from Canadian heavy oil production (Bakx, 2019).

Unfortunately, the financial damages suffered by oil sands companies due to the downturn in oil prices have made environmental initiatives challenging to pursue. As of June 14th, 2020, Suncor Energy, Canadian Natural Resources and Cenovus Energy have cut a combined US$1.32 billion in planned spending on green initiatives (Nickel and Lewis, 2020). As such, this double whammy of financial losses and persistent environmental issues amidst COVID-19’s impact on economic growth has presented governments – both provincial and federal – with a conundrum as to how to bolster this subsector.

The Alberta Provincial Government’s Undeterred Pursuit of Oil and Downplaying of Environmental Concerns

The Conservative Alberta Government, led by Premier Jason Kenney, has vowed to maintain the strength of the oil sands. With the Oil, Gas, and Mining sector being the highest contributing sector to Alberta’s economy – representing 16.3% of GDP in 2017 – Kenney’s current commitment to the oil sands is understandable; especially when considering that the oil sands accounted for 64.5% of Alberta’s energy revenues in 2017 (AB Gov, 2019). Due to this oil-based economic model though, the Royal Bank of Canada’s (RBC) June forecast for Alberta to undergo a real GDP growth of -8.7% in 2020 is due primarily to the 2020 oil price decline. This will be the second oil-related economic contraction in recent memory, as WCS declined by 81.2% from June 2014 (US$86.85/bbl) to February 2016 (US$16.30/bbl), resulting in Alberta’s annual GDP growth rate (at basic prices) declining from 5.88% in 2014 to -3.64% in 2016.

The Alberta government’s commitment to oil was displayed quickly through its announcement on March 20th to fund the industry levy for the Alberta Energy Regulator for six months, achieving CDN$113 million in industry relief (Keller et al., 2020). A key moment occurred on March 31st when the Alberta government announced its decision to invest US$1.1 billion in TransCanada (TC) Energy’s Keystone XL pipeline (AB Gov, 2020a). The 1,947 km long (1,210 miles) pipeline is intended to be ready by 2023, pumping 830,000 barrels per day of crude oil from Hardisty, Alberta to Steele City, Nebraska and generating an estimated $30 billion in tax revenues for future generations of Albertans and Canadians (Ibid.,).

Yet, a series of US legal developments have stymied construction process in the US. Chief U.S. District Judge Brian Morris of the District Court in Montana made a ruling on April 15th that cancelled the U.S. Army Corps of Engineers’ Nationwide Permit 12, which allows dredging work on pipelines across water bodies in the US (Brown, 2020). Morris said that the Army Corps did not adequately consult with the U.S. Fish and Wildlife Service on risks to endangered species and habitat when it renewed the permit in 2017 (CBC, 2020). While the Trump administration requested to revive this permit program, a US appeals court in California on May 28 declined this request, resulting in the Trump administration asking the U.S. Supreme Court to revive a permit program as of June 16th, 2020 (CBC, 2020; Washington Post, 2020).

Whilst waiting upon the supreme court’s ruling, these legal developments, for the time being, will effectively halt the construction of the pipeline across US waterways, thereby likely delaying the project’s completion in the US. Moreover, these environmental concerns have been raised by US Democratic Presidential candidate Joe Biden, arguing that the oil sands impact on the environment must be mitigated by not committing to Keystone XL (Mertz, 2020). Premier Jason Kenney of Alberta responded to Biden, stressing America’s dependence on Canada’s energy exports (Ibid.,).

In spite of this environmental reputation to Keystone XL, the Alberta Energy Regulator suspended a wide degree of environmental monitoring and reporting for the oil patch amidst COVID-19 (Weber, 2020). For instance, companies no longer have to monitor fumes emitted by burning or conduct programs to detect and mend methane leaks, which is a potent greenhouse gas (Ibid.,). While this policy is implemented to prevent COVID-19’s spread, it nonetheless does not help the negative environmental reputation of the oil sands.

Accordingly, it is apparent that amidst COVID-19’s spread the Alberta government remains committed to the oil sands first before the environment. The Federal Government’s response though is rather different, and must consequently be considered.

The Federal Government’s Limited Support For Oil Sands And Concern for the Environment

COVID-19’s forced lockdown of states and subsequent reduced economic activity accounts for the majority of Canada’s forecasted -5.9% real GDP growth for 2020 (RBC, 2020). Yet, the oil sands certainly play a role in the Canadian economy, as oil sands companies spent CDN$3.2 billion on supplies and services from 2,230 companies in the 9 provinces and 3 territories outside of Alberta from 2016-2017 (CAPP, 2020). Moreover, the 2014-2015 decline in Canadian GDP growth from 2.87% to 0.69% following the previously mentioned collapse of global oil prices in 2014 provides an understanding of how the oil sands decline in 2020 will also impact Canadian GDP growth (RBC, 2020).

Given the role of the subsector to the Canadian economy, with oil sands companies experiencing financial losses and a growing negative environmental reputation, Canadian Prime Minister Justin Trudeau implemented financial packages that are supportive to the oil sands but still support the Liberal Federal Government’s environmental outlook. In particular, the Federal Government began offering bridge financing under the Large Employer Emergency Financing Facility (LEEFF) program for big Canadian businesses across all sectors as of May 11th (Bakx and Seskus, 2020). With every applying company being subjected to an upper cap loan amount, companies receiving the loans must, however, also disclose their environmental plans (Ibid.,).

The LEEFF program has received mixed responses. As explained by Athabasca Corp’s CEO Rob Broen, there is a lack of clarity coming from the Federal Government as to how a company can qualify for LEEF (Paraskova, 2020). Moreover, other executives, such as Todd Brown of Cequence Energy Ltd, feel that their ineligibility for federal financial relief raises questions as to whether the Federal Government is sincerely intending to help the oil industry (Ibid.,). Notwithstanding this skepticism from oil sands companies, Alberta Finance Minister Travis Toews believes that it should help viable oil and gas companies ride out an economic slump (French, 2020).

Verdict, Review of Findings, and Prospects for the Canadian Oil Sands

In reflection of the report’s findings above, this report contends that Canada’s oil sands will likely continue to be challenged for the rest of 2020 and into 2021. This assertion is supported by the amount of uncertainty regarding oil prices, the different governmental responses to the oil sands crisis, and the challenging recovery process based on an uneasy compromise of oil ambitions and environmental responsibility.

First, there is considerable uncertainty regarding global oil prices. Although global oil prices have rebounded since their low point in April, the International Energy Association and the US Energy Information Administration both speculate that global demand will still remain below pre-pandemic levels by the end of 2021 (Lee, 2020a). In particular, future prices will depend in part on how well OPEC will manage the global oil supply over the coming months and how well countries comply with current and future proposed production cuts. While OPEC+ compliance has generally been strong and is anticipated to improve over the coming months, supply from non-OPEC members in the second half of 2020 is anticipated to be about 300,000 barrels per day higher than previously thought, as there is no method to ensure compliance for non-OPEC members (Resnick-Ault, 2020; CNBC, 2020; Lee, 2020b). The same can be said for even OPEC members, as the use of secondary sources to monitor production levels has resulted in inaccurate reporting on Nigeria’s productions cuts in May, while the mechanism used to punish errant OPEC producers like Iraq ­– who produced roughly 600,000 barrels per day over its agreed limit for the month of May – remains unclear (Lee, 2020b; Turak, 2020).

At the same time, oil sands companies’ ability to recover is dependent upon the containment of COVID-19, as a second wave of COVID-19 in the second half of 2020 will force the perpetuation of lockdowns. (IEA, 2020a; IEA, 2020b). This of course would result in another downturn in oil demand and subsequent low global oil prices, causing oil sands companies and this subsector as a whole to financially suffer further losses. (Ibid.,). Therefore, with there being no sure way of predicting with certainty how OPEC compliance and COVID-19 containment efforts will unfold, there is still uncertainty regarding oil prices, which supports the argument that the oil sands will likely continue to be confronted with challenges.

Second, there very likely will continue to be mixed support measures for the oil sands between the Alberta Provincial Government and the Canadian Federal Government. On one hand, the Alberta Provincial Government will continue to support the oil sands with environmental concerns taking a back seat for the time being. This is displayed particularly in the loosening of environmental regulations and through the support of Keystone XL (Weber, 2020; Mertz, 2020).

On the other hand, the Federal Government will likely only support this subsector so long as this compromise between environmental focus and energy ambitions are maintained. Indeed, the Liberal Federal Government will look to comply with their environmental agenda, meaning that an oil sands bailout package will probably not be introduced. Accordingly, future federal support for the oil sands will likely continue to be limited to LEEFF. This lack of environmental responsibility and absence of a federal bailout will not aid the oil sands environmental reputations nor their financial circumstances, providing more reason for the likelihood of the oil sands continuing to face difficulty.

Third, even if global oil prices were to climb and there is a governmental commitment to infrastructure, the financial recovery of the oil sands ­– which is premised on finding a balance between oil ambitions and environmental compliance – will not be easy. Regarding oil ambitions, the Keystone XL project will still face challenges over the year, as recent US court decisions could still delay construction progress of the pipeline across the US (CBC, 2020). If key oil projects like Keystone XL continue to falter, it will make investors think longer over their reasons for investing in the oil sands.

Regarding the environment, the 2020 oil price decline has already forced more cautious expenditure planning as well as cuts to environmental spending, making financially burdensome environmental projects an unlikely pursuit for oil sands companies (Nickel and Lewis, 2020). While there are two carbon capture projects in the oil sands as of June 2nd, 2020, even amplifying carbon capturing for larger oil sands companies will prove difficult due to the high capital costs and the lack of a regulatory driver via recent loosening of environmental regulations (Bakx, 2020; Huot and Grant, 2012; Weber, 2020). Furthermore, the likelihood of many oil sands companies pursuing environmental compliance through LEEFF is challenging to calculate at this point in time, as there have been disapproving responses to LEEFF from many executives and officials from oil sands companies (Paraskova, 2020). Ultimately, if commitment to green initiatives continues to waver, then Canadian heavy oil producers will face difficulty in convincing investors and environmentalists of their role in a future lower carbon economy (Nickel and Lewis, 2020). Therefore, the pursuit of oil ambitions and environmental responsibility seems a challenging prospect, thereby furthering the chances of notable difficulties faced by oil sands companies in the future.

Concluding Remarks

In conclusion, due to the uncertainty regarding oil prices, the different governmental responses to the oil sands crisis, and the challenging financial recovery process – based on an uneasy compromise of oil ambitions and environmental responsibility – the Canadian oil sands will likely continue to be challenged for the rest of 2020 and into 2021. The oil sands will be the subject of considerable discussion over the coming months, but, more importantly, will also be subject to potential rapid changes given COVID-19’s spread and a tumultuous global oil market. As such, future reports that reflect upon the oil sands following developments over the summer months will be necessary to provide future insight into the risks and opportunities within this Canadian subsector.

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