Profits before people?

^{JUNE WARREN-NICKELS}

Special Report*

For a country with the world’s second largest oil reserves, Canada until recently received little attention on the energy security agenda. Its enormous resources — an estimated 175 billion proven barrels of oil — are almost all in the form of oil sands; a mixture of sand and thick, oily bitumen which can be upgraded to “synthetic crude.”

They were not, however, attractive while “lighter” and more easily accessible oil was freely available elsewhere, but since early this decade, resource nationalism in oil-rich countries and historically high prices have pushed big oil companies to pursue such “unconventional” reserves with great determination.

The resultant rush has been described as “the biggest industrial project on Earth:” capital spending on oil sands development in Alberta topped C$50 billion (US$ 47 billion) from 2000-2007, with well over C$200 billion in addition planned until recently.

Now, rising costs together with the fall in the oil price over the last several months, have stalled much of this investment. But when the oil price revives — as many expect it will — the rush could well resume.

For all their potential, however, the oil sands involve significant environmental challenges which — if not adequately addressed over the long term — could undermine the very value of these enormous investments.

The environmental challenges have been well documented: for example, the heavy water usage and inevitable impact on Alberta’s boreal forest involved in oil sands production have attracted strong criticism, though the industry vigorously defends its performance.

Producing a barrel of synthetic crude from oil sands also emits, according to some estimates, three to five times as much CO2 as producing a barrel of conventional crude. While the difference narrows considerably once emissions from the actual use of the oil (in cars, for example) is taken into account, developments in Greenhouse Gas regulation or carbon pricing nonetheless could impact heavily on the industry’s economic calculations.

Crude assumptions

Supporters of the oil sands tend to downplay this concern. As Alberta Premier Ed Stelmach put it, “I’m confident that by the time the regulations are put in place, we will meet or exceed” them. Such self-assurance appears to rest on two assumptions: that carbon constraints will not take effect for many years (especially given the world’s continuing need for secure oil supplies); and that by the time they do, oil sands production will be clean enough to comply. Experience may well prove both assumptions correct, but neither can be taken for granted.

While robust carbon regulation and pricing remain a distant prospect, there are signs that progress in this area could already be building momentum. In addition to moves by the Canadian and Albertan governments to begin cracking down on carbon emissions from industries in their jurisdiction, regulators have also been busy in the key market across the border, potentially restricting oil sands producers’ ability to sell their products in the US.

California is leading the way, having recently adopted a low carbon fuel standard requiring all transport fuel supplied to the state to meet a carbon-intensity standard over its life-cycle; numerous other states and the US Conference of Mayors (a club of major cities acting at the federal level) have also supported curbs on the use of high-carbon unconventional fuels. Importantly, President Barack Obama has proposed similar legislation nationally, while the US Congress has upheld, though not yet enforced, a separate 2007 law prohibiting the federal government from buying carbon-intensive fuels. Even the EU recently amended its Fuel Quality Directive, also with the aim of reducing the life-cycle emissions of its fuels.

It is not yet clear exactly how these new and proposed regulations will affect the sale of oil sands products; besides, as the industry has hinted, there is likely to be ample demand elsewhere should the US choose to close its markets. Nonetheless, when viewed alongside broader trends pushing for lower GHG emissions — not least the wider environmental reforms promised by President Obama and ongoing efforts at the UN to agree a post-Kyoto emissions regime — such regulations may suggest that the world is moving against CO2 faster than some oil sands executives assume. Reliance on countries’ thirst for oil consistently trumping environmental concerns may, especially regarding the US, be an increasingly risky strategy.

To an extent, to give due credit, the industry has taken this on board; companies accept that eventually their projects will need to get cleaner. Their greatest hopes are pinned on carbon capture and sequestration (CCS), which removes CO2 from emissions and injects it (hopefully permanently) underground; according to proponents this could eventually reduce some oil sands operations’ CO2 emissions by 75%. Encouragingly, Alberta’s government is taking a global lead on developing the technology, announcing in 2008 a C$2B fund to support CCS projects in oil sands and other heavy industries.

Capturing carbon and value

But it is far from clear that current efforts will prove sufficient to allow oil sands companies to meet forthcoming regulations. The first-stage commercial plants are expected to take several years, and the technology seems unlikely to have a substantial impact much before 2015.

This delay is partly inevitable due to the construction and testing times involved, but insufficient funding also may be holding back faster development. Companies have so far been reticent to commit substantial sums without government backing; given the investments at stake, it may be in their interests to take more responsibility for ensuring that CCS is developed quickly.

The case for doing so is strengthened by continuing doubts from some quarters that the technology will ever work effectively in oil sands projects. A recent Canadian-Albertan government joint report, for example, concluded that in oil sands operations “only a small percentage of emitted CO2 is ‘capturable’ since most emissions aren’t pure enough.” From the companies’ perspective the only way to dispel such doubts may be to quickly build CCS plants that demonstrably work.

Alongside more strenuous efforts to prove the technology, meanwhile, the industry also needs to engage energetically and over the long term with regulators to ensure that emissions reductions derived from CCS are taken into account when the life-cycle carbon intensity of oil sands products are assessed. Otherwise their CCS investments may not protect demand for their product as they intend.

Insufficient activity in these areas could be leaving some oil sands producers with little margin of error should carbon regulations hit harder and sooner, or should CCS present more difficulties than expected.

The potential business impacts of the environmental risks for oil sands are also beginning to be acknowledged by investors — both “ethical” and mainstream funds (albeit mostly the former). Co-operative Asset Management, a major UK investor, fears that “companies investing heavily in unconventionals are too focused on short-term profit and their strategy is too defensive”; F&C, Calpers and Calstrs (California’s public pension funds), among others, have also expressed concern that environmental performance could undermine the projects’ profitability.

In fact, it may perversely prove to be a blessing for the companies involved that the recent collapse in the oil price and the drying-up of finance has brought new investment in oil sands almost to a standstill. With the competitive imperative to keep pace diminished, companies can take time to test their assumptions about the long-term viability of their investments, and if necessary step up their work on CCS. Some may even decide against further investment until there is more certainty around the technology and around
imminent regulations. If such approaches are adopted, the industry might emerge from the current slowdown less frenzied but with its long-term prospects considerably more secure.

*Rob Foulkes is an associate and

*Daniel Litvin is director of Critical Resource, an advisory firm specialising in sustainability and stakeholder issues in the natural resources sector. Rob.Foulkes@c-resource.com,Daniel.Litvin@c-resource.com,www.c-resource.com.

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