Too Much of a Good Thing

There is one Canadian province just bursting with joy–Alberta! With crude oil charging at $80.00 per barrel, all you can hear in Alberta is the sound of money. The only problem is that Albertan’s are not only hearing the money coming in, but also coming out–or rather, gushing out. In Alberta, amidst all this prosperity, costs of doing business, and by extension, costs of living as well, have reached the point of ridiculous.

By 2015, Alberta’s oil sands should be producing 3.0 million barrels a day, which is almost three times more than the current production levels. And by 2020, western Canada’s output should hit 4.7 million barrels per day. By all accounts this is huge, if for no other reason than while everywhere else the production is in decline, in Canada it is increasing.

But, with Alberta’s “good thing” came monstrous costs. The province lacks skilled workers, while the still-in-development- stages technology for separating crude from sand is creating production backlogs. The problem is that oil sands projects make financial sense only at high prices of crude futures. If we were to go back to prices of $40.00, or even $50.00, many projects would never leap off the proposal pages.

What is making Alberta’s costs hit the roof? Well, labor costs are outrageous and not necessarily accompanied with skill. For example, the need for pipe fitters is so dire that companies resort to hiring, for example, telemarketers and salespeople. And while this ad hoc labor force could be quite keen on doing a good job, it still has to follow a steep learning curve, which, in turn, creates more delays and costs more money. On top of that, once such workers are fully trained, they can go to competitors and name their price because they are hot in demand.

Then there is the issue of infrastructure, or lack thereof, rather. Instead of building railways to transport stuff to and from oil sands, the Alberta government opted to build highways. So now infrastructure prices are skyrocketing as well, from steel to truck tires to asphalt.

Most Canadians fume at gas pumps and direct all kinds of nasty words towards oil producers. But, believe it or not, those that actually develop oil sands have little impact when it comes to costs, which will be even truer once the development moves underground. You see, to get to underground oil sands, oil producers must inject steam into drill holes. The steam heats up the bitumen and transforms it into liquid form, at which point it can be pumped to the surface for processing. Obviously, this costs more money than conventional oil drilling since to make steam, developers must burn something else that is also in short supply– natural gas!

Sure, as long as crude oil prices are high, Alberta will be able to keep its “good thing” going. But, unless this downright giddy province finds a way to keep its costs down, crude price dips of even $5.00 or $6.00 could jeopardize profit margins and transform the economic landscape of oil sands from bad to worse in one clean move.

For investors interested in oil sands plays, “Big Boys” Imperial Oil and Suncor historically keep their margins at safe levels and are capable of absorbing crude’s price dips. However, mid-level players, such as Petro-Canada might find themselves under earnings pressure should oil prices drop from current levels.