Depictions of the oil industry often involve images of geysering derricks, boisterous Texans and ultra-wealthy Arab sheikhs. Though these stereotypes have some element of truth in them, they conceal more than they illuminate about hydrocarbons in the 21st century. Conventional oil will remain the cornerstone of our energy economy into the forseeable future, but high demand, technological breakthroughs and political factors all suggest that unconventional energy sources are likely to play a crucial supporting role.
What is Heavy Oil?
Heavy oil is that which is extremely viscous, and very dense. Additionally, heavy oil tends to be very sulfurous or “sour”. Oil sand, or bitumen, is even more viscous, and by weight contains much less useful hydrocarbon than other crudes. Oil sands are composed primarily of clay, sand and water. Though oil gradation standards vary by country, heavy oil can be roughly defined as those crudes of less than 22° API gravity (American Petroleum Institute). Most standards bodies classify oil sands as distinct from heavy oil, but both pose similar extracting and refining challenges. Heavy oils such as these are generally used to produce fuel oil for heating, while light oil is more suited for creating gasoline and diesel.
The density, viscosity and impurity of heavy oil and oil sands makes extraction and transport much more expensive than “light” crude. It is necessary to dilute heavy oil before pipeline transport. Oil sands must pass through bitumen upgraders to become synthetic crude, or refined before long distance transport is viable. These costs are somewhat offset by the shallower depths of most heavy oil sources, decreasing drilling costs. Scientific advances and record prices have greatly improved profitability of heavy oil and oil sand extraction. Surface mining was once the only method of extraction, but in situ (in place) methods have made previously inaccessible deep oil sands viable.
Where is Heavy Oil Found?
The quantity of these unconventional hydrocarbon resources is immense. Some estimates peg the worldwide totals as approaching twenty trillion barrels of oil sands alone. Though not all of this is recoverable, it illustrates the potential value of heavier crudes.
Heavy oil is often found in deposits and formations with lighter, sweeter oil, and therefore all major oil-producing countries possess some heavy oil. However, large-scale extraction has thus far been largely concentrated in Canada, Venezuela, and the Soviet Union successor states. Venezuela’s Orinoco heavy oil belt and Canada’s Athabasca oil sands are the most notable projects worldwide. Recent prices have also spurred traditional light crude producers into reexamining their heavy oil reserves. The best example of this is Saudi Aramco’s recent announcement that it will construct multiple new refineries for heavy crude over the next decade.
Investing in Heavy Oil
So long as oil prices remain high, heavy oil and oil sands will be part of the fossil fuel economy. As energy prices have climbed over the past years, unconventional hydrocarbon projects have experienced a boom surpassing that of the late 1970s. Those extracting heavy oil and its close cousin oil sand have been among the chief beneficiaries of increasing energy prices.
Investors expecting dramatic decreases in oil prices should limit their exposure to heavy oil companies. The Canadian National Energy Board estimates “that US$30 to $35 per barrel for WTI [West Texas Intermediate Crude] is required to provide a 10 percent real rate of return to the producer.”
Most private investment has been concentrated in Canada so far. Several structural factors favour Canada’s unconventional oil sector. Most importantly, it has the largest reserves of unconventional oil in the world. “Alberta’s three major areas contain approximately 1.7 trillion barrels of bitumen in place; proven measures indicate there are 173 billion barrels of recoverable oil in the oil sands.” As well, America is the world’s thirstiest consumer of oil. These complementary facts allowed Canada to recently overtake Saudi Arabia as the leading supplier of oil to the U.S. Proposed North-South pipelines are likely to accelerate this trend in the future. A more tentative plan to create pipeline capacity to the Pacific Coast would allow Canadian heavy oil to reach Japan and the increasingly thirsty Chinese market. Finally, Canada has a combination of effective regulatory bodies, transparent government and publicly-traded oil companies that is extremely rare in oil exporting countries.
Investing in Canada’s oil sector is not risk-free, however. Alberta’s superheated economy has resulted in a chronic skilled labour shortage. Input costs are rising as demand for steel, energy and equipment grows worldwide. The American desire for more environmentally friendly energy also poses a significant risk. The U.S. Congress has already begun to act, passing the Energy Independence and Security Act of 2007, which prohibits Federal agencies from using fuel sources unless the lifecycle greenhouse gas emissions of that fuel are “ less than or equal to such emissions from the equivalent conventional fuel produced from conventional petroleum sources.” Though this clause will likely be amended or removed, it illustrates a legislative and political environment that must be watched carefully.
These uncertainties have led some players to slow down investment in the Canadian heavy oil/ oil sands sector. StatoilHydro ASA (NYSE:STO) and Nexen Inc. (TSE:NXY) have asked for a clearer idea of forthcoming regulations before they continue accelerating their involvement.
Venezuela’s reserves of unconventional oil are roughly analogous to Canada’s, and existing infrastructure supplies the United States, but the political dynamics are unstable. President Hugo Chavez’s sweeping nationalization of the energy sector in 2007 and subsequent poor management of the Venezuelan state-owned oil company PDVSA have helped create a profoundly underperforming energy sector. Chavez’s government has systematically appropriated PDVSA’s profits to fund social programs, with predictable consequences. Exploration, maintenance and equipment procurement have all suffered. In the near future Venezuela will need foreign investment in its oil sector, but is more likely to ask state-owned energy companies than publicly traded ones. The savvy investor should therefore keep an eye on developments in Venezuela, but not hold out hope for significant change in the near future. Russia and the post-Soviet states have a similarly hostile investment climate.
With demand for oil continuing to grow in the developing world and supplies straining to keep up, a timely investment in unconventional hydrocarbons may soon look like a bargain. Barring a massive decrease in crude prices, or the sudden discovery of a cheap, environmentally friendly energy source, heavy oil and oil sands will remain profitable commodities. The 21st century may therefore see the creation of a new oilman stereotype; the polite Canadian.
