Debate has intensified in 2010 over the future of upgrading bitumen in Alberta. In August 2009, the Alberta Department of Energy issued a Request for Proposals for the processing of Crown Royalty Bitumen. Later in 2009, Imperial Oil announced that bitumen produced from its Kearl Lake project would not be upgraded in Canada, but would instead be sent to the United States for refining. Suncor has also suggested that bitumen produced from its Firebag 3 project would be sent to the United States for further processing. At the Progressive Conservative Association of Alberta’s 2009 Annual General Meeting, members passed a resolution calling for, among other things, the Government of Alberta to stop the shipment of unrefined bitumen to other jurisdictions.
To appreciate the positions that have been and are being taken by various parties interested in the debate over the future of upgrading in Alberta, it is necessary to place in context the chemical / refining processes involved and then relate them to upgrader economics. At its most basic level, upgrading involves refining bitumen, which is a thick tar-like substance extracted from oil sands, by breaking down the complex molecules, and removing acid and sulphur content, to make synthetic crude oil (SCO), a much lighter oil that can be processed by refineries and distilled into naphtha, distillate, gasoil, and residential fuel oil, and further processed into refined petroleum products (RPP) such as gasoline, diesel, jet fuel and lubricants.
The process of upgrading generally falls into two categories: (1) carbon removal and (2) hydrogen addition. The most common form of carbon removal is referred to as “coking”, whereby heat and other catalysts are used to produce lighter oils and a solid carbon by-product; hydrogen addition, also known as “hydrocracking”, involves adding hydrogen which ultimately cracks or breaks the longer molecules that form bitumen into lighter oils. Each process has advantages and disadvantages. Coking is generally cheaper, but it ultimately yields less oil since approximately 15% of the original volume of bitumen produces coke, a charcoal-like solid, which is then burned as fuel or disposed of as waste. Hydrocracking is more expensive because it relies on the use of natural gas as a fuel-stock which must then be converted into hydrogen, but because there is effectively an addition to the bitumen, it yields more SCO than the original volume of bitumen. By using the process of hydrocracking, every 100 barrels of bitumen yields more than 100 barrels of SCO.
Integrated versus Merchant Upgraders and the Economics of Upgrading
Upgrading has historically been integrated with existing oil sands mining or in situ operations in Alberta, but there is nothing to suggest that an upgrader cannot "stand alone" and operate on a fee-for-service basis as a merchant upgrader, securing a supply of bitumen from oil sands producers and then returning the upgraded SCO to the oil sands producers for further refining. Whether SCO is produced from an integrated or a merchant upgrader, refineries set pricing for the SCO that they purchase based on the value of RPPs ultimately produced by the refinery and sold in the market.
Decisions about whether an upgrader will be integrated with an existing project or operated as a merchant facility depend on project economics, and economics in the current market are extremely complex. For example, an upgrader coking facility in Alberta has typically cost billions of dollars to construct and, if recent history is any indication, is costing more than double what a similar facility costs on the Gulf of Mexico Coast. Capital costs of such facilities have tripled over the last 10 years. At the same time, one of the key economic drivers affecting upgrading is the “light-heavy differential” - the difference between the market price for a barrel of light crude and a barrel of heavy oil. Bitumen and heavy oil currently sell at a discount to light oil because heavy oil requires upgrading before it can be refined into higher value products like gasoline or diesel. Aside from the actual per barrel cost of upgrading, the light-heavy differential is influenced by the capacity of refineries to process bitumen. When refineries have excess capacity, the demand for bitumen and heavy oil, and their respective market prices, will rise and the price differential between light and heavy barrels will shrink. If, on the other hand, there is a shortage of refining capacity (because more light crude is available to refineries), the supply of bitumen in the market increases, the price of bitumen will drop, and the differential will widen. Upgraders are generally considered viable (economically) when the differential is wider than $20.00 per barrel and highly profitable when the differential approaches $30.00 per barrel.
It is undoubtedly frustrating for both oil sands producers and upgraders that the differential price has ranged from a high $45.00 U.S. per barrel to a low of $3.00 U.S. per barrel and that the volatility of the differential price, as measured by the Montreal Exchange as the standard deviation of prices over a 30-day period, has ranged from a high of 516% to a low of 27%. In an attempt to overcome this market volatility in differential, the Montreal Exchange, by circular dated May 14, 2010, has indicated an intention to begin listing a futures contract for Canadian heavy oil, being the differential between the prices of Western Canada Select Heavy Crude Oil (WCS) and West Texas Intermediate Light Sweet Crude Oil (WTI). By way of benchmarking only, as of May 31, 2010, the light-heavy differential was hovering around $22.75 per barrel.
Another factor influencing upgrader viability within a mining or in-situ production operation is the "netback", or the price received for bitumen less the cost of bitumen transportation, blending, and marketing, which the project developers expect to receive, and the extent to which this netback offsets the capital cost and otherwise removes risk from any decision to develop an upgrader. Given the exceedingly high cost of building a coking facility in the current economic environment, there would need to be a higher likelihood that the netbacks would be substantial before an upgrader project would proceed.
The Debate Over Upgrading in Alberta
The debate over upgrading in Alberta is divided between those who believe in an "Alberta Upgrading Advantage" - that bitumen must be upgraded in Alberta and those in the "Free Market" camp, who believe that market forces will properly dictate how and when upgraders will be built.
Alberta Upgrading Advantage
The Alberta Upgrading Advantage supports having Alberta’s bitumen and heavy oil upgraded locally, whether via merchant upgrading or integrated within projects, including such proposed projects as the Northwest Upgrader, Heartland Upgrader, Fort Hills Upgrader, or those proposed by Total E&P Canada or Statoil. This approach will assist in securing Alberta's long-term industrial future by enabling the Province to attract and keep skilled tradesmen and those trained and experienced in the operation and maintenance of upgraders.
The National Post, in paraphrasing from the Book of Joshua, has described Alberta and Canada as "hewers of bitumen and drawers of crude", suggesting that Canada is supplying raw materials to the United States, where greater product value is ultimately created. The National Post argues that in the case of the oil sands, the shipment of bitumen to the United States could become the greatest loss of economic value for any country in world history. It has even been suggested that Canada risks being turned into an exploited “banana republic”, and should instead follow the lead of Venezuela and require that all new oil sands production be upgraded in the Province as of 2015.
Another rather sophisticated argument advanced by those endorsing the Alberta Upgrading Advantage is that with the completion of the Keystone Pipeline and the Alberta Clipper Pipeline which are aimed at carrying significant volumes of bitumen to the United States, any attempts to later cut back shipments in the case of an emergency would put Alberta and Canada offside the provisions of Article 605, the proportionality clause, of the North American Free Trade Agreement. Some contend that this clause would prevent Alberta from reducing shipments of bitumen to the United States in the event of an energy crisis, unless a similar reduction was made to Canadian consumers. This, it is argued, would be unacceptable in the event of an energy crisis, when Alberta should otherwise be redirecting supplies of bitumen to satisfy domestic needs elsewhere in Canada.
Free Market Arguments
The Free Market proponents argue that it is folly to intervene in a market that is currently expressing no need for new upgrading facilities. The logic, as expressed by one commentator, suggests that any excess upgrading capacity must be filled first, and that expansion of existing facilities will occur second, since those expansions, such as the expansion of Shell’s Scotford Upgrader, are less costly than greenfield construction of new facilities. Only upon the fulfillment of the first two conditions does it make sense to pursue the construction of new upgraders.
Currently, analysts are noting that there is excess refining capacity in North America. Reduced heavy oil supplies from Mexico and Venezuela have caused the light-heavy differential to shrink, resulting in producers getting a higher price for bitumen not upgraded into SCO. It has become more cost-efficient for producers to simply ship bitumen to existing refineries for processing rather than implementing their own integrated or merchant upgrading plans.
The Free Market proponents simply refer to current economic reality:
- Imperial Oil’s Kearl Lake and Suncor’s Firebag 3 oil sands projects are being developed with a predisposition anticipating transport of bitumen to the United States for upgrading and refining;
- US refineries in both the mid-west and along the Gulf Coast are spending a reported $56 billion to retrofit their facilities to process daily over one million heavier barrels of raw bitumen as opposed to lighter SCO;
The free market argument was succinctly stated by columnist Deborah Yedlin when she noted that "If Imperial Oil can’t make the [upgrading] numbers work in Alberta, who can?"
Two of the most interesting initiatives supporting the Alberta Upgrading Advantage side of the debate are the Government of Alberta’s Bitumen Royalty in Kind, or BRIK, Program and a proposal calling on the Government of Alberta to require that bitumen be upgraded in Alberta and, if necessary, blocking the shipment of unrefined bitumen to destinations outside the Province.
The Bitumen Royalty in Kind Program
Under section 34(3)(a) of the Mines and Minerals Act (Alberta), royalties are deliverable in kind unless stated otherwise. The Alberta Department of Energy has stated its intention to take its bitumen royalty in kind and in July 2009 issued a Request for Proposals for the processing of Crown royalty bitumen. The proposal required proponents to either (a) purchase between 50,000 and 75,000 barrels of bitumen per day and irrevocably commit to upgrade those barrels in Alberta, or (b) offer to process Crown royalty bitumen and then elect to offer product selection and/or marketing services in addition to the processing services.
By mid-May 2010, the Province had announced that negotiations were underway to build a new "bitumen refinery" as part of BRIK Program. While by no means a "done deal", North West Upgrading, in venture with Canada National Resources Limited ("CNRL"), proposed to build northeast of Edmonton and in three stages a 150,000 barrel per day refinery intending to go beyond upgrading (to SCO) to include higher value products such as diesel fuel. Upon completion, North West Upgrading would process 75,000 barrels per day of BRIK on behalf of the Province, and would have additional capacity to support CNRL or other bitumen producer upgrading initiatives as well.
While by no means a full upgrading industry solution, the proponents of this strategy maintain that there would be considerable economic return associated with the project.
Compulsory Upgrading in Alberta
In the Fall of 2009, the Edmonton Whitemud constituency of the Progressive Conservative Association of Alberta passed a resolution calling on the Government of Alberta to embargo the shipment of unrefined bitumen to other jurisdictions and, if necessary, legislate that bitumen be upgraded in Alberta. This resolution, while not binding, was delivered to the Progressive Conservative caucus and is intended to influence government policy.
The Future of Upgrading in Alberta
While at first blush there does not appear to be any middle ground in the debate over whether bitumen must, or even should, be upgraded in Alberta, that may be an oversimplification of the issue. The continuing uncertainty concerning the "heavy – light differential" that would affect a producer's decision to proceed with upgrader development may well be circumscribed by the maturing of the heavy oil market and the trading of futures contracts. The currently less than robust economics surrounding Alberta upgrading will be influenced by (a) the BRIK Program, (b) additional merchant upgraders supporting technological innovation, (c) the development of additional pipelines to markets out of Alberta (and whether such pipelines make allowances for diluent such that diluted bitumen may be easily exported), and (d) the forecasted increase in oil sand production from approximately 1.2 million barrels per day to 2.3 million barrels per day by 2020.
Only time will tell as to whether both strategies can co-exist. What is certain is that heated debate will continue in 2010 as Alberta oil sand development becomes increasingly viable and capital projects are resurrected.