Soaring costs plague oil sands

It was the Dutch pipe's fault.

For weeks, Bill Harper watched his 30-man crew wait -- and wait -- for a shipment of high-grade pipe from the Netherlands to arrive at Muskeg River.

It was the late fall of 2001, and Mr. Harper, a supervisor at Shell Canada Ltd.'s massive Athabasca Oilsands project in Northern Alberta, was watching his deadlines slip away with every missed shipment of pipe.

Engineers had chosen the Dutch pipe because a special coating made it tough enough to withstand the pounding from the slurry of oil and sand that would run through it at high speed and pressure.

An ideal solution on paper, the pipe became a big problem in practice. The delays meant that it took the crew five months to install the pipe, rather than the scheduled three months.

It also cost Shell lots more in expensive overtime, up to $110 an hour for each crew member. And the delays in laying the pipe threw off the schedules of other parts of the project. "It just was a ripple effect," says Mr. Harper, who first worked in the oil sands sector in 1976.

The ripples from the Dutch pipe -- and hundreds of other ripples -- have sent the cost of Alberta's oil sands megaprojects soaring in the past couple of years.

Shell Canada's main oil sands executive says the entire industry is struggling to understand what has caused the overruns. Neil Camarta, Shell's senior vice-president of oil sands, says that if costs can't be controlled, major new synthetic crude projects are at risk. "If there's going to be another oil sands megaproject, we have to break the back of that problem."

Shell's project, originally slated to cost $3.8-billion, carried a final price tag of $5.7-billion. The cost of Suncor Energy Inc.'s Millennium project shot up to $3.4-billion from a predicted $2-billion. Syncrude Canada Ltd., too, saw its project cost rise by $1-billion.

Even with those budget-smashing overruns, the projects went ahead.

But the shadow of those extra billions have cast a chill over capital investment in the sector. FirstEnergy Capital Corp. says nearly half of the $50-billion in investment being contemplated for the oil sands will likely be cancelled in the next five years, chiefly because of capital cost concerns.

Steven Paget, a research analyst at FirstEnergy, says the budget overruns at Shell, Suncor and Syncrude have changed the industry's mindset about the economics of producing bitumen and synthetic crude. "Oil sands were believed to be a much cheaper deal," he says.

However, the Canadian Association of Petroleum Producers says concern about diminishing investment in the oil sands is overblown. CAPP vice-president Greg Stringham says the FirstEnergy estimates reflect the consensus for the likely amount of capital spending in the oil sands. No one, Mr. Stringham says, ever expected all the projects to go ahead.

Mr. Paget, even while warning of deferred spending, points out that he is projecting an 8.7-per-cent annual expansion in oil sands production -- a growth rate that any oil-producing region will be hard pressed to match.

Still, the early signs of a capital spending slowdown, if not drought, are already emerging. In January, TrueNorth Energy LLP shelved its $3.5-billion project, citing capital cost concerns, as well as the impact of the Kyoto Protocol. Petro-Canada said last month that it is deferring spending on its oil sands expansion until it can find a way to get control of capital overruns. (Interestingly, Petrocan president and chief executive officer Ron Brenneman said that Kyoto -- for months, the bugaboo of the energy industry -- was not a significant factor in the decision to delay.)

Shell Canada has launched a massive review of its Muskeg River project, which Mr. Camarta calls a "lookback." The results aren't due until the end of the year, but the question of project scale is likely to be an important piece in the puzzle. Too large a project means there are too many chances for one element -- such as a piece of pipe -- to impede progress.

Big is bad in another way. Only a limited number of skilled tradespeople are available at the best of times; when megaprojects are competing for labour, a skills crunch quickly becomes a skills crisis.

Mr. Camarta says qualified supervisors are even harder to find. With one supervisor needed for every 10 workers, the pool of available foremen can be quickly depleted, he says.

Much has been written about the productivity problem in the oil sands, but Mr. Camarta emphasizes that the cost overruns do not stem from unionized workers leaning on their shovels. "We're not blaming the craftsmen," he says.

It's clear in speaking with the trade unions, however, that the question of labour costs has been a constant topic of discussion in Fort McMurray.

"There's enough blame to go around -- no one should feel left out," says Mike Buffham, north manager of the Alberta Building Trades Council.

Mr. Buffham says the proportion of "non-productive people" on oil sands projects is about the same as at other sites, around 2 per cent of the work force. The lack of qualified engineers is a more pressing problem than a skills shortage among tradesmen, he says.

Indeed, the productivity problem is much more than unionized workers being paid too much to do too little for too long. Logistical mix-ups, engineering challenges and the remoteness of the oil sands are all part of the complicated issue.

Fort McMurray, the economic epicentre of the oil sands, is hundreds of kilometres from any other major city. The distance, combined with the competitive labour situation, compelled firms such as Shell to keep craftsmen on the payroll, even when delays in material shipments might have meant layoffs in a large project in another location, says Mr. Harper, the oil sands supervisor. "You just can't keep laying guys off, bringing them back. You're talking about Fort McMurray -- there's quite a bit of cost in mobilizing them, housing them."

However, location isn't the only challenge.

Petrocan says it faces cost overruns of between 70 and 100 per cent on the first phase of its oil sands expansion, the conversion of a refinery outside Edmonton to process bitumen.

Mr. Brenneman, announcing the delay of engineering spending three weeks ago, said capital cost projections for the refinery had risen because major pieces of equipment and interconnecting pipelines were more expensive than forecast. The Petrocan CEO also pointed to lower labour productivity.

Oil sands operators have agreed on some solutions to rein in costs. Ensuring that at least 80 per cent of engineering planning is done before construction begins is now seen as a way to minimize the amount of work needed to be redone.

And the operators have begun to stagger their work to avoid the extra labour costs of overlapping projects, says Bill Almdal, executive director of the Athabasca Regional Issues Working Group Association, a group set up to deal with the stresses of oil sands expansion on the Fort McMurray area.

Shell's Mr. Camarta agrees that the overlap between the startup of his company's project and the latter stages of Suncor's was one of the many factors leading to a $1.9-billion overrun. "Two is one too many."

Yet, the industry remains divided on larger solutions to the productivity problem. Suncor Energy's president and CEO, Rick George, has said that his company may try to limit the size of future projects to less than $1.5-billion. Logistical difficulties begin to mount once a project gets much larger than that, he says. Canadian Natural Resources Ltd. endorses that view, and has split its Horizon project into relatively small segments in an effort to minimize cost overruns.

However, Mr. Brenneman questioned the logic of incremental investing in late April, saying much of the capital invested in the first stages of a project will stagnate until the last phases are complete.

The problem is clear, even if solutions aren't, Mr. Camarta says. If and when Shell goes ahead with its next oil sands project, an expansion at Jackpine Mine, it wants to be sure how to stick to the projected $2-billion budget, he says. "We don't want to be surprised again."

A costly resource

Soaring labour costs, productivity issues and logistical problems have knocked Alberta oil sands projects well off their budgets in recent years, threatening billions in capital investments.

High-case scenario: If all oil sands projects being contemplated were to be built, production of synthetic crude and bitumen would soar to 3.3 million b/d by 2015 for just over 700,000 b/d last year. That projection assumes $50-billion in new investment over the next 12 years, and would more than double Canada's total oil output to more than four million b/d...

Mid-case scenario: ...but under the most likely scenario, $27-billion worth of new projects are put in place by 2010, boosting production to 2.3-million b/d by 2015. Even though about $23-billion in contemplated investment is shelved, the scale of the new spending is still massive -- the equivalent of five new megaprojects...

Low-case scenario: ...without any new projects, productions would rise to just 1.8-million b/d by 2015. Even with investment frozen, oil sands production still grows by 5 per cent a year, overtaking conventional output in 2005.

SOURCE: FIRSTENERGY CAPITAL CORP.