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Samir Kayande covered oil and gas for 20 years, most recently at a Calgary-based SaaS company. He now consults on business strategy and analytics product management.

Canadian oil sands will have trouble competing with oil from U.S. tight oil forever – regardless of how many pipelines they build.

The U.S. added more than 10 million barrels a day of crude oil production after the 2008 trough, for 150-per-cent growth. Canada, in the meantime, added 2.3 million barrels a day, growing 70 per cent. Canadians blame the lack of pipelines for this discrepancy. Surely pipelines matter, but they are not the whole story. Canadian management teams failed to credit the unique economic strengths of the U.S. tight oil, or shale, resource. Consequently, they fell behind.

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Why should we care?

Governments and investors have been obsessed with pipeline growth over the past five years. Pipelines are indeed necessary to move an isolated, landlocked resource to market. But new pipelines alone are insufficient to grow the business, motivate capital investment and create good jobs. For that, we need both pipelines and economic resource. Unfortunately, Canadian oil sands will continue having trouble competing with the unique benefits of U.S. shale.

To be clear, the tight oil business is not a model to emulate. Like many new technologies, the initial promise of extensive, low-cost resource unleashed an orgy of debt, self-dealing, extreme management compensation and shattered investors. Wrecking oil sands businesses was incidental to all of the other harms – but for Canadians, an important one.

Wishful thinking could take comfort in the business-model failures – perhaps shales aren’t so scary after all. Instead, it was the sheer productivity of the U.S. shale resource that hurt investors, and Canadian managers failed to credit it as a threat. Commodity businesses often deliver productivity gains to consumers in the form of lower prices. Those low prices are especially hard on suppliers, who don’t share in the productivity gain.

One key strategic advantage of tight oil lies in a factor that many consider a defect: the high decline rate. Shale oil wells produce at a high rate initially, then decline hard. Half of a well’s resource may be produced in the first three years. This sounds like a bug, because producing a consistent flow of oil requires continuous capital spending.

Instead, the high decline rate is a feature. Another way to describe shale declines: A shale well requires four years at US$50/bbl to recover its initial investment. A new, best-in-class steam-assisted gravity drainage (SAGD) oil project might pay back in about five years after production starts. Plus, SAGD capital is spent in billion-dollar chunks, while shale wells are bite-sized, $8-million slices.

Half of a shale well’s investment is recovered in the first one and a half years, plus a few short months of drilling. In contrast, SAGD has a multiyear investment cycle, followed by years of production to recover half the invested capital. In plain English, a shale operator needs to look five years into the future to make a capital investment decision. A SAGD operator needs eight or more. The difference matters – more so if uncertain market share growth for renewables means we can’t forecast oil demand.

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If oil prices collapse, drilling the next shale well can be deferred. If oil prices increase, shale companies can increase production by drilling more wells. This flexibility reduces risk. An oil sands project must always produce, even if the oil market is screaming for less supply in the form of low prices.

Small capital slices also enhance learning. Each shale well is a separate event, with a separate suite of operational decisions. While nobody wants to burn $8-million on a failed well, the cost of failure in shale is smaller than, say, deferring the start of a $1-billion project for a month. As a result, shale can rapidly iterate and improve.

Of course, SAGD improves too. But the pace is slower – the business is simply less agile, because of the higher financial and operating risk of multibillion-dollar facilities.

What about the impact of pipelines? More pipelines, sooner, from Canada to tidewater markets would have helped increase oil sands production. Pipelines from Texas shales to the Gulf Coast were easy and cheap to build, thanks to a regulatory environment for permitting pipeline construction that doesn’t exist anywhere else in North America.

The completion of current Canadian pipeline projects, such as Line 3 and the Trans Mountain expansion, will offer an opportunity to test how much pipelines mattered compared to strategic factors.

The kind of investment that would fill the new pipes is not being contemplated by any of the large oil sands producers. Instead, they now focus on environmental performance, lowering operating expenses, merging and returning cash to shareholders as dividends and buybacks. These are the correct responses to an uncompetitive new-project supply cost outlook.

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For Canadians generally, this means we shouldn’t plan on a wave of new capital spending and great fly-in-fly-out jobs that backstop communities from coast to coast. We shouldn’t count on new rising tax and royalty revenue from growing oil sands production. We shouldn’t worry about increasing CO2 emissions – they will likely go the other way even with zero action as operators increase efficiency.

We should think about a new future – one in which the oil sands matter a whole lot less.

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