Alberta looks to join in building of new oil sands upgrader

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The Alberta government is moving to rekindle the dying dream of processing heavy oil sands bitumen in Canada, choosing one of the country's most important energy companies to build a major new upgrader.

The province, which is using its own bitumen supplies to revitalize near-dormant efforts to draw more revenue and jobs from its oil sands, has picked a multibillion-dollar project proposed by Canadian Natural Resources and North West Upgrading.

The move is a culmination of years of effort to push for more upgrading on Alberta soil, an effort that much of the industry has abandoned but the province has now itself committed to maintain.

The move will see the Alberta government tie its own fortunes more tightly with that of the industry, which will process the bitumen for a fee and leave the province with whatever revenue remains.

Canadian Natural and North West, who are jointly pursuing the upgrader, said yesterday construction of their joint project could begin as early as next year, marking a sudden reversal of a corporate trend that has seen upgrader projects abandoned in favour of unprocessed bitumen exports to the U.S.

It will take more than six months to finalize contract negotiations - financial terms were not disclosed, nor are there any assurances that talks will succeed. The upgrader could be the first to come back to life after many projects were abandoned or indefinitely suspended.

"This is a journey of a million steps, so we've completed at least one of them. We've got a few more to go," said Ian MacGregor, chairman of North West Upgrading, which has already spent $400-million on the project, including the purchase of some items that are ready to be installed in the new plant.

Upgraders take oil sands bitumen, a hydrocarbon so heavy it resembles a hockey puck at room temperature, and refine it into a lighter crude that can flow through a pipeline before being further refined into products like gasoline and jet fuel.

The North West Upgrading project would go one step further, directly producing diesel and naptha, which can be used to feed petrochemical plants.

The 150,000-barrel-a-day upgrader would be built in three equal phases. The government of Alberta has committed 75,000 barrels per day, while Canadian Natural has committed a further 25,000 barrels - enough to feed the first two phases.

The Alberta government, which has pushed for upgrading in the province as a way to extract more value and employment from its crude, has the ability to collect royalties in physical bitumen rather than as cash payments. It is using some of those royalties, which could reach 400,000 barrels per day by 2020, to feed more-local upgrading, which industry has largely abandoned.

Several years ago, broad ambitions to process bitumen in Alberta led some to dub a huge plot of land near Fort Saskatchewan, Alta., "Upgrader Alley" amid plans to build $80-billion worth of new plants.

But those hopes were dashed by the rising costs of construction, the recession and a sudden reversal in the economics of upgrading. A fall in heavy oil supply from Venezuela and Mexico created new demand for Alberta's product among U.S. refiners, who bid up prices for the product. That prompted companies, including Suncor Energy Inc., Imperial Oil Ltd. and Norway's Statoil ASA to largely turn their backs on costly Alberta upgrader projects. Only France's Total SA is still actively pursuing an upgrader in Alberta.

North West has not disclosed the cost of its project, although some have estimated the tally could reach $5-billion per 50,000-barrel segment.

Yet questions remain about why it and Canadian Natural are pursuing an upgrader at a time when refining margins are so slim that nearly 10 per cent of North America's refining capacity has been shuttered in the past two years.

The North West project will capture carbon, which can then be sold to oil companies who want to use it to increase oil production in old wells. Mr. MacGregor said that fact makes it a greener project that will have advantages in coming years, as society moves to put a price on carbon.

But Canadian Natural offered few insights into why it is pursuing the project, other than to say that it has long supported more upgrading capacity in North America, and has seen attempts to negotiate deals with other refiners fall through.

"It's a very strong strategic fit with [Canadian Natural]" said Réal Cusson, the company's senior vice-president of marketing. "It's good news for Alberta, it's good news for us to be associated with the government - it might make a few things easier from that perspective."

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Red flag on rising costs

Oil sands construction costs will rise steeply in coming years as companies rush back to build new capacity, Canadian Natural Resources Ltd. [[entity]]anadian Natural Resources [[/entity]]NQ-T is warning.

The company hopes to approve a 132,000-barrel-per-day expansion of its Horizon oil sands mine later this year, but president Steve Laut said costs will almost certainly exceed what it paid for its initial 110,000 barrels of capacity, which rang in at $9.7-billion, or more than $80,000 per flowing barrel.

"I think there's a very strong likelihood when we get into phases two and three we'll have a highly inflationary period just like we had with phase one," Mr. Laut said Tuesday.

The company is gathering estimates, conducting detailed engineering and talking to potential contractors ahead of the planned expansion. A key concern is managing costs, which rose by 43 per cent from initial estimates on the first phase of Horizon. It is doing that in part by pushing for more fixed contracts.

"The biggest concern for us is not so much what the cost is but is there going to be escalation? And can you handle the inflation that might come at you?" Mr. Laut said.

Canadian Natural is the latest company to flag rising costs. Both Encana Corp. and Cenovus Energy Inc. have warned that inflation has returned, while Royal Dutch Shell PLC has called the oil sands one of the most expensive places in the world to build, and is delaying growth plans by at least five years. A 100,000-barrel-a-day expansion that Shell is building has cost it about $140,000 per flowing barrel, or 57 per cent more than Canadian Natural's initial Horizon project.

Nathan VanderKlippe