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Oil at the first phase of separation from the sand at the Suncor oil sands processing plant near Fort McMurray, Alta.

TODD KOROL/REUTERS

Operations manager Dan Jones barks a simple rule to visitors entering Plant 300, the bitumen factory at the centre of Suncor Energy Inc.'s operations about 30 kilometres north of Fort McMurray: "Don't touch the froth," he says. "It's hot."

Inside the cavernous facility, boiling vats of the oil sands slurry mark the first stage of a high-cost extraction process that is undergoing an aggressive makeover. With global crude prices softening, Calgary-based Suncor is scouring its massive production complex in search of efficient ways to squeeze more oil from existing assets rather than plow money into expensive new projects.

"It's a very sophisticated science," says Mark Little, Suncor's executive vice-president in charge of upstream operations. "In some cases, I've seen one valve in a very complex facility get changed and the throughput go up 8 per cent."

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Through such moves at existing operations Suncor expects to dramatically increase its oil production, adding roughly 100,000 barrels a day by the end of the decade at a fraction of the cost of new projects.

The hunt for cheaper ways to wring crude from northern Alberta's oil sands started long before the recent slide in oil prices began, Mr. Little said. But the work today has become more urgent, as global oil markets are buffeted by the sharp rise in U.S. shale oil production and weaker-than-expected demand from China and Europe.

Oil prices started to hit the skids this summer. In June, North Sea Brent topped $115 (U.S.) a barrel – the price had fluctuated between $105 and $115 all year – but it retreated all summer to a low of $95.60 this week. After peaking at $104 in June, North American benchmark West Texas intermediate fell below $93 this week.

The recent slide in prices reflects fundamental changes in supply and demand trends that are upsetting a long-held expectation of ever-tightening crude supplies, a conviction that prevailed for much of the past decade.

Today, the global market is awash in crude. Abundant supply is increasingly evident around the world: Europe's inventories are bulging; China's strategic oil reserve is nearly full; U.S. Gulf coast refineries are increasingly filled with U.S. crude as their need for imported oil plummets; and global oil prices have largely failed to respond to extended conflicts in the Middle East, Ukraine and other areas, traditionally a trigger for higher prices.

And on the high seas, tens of millions of barrels of oil are currently being stored in massive oil tankers, as traders aim to earn better prices on future delivery rather than sell into the current weak market. The Chinese trading firm, Unipec, a subsidiary of oil giant China Petroleum & Chemical Corp. (Sinopec), has booked the world's largest crude tanker, the TI Europe, to store oil for future delivery.

For the Alberta energy industry, weaker prices mean oil sands companies can no longer count on constantly rising prices to cover ever-increasing costs of massive megaprojects. As with high-cost producers around the globe, the new mantra in Calgary is capital discipline.

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'Peak demand'

There is a sense of foreboding in the city's oil towers. Energy giants are pushing hard to export more Alberta oil abroad, but rapidly shifting supply-and-demand factors threaten to keep pressure on global prices. They include booming unconventional production in the U.S.; the likelihood of its spread to other oil-producing regions; slower demand growth in China; and a global climate change agenda that could dramatically curtail the world's demand for crude. The notion of "peak demand" is gaining currency in an industry where the theory of "peak oil" supply was hotly debated just a few years ago.

It adds up to a less exuberant outlook for oil sands growth, as major companies take stock of ambitious production targets set when oil prices were expected to rise inexorably and the future appeared limitless. Plans for investment in the oil sands – expected to run at a $30-billion (Canadian) clip for the next few years – will be revisited when producers set their 2015 budgets.

Much of the planned investment will proceed, but high-cost projects are already foundering. Just this week, Norway's Statoil ASA shelved plans for a major oil sands project in northern Alberta called Corner, citing high construction costs and extensive delays building new export pipelines designed to boost the value of Canadian oil. The move followed Total SA's decision to mothball its $11-billion Joslyn mine earlier this year.

"I think what people are realizing is that you can't place your bets on multiple areas here. You have to be selective," said James McLean, a Calgary-based partner in PricewaterhouseCoopers LLP's energy practice. While foreign investors still see long-term potential in the oil sands, "some of the growth expectations that were placed on those businesses originally may not come through as quickly as was originally foretold," he said.

Prime Minister Stephen Harper, in a televised interview with Wall Street Journal editor-in-chief Gerard Baker in New York this week, played down the impact that sliding commodity prices – and crude in particular – would have on the Canadian economy. "Everything I know says to me we're not going to see rock-bottom [oil] prices in my lifetime," Mr. Harper said.

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Certainly no one is predicting a crash that would send prices below $50 (U.S.) a barrel. But there are increasingly plausible scenarios that projected crude prices could slump to the $70-to-$75 range and stay there for years.

'Tipping point'

Citigroup Inc. economist Edward Morse said the global oil markets hit a "tipping point" in 2014.

"The world is becoming significantly less energy intensive," said Mr. Morse, Citigroup's global head of commodities research in New York. "For the world as a whole, the historic relation between economic growth and petroleum product demand growth has slipped, and we think it is going to slip further for structural reasons." On the supply side, Citigroup economists expect the light, tight oil boom that is driving production growth in the United States to expand to other countries, including Russia, Mexico and Argentina, as improving technology keeps production buoyant in North America.

At the same time, the global economy has slowed. Citigroup economists this week cut their forecast for the second time in two months, and now see the global economy growing by a mere 2.8 per cent in 2014 and 3.3 per cent next year. They cited weakening conditions in the key BRIC countries – China, Brazil and Russia – for the more pessimistic view.

Global crude demand – once expected to grow by 1.5 million barrels a day this year – will likely rise by only 600,000, said Amrita Sen, chief energy economist at Energy Aspects Ltd. in London. With the slower demand, global inventories have climbed, with storage at sea and on land. Ms. Sen estimates there are now 50 million barrels in storage that will flood into the market at the first sign of a price increase.

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The International Energy Agency says China will account for half the growth in world oil consumption over the next two decades. But that's not a sure bet – the pace of Chinese growth could be much slower than many expect. "We think there are really fundamental changes in the demand outlook for China and the rest of the world," Mr. Morse said.

The Asian behemoth is the world's second-largest consumer of oil and is expected to surpass the United States this year in net imports. But like the Americans before them, the Chinese are increasingly nervous about energy security and their reliance on the politically volatile Middle East for crude. Beijing is also determined to reduce pollution in major cities and cut its carbon dioxide emissions as part of the fight against climate change. It is leading the world in the development of mass transit and alternatives to oil-fuel transportation, including natural gas for trucks, buses and electric vehicles. China's demand for diesel – which is roughly half its oil consumption – has flat-lined for the past two years.

A significant portion of the growth in Chinese oil demand has come from its determination to build strategic reserves, a testament to its insecurity over rising imports. But that stock building will soon end. Its vast array of holding tanks is expected to be full some time in 2015 or 2016. Analysts say China's strategic reserve alone sucked up 100,000 to 200,000 barrels a day. Last year, the entire country's oil demand grew by 295,000 b/d.

New sources of oil supply

Oil sands producers are also competing with new sources of supply.

The flood of light, tight oil pouring out of the North Dakota prairie and from the scrub land of south Texas has dramatically altered the landscape for companies in northern Alberta. Suncor and Total last year mothballed their $11.6-billion (Canadian) Voyageur upgrading plant, saying the project was uneconomic in the face of roaring Bakken output, which blew past 1.1 million b/d this summer. The partly built project is now being converted to a tire-recycling plant.

And there is potential for other new sources of oil supply – or old sources that could turn around long-term production declines. Mexico and Venezuela have been experiencing significant production declines in recent years. But Mexico has pushed through aggressive energy reforms that could transform it into a more muscular producer – adding competition for Alberta to supply U.S. refineries.

So far, Canadian producers have largely weathered the price slump, as the glut of light crude in the U.S. alongside steady refinery demand for heavy oil has shrunk the price gap between West Texas intermediate and Western Canadian Select, the leading benchmark for lower-quality oil sands crude. In recent years, that differential has mushroomed to as much as $40 (U.S.) a barrel, but this week sat at $14.50 for crude destined for November delivery.

"Heavy oil pricing is holding in there quite nicely," said Peter Tertzakian, chief economist at ARC Financial Ltd. He said Canadian oil and gas producers were expected to post sales of $161-billion (Canadian) this year, a figure that has declined slightly to $156-billion due to the summer swoon. That's still a "blowout year," he added.

But the Calgary-based economist said there is still concern. "Canada is not as weak as other markets for a change, but that doesn't mean there isn't nervousness. Capital spending is based on expectations. So people are watching it pretty closely," he said. There will be plenty of money still flowing into the oil sands, Mr. Tertzakian said, but likely at a slower clip.

The U.S. Energy Information Administration released its long-term forecast this week, showing a base-case forecast for international light crude prices declining to $92 (U.S.) a barrel over the next three years, and then rising steadily to $141 (in constant dollars) by 2040. It's that long-run optimism that oil sands producers are banking on; their projects typically have 40-year time horizons and they can withstand some temporary price drops, even if their shareholders get queasy.

But U.S. government forecasters also published a "low-price" scenario in which world prices fall to $70 by 2016 and remain at or below $75 over the long term. Under that scenario, only investment in the lowest-cost oil sands projects could be justified.

The Canadian Energy Research Institute recently calculated that a new mining project would need a $100 oil price to earn a reasonable rate of return, while a steam-driven project would need $85. Peters & Co. calculated break-even economics for a steam-driven plant at $75.

Dark clouds in Calgary

Energy Aspect's Ms. Sen visited Calgary last week and found a litany of concerns: the lack of pipeline access, challenging relations with aboriginal Canadians, drying up of foreign investment – all compounded by rising costs and falling prices. "I think the mood in the U.S. is a lot more positive," she said. "There does seem to be a lot more cautiousness when it comes to Canada and Canadian production. Which really surprised me."

Still, Fort McMurray and its oil sands industry has kept the allure as a place where money flows easily and jobs are plentiful for workers from across Canada, even if more residents are dependent on the food bank – usage spiked 43 per cent last year – as locals report a cooling labour market.

The prospect of a high-paying job in the sector was enough to convince Gordon Watson to buy a 1970s-era motorhome for $3,800 and drive 852 kilometres from Saskatoon. The 53-year-old former pizza shop owner is optimistic about the future. "I'm hoping to get in at one of the mines," he said on a recent afternoon, standing in a Wal-Mart parking lot that now doubles as his front yard. "I wish I would have come here 20 years ago and bought 20 houses for $80,000 a piece," he says.

He may be too late. In a bid to keep a lid on costs, some companies are looking to ship project-related work beyond Fort McMurray and even North America.

Husky Energy Inc., which is developing the Sunrise project with BP PLC, has set up a procurement office in China to understand where large oil sands modules could be developed, a person with direct knowledge of the strategy said. A Husky spokesman said procurement decisions are made from Calgary and co-ordinated with field offices.

Woodbridge, Ont., metal shop Alps Welding Inc. is benefiting from that search for cheaper production work outside Alberta. Alps president Dennis Dussin said half his company's fabricating orders are now oil sands-related as Ontario's lower wage rates help him stay competitive.

And the oil sands production complex north of the city still hums with activity. At the site of Suncor's $13.5-billion (Canadian) Fort Hills mine, giant earth movers and trucks are sculpting the next phase of the company's growth plans from the boreal forest. The joint venture with France's Total and Teck Resources Ltd. will add 180,000 b/d of fresh capacity in the region starting in 2017.

Suncor's Mr. Little said the energy giant is looking to markets outside Alberta for some equipment and project-fabrication work.

"These are big projects" with the risk of "hyper-inflation," Suncor's Mr. Little said. "That's what we're trying to avoid."

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