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Risk at the refinery

The Sturgeon Refinery Project in Edmonton, Alberta on Thursday, February 9, 2017.

The $8.5-billion first phase of the Sturgeon Refinery comes with a hefty price, and is challenged by the slowdown in industrial activity in Western Canada and an already well-supplied diesel market

In a rural industrial zone northeast of Edmonton, a deadline draws near. Just months remain before the country's first new-built refinery in decades is set to begin operations, and more than 5,000 workers are labouring around the clock in the dense network of pipes, scaffolding and steel.

The $8.5-billion initial phase of the Sturgeon Refinery is almost complete. It's expected to be processing crude from Alberta's oil sands, and supplying low-sulphur diesel and other fuels, into Western Canadian markets before Christmas.

But away from the hum of machinery and the clanging of steel sit mostly empty grounds prepped for construction but missing the same nearby buzz of activity – a sign of the uncertainty regarding future expansions.

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Two key backers of the ambitious project – the Alberta government and Canadian Natural Resources Ltd. – have so far refrained from any further commitments to the refinery's second and third phases. Under a contract for Phase 1, they will supply bitumen to the operation for 30 years, and participate in the project's rewards and risks. But even the first phase of the refinery comes with a hefty price, and is challenged by the slowdown in industrial activity in Western Canada and an already well-supplied diesel market.

The refinery would not have been built without Alberta government backing – a deal secured in an era of higher oil prices and more stable provincial finances. And now, with $25-billion in public dollars in toll payments – fees to have the bitumen processed into diesel – committed to the project over the next 30 years, the government has little to say regarding the deal. Even as the facility nears startup, the overriding question is whether it will turn a profit, break even, or become a cautionary tale about government forays into the world of business.

"I don't think the actual risks to Alberta taxpayers have ever been spelled out," said Alberta Party Leader Greg Clark, an opposition MLA.

But the venture began with the political desire to create more upgrading and refining jobs in Canada – instead of in the U.S. Midwest or Gulf Coast – and add more value to tarry bitumen from Alberta's oil sands.

On that subject, it's difficult to match the enthusiasm of Ian MacGregor, 68, the Calgary engineer and investor who has been the driving force behind the project.

NWR Sturgeon Refinery Project Chairman Ian Macgregor during an interview in Edmonton, Alberta on Thursday, February 9, 2017.

A dogged booster who sometimes rides the company buses with Edmonton construction workers travelling to the site, Mr. MacGregor said the refinery supports the evergreen goal of diversifying Alberta's oil and gas-focused economy. The project also includes a fully integrated CO2 capture system for a carbon-constrained world, and won't suffer the same pipeline capacity limits that crude shippers face on a daily basis.

Peering out from behind his signature retro square glasses, the president, chief executive and chairman of North West Refining Inc. said the project's completion has become his "objective in life."

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"I started off with a dream that I would build the whole thing before I conked out," Mr. MacGregor said, speaking earlier this month at the refinery office, located 45 kilometres from Edmonton and part of a larger "industrial heartland" north and east of the city that already is home to a multitude of refineries and petrochemical plants.

"My dream for the place is that it [becomes] like Houston North," he said of the capital region. "And we compete with everybody in the U.S. for the world market."

The Sturgeon facility will be first new refinery built in Canada since 1984. Together, the Alberta government and Canadian Natural Resources Ltd. will provide about 79,000 barrels of diluted bitumen feedstock per day (or 50,000 barrels of raw bitumen) for Phase 1 through agreements that guarantee the refinery a 30-year supply. Everyone in the arrangement is meant to profit from the higher prices that low-sulphur diesel and diluents will fetch over less-processed heavy oil exported south to U.S. refineries.

Mr. MacGregor said he spends his time managing the daily pressures that come with the near-end of a megaproject, but he has some wind at his back. Phase 1 employed 7,500 workers at peak construction, and thousands of others who worked to fabricate modules for the plant, even while other parts of Alberta's economy were shedding jobs.

And last month, Moody's Investors Service changed the North West Redwater Partnership's credit outlook to "stable" from "negative," based on the project's reliance on CNRL's credit quality and an earlier upgrade given to the Canadian oil giant.

But for its part, CNRL, which co-owns the project through that partnership with Mr. MacGregor's North West Refining – and will also provide one-quarter of the total feedstock – said no one was available for an interview on the refinery.

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The NDP-led Alberta government, which inherited the project from the past Progressive Conservative government, but had also campaigned on upgrading more oil in the province, appears cool to future commitments. Energy Minister Margaret McCuaig-Boyd said only that the province wants to see the facility having a positive effect on the province's economy before making any decisions on Phase 2.

The Sturgeon Refinery northwest of Edmonton still employs more than 5,000 construction workers with a goal of having it processing oil sands crude into low-sulphur diesel before Christmas.

Because of the nature of work and the long-haul trucking needs of the region, Western Canada is more reliant on diesel fuel than the eastern half of the country. When Alberta's economy was more robust, there were significant concerns about the long-term supply, as well as periodic shortages, of the industrial fuel.

But today the Western Canadian market for diesel is well-supplied, and the commodity-price-driven activity slump in the oil patch has led to less demand, said Michael Ervin, senior vice-president at fuels market consultancy Kent Group Ltd.

The Sturgeon Refinery is going to add a significant amount of fuel into the regional Western Canadian market for diesel, he said. "From there, where does it go? And how well-placed is it relative to other diesel-producing entities which include Shell, Imperial and Suncor?"

Mr. MacGregor won't reveal details about the refinery's marketing but has worked out shipping arrangements from the Sturgeon site. He believes Western Canada's market still has room for more diesel. He also said if the domestic market is too confining, it would be economical – and competitive – to ship diesel by rail to the West Coast, and abroad to Asian markets.

"There are 600,000 service stations in the world. There are only about 50 refineries that can handle bitumen."

However, most refineries produce gasoline, as well as diesel and other fuel products. En-Pro International Inc. fuel analyst Roger McKnight said he believes the facility price is high considering the refinery will only produce diesel. "You have no other alternatives but the diesel market. You better have a long-term agreement with a reliable consumer."

Mr. McKnight also questions whether exporting overseas will be feasible – saying refining costs in Asia are bargain-basement low – and raises the common question of why a major integrated oil company wouldn't build this refinery if the idea was so compelling.

Workers at the NWR Sturgeon Refinery Project in Edmonton, Alberta on Thursday, February 9, 2017.

In response, Mr. MacGregor points to the 30-year fee-for-service processing agreement with the government, and CNRL, that underpins the construction, operation and equity returns of the Sturgeon refinery – and makes borrowing costs less expensive. The government commitment to the refinery was made in the Ed Stelmach years (2006-11) of Alberta's Progressive Conservative party's reign. It was a time when the government was keen to keep its promise to add upgrading and refining capacity, and to keep more jobs in Alberta instead of shipping less-processed heavy oil to U.S. refineries.

Under the Bitumen Royalty-in-Kind (BRIK) program, the government started taking bitumen in lieu of resource royalty payment to offer long-term commitments of supplies that would strategically spur the building of upgraders and refineries in Alberta.

The Sturgeon project emerged as the winner of that policy decision.

But the costs have crept up over the years. The project, sanctioned at $5.7-billion in 2012, increased almost 50 per cent to $8.5-billion for Phase 1 one year later – meaning the government had to increase its financial support.

With the higher price announced in 2013, the provincial government and CNRL committed to more than $300-million, each, in loans to the refinery partnership.

More critically for Alberta's bottom line, the government revealed in 2014 that, because of the increase in building costs, $26-billion in toll fees are on the line for taxpayers over the 30-year commitment – up from $19-billion. The toll fees will pay billions for the bonds issued to build the refinery, as well as operating costs. The government said the fees will also provide an equity return to the partnership, and an "incentive payment" to the partnership if the refinery makes a profit for the toll payers. As a result of reduced borrowing costs for the refinery, the figure has since been scaled down to $25-billion.

A worker monitors control panels at NWR Sturgeon Refinery Project in Edmonton, Alberta on Thursday, February 9, 2017.

The risk for the Alberta government under the agreements is "the price differential between bitumen supplied as feedstock and marketed refined products, relative to the costs of the processing toll," according to an Alberta Energy report. And because of the nature of the contract, no matter when the refinery starts up – or if there is poor operating performance – the province will still be on the hook for the toll fees related to the debt financing portion of the project. That is an undisclosed amount, but it is money critics say might have been more wisely committed to health care, schools or highways.

"I am conflicted about this because people need to work. But do the benefits justify the risks?" Mr. Clark, the Alberta Party Leader, said.

However, the Alberta government might well make a tidy profit, or break even, in having its bitumen processed in Sturgeon County. Mr. MacGregor argues the margins on diesel, and the structure of the financing, means that, once the refinery is running, the government could take in a couple hundred million dollars a year. The government has not publicly provided its own analysis of the potential yearly profits.

Other challenges remain. The carbon capture and storage aspect of the project was a major selling point, and has become even more relevant in an era of carbon pricing and low-carbon fuel standards. But the economics of the Alberta Carbon Trunk Line, which would see emissions from the refinery pumped into the ground to help produce leftover crude rather than be vented into the atmosphere, has been challenged by lower oil prices. Mr. MacGregor still believes the trunk line will be built, but won't be running as the refinery opens.

With Phase 1 nearing completion, Mr. MacGregor would like to just keep building, and get started on the identical second and third phases. In a period of high unemployment for the energy-focused province – and this year's completion of other construction megaprojects in the oil-sands region – he dangles the tantalizing promise of another decade of construction work for thousands of tradespeople.

He maintains that bitumen resources need to be better used to broaden the scope of the province's economy.

"I don't think there's much else to do in Alberta," he said. "We're going to keep rolling up the sidewalks if we don't start doing more stuff like this."

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