IT WAS SUPPOSED TO COST $3.4 BILLION. THEN $4.2 BILLION. THEN $4.6 BILLION. And now, in April, 2007, the bill was $5.3 billion.
Charlie Fischer had some explaining to do. The CEO stood stoically before reporters after Nexen Inc.'s annual meeting in Calgary, trying to explain why his firm was trapped in an upward budget spiral in the oil sands.
"It's very hard to predict costs," Fischer told the reporters. "These are massive projects. The competitive forces in the last half-dozen years have been unprecedented."
Anyone involved in the building boom in Northern Alberta might use that excuse. But Fischer had special cause: The spiral in question is for a technologically ambitious project, dubbed Long Lake, that could be a game changer for the entire oil sands. Novel technology put into play in a joint venture with upstart Opti Canada Inc. promises to slash a key operating cost--the natural gas used to power the production process--to the tune of $10 per barrel.
If achieved, that saving is going to be a huge advantage in a world of $100-plus oil and demand that won't let up. If. This is the doubters' constant refrain, from investors in Toronto and beyond, and among engineers in Calgary. The inherent risk in projects costing billions of dollars is always astounding. To doubters, a leap of faith on untried methods is taking things one step too far. Just look at the escalating costs: Since Fischer was in the hot seat at the annual meeting, the price has soared even higher, to $6.1 billion, and the schedule for actually producing some oil has been pushed back.
Fischer says he'll soon prove the skeptics wrong. "We're on the verge," he says in an interview. "Where for the last four years I've been challenged--'Does the technology work?'--I'll be able to say: 'Yes, it does work, and here's the results. And now you can go ask all those other guys what they're going to do to make up the $10 margin advantage.' "
THE ROAD TO LONG LAKE STARTS IN Yavne, Israel, south of Tel Aviv. That's where Nexen dispatched engineer Jim Arnold in 1998. His task: Check out an intriguing invention.
The invention owed its genesis to Israel's geopolitical quandary. Surrounded by hostile countries but with none of its own oil, Israel in the 1950s poured research funding into solar power. At the country's national physics lab, engineer Lucien Bronicki came up with a turbine design that could generate electricity from solar-heated water. The idea led to the founding in 1965 of Ormat Industries Ltd. by Bronicki and his wife, Dita.
Ormat was a "green" company decades before the term was coined. It worked not just on solar power, but also on geothermal and other alternative sources of energy. In the mid-1990s, Ormat looked at residues from oil refineries and saw a potential source of inexpensive power. That line of inquiry turned the company's attention to Canada's oil sands, which produce a very low-grade oil--"heavy," in the parlance of the oil patch, hence suitable to Ormat's research.
The priority of oil producers and refiners is the "light" portion of a barrel, which is most easily made into gasoline, jet fuel and the like. Ormat turned the barrel upside down, focusing on the heavy stuff that most people consider simply a hindrance.
Yoram Bronicki, the son of Ormat's founders, tested the new idea in "lab-scale, beaker-type activity." The invention that Ormat developed took a barrel of heavy oil, sucked out the residues using established processes-- but sequenced in a new way--and pro- duced two products: semi-processed oil and asphaltenes, which are a mixture of carbon, hydrogen, nitrogen, oxygen and sulphur.
Progress was rapid. In less than a year, the invention, dubbed OrCrude, went from processing one-off batches to continuously pumping out one barrel per day. This is when Nexen got wind of the project. Ahead of Jim Arnold, it sent 60 barrels of heavy oil to Ormat. "We were somewhat skeptical: What can a company in a country with no oil know about this stuff?" Arnold remembers.
A day or two before Arnold and some colleagues arrived, mechanical problems popped up. Bronicki and his team worked feverishly on fixes. "The chief mechanic, myself and the chief electrician slept in a trailer on site for the whole week to babysit the pilot plant," Bronicki says.
The demonstration for Arnold's delegation was a success. "I think," Bronicki says, "they were thoroughly impressed."
BUT THE PRICE OF OIL WAS NOT SOimpressive: It was collapsing toward $10 a barrel, not the sort of price that encourages forays into marginal parts of the barrel. And the Israelis' invention was still in its early stages. So Nexen passed on OrCrude. Ormat then made a crucial connection with Suncor Energy Inc., the oldest oil sands miner. Suncor was wholly focused in the oil sands north of Fort McMurray, but it also had an orphan exploration lease about 40 kilometres south of town that was set to expire unless the company did something with it. It looked like a good fit for an experiment.
Striking up a 50-50 joint venture, Ormat got half the rights to the land that became the Long Lake site. It would conduct drilling and spend $20 million to build a 500-barrel-a-day OrCrude demonstration plant in nearby Cold Lake. Suncor would supply the raw product.
So, Ormat, founding Opti for the purpose of the joint venture, was in the oil business. Meanwhile Arnold, convinced Bronicki and his team had made a great discovery, placed a bet on his own future and quit Nexen to become Opti's first employee. It was a gamble. Sure, Ormat's science project worked at a barrel a day in the warmth of Israel. But how would it manage 500 barrels a day in the stinging cold of Northern Canada?
For the first few weeks of its life in 2000, Opti was headquartered in the basement of Arnold's Calgary home. "I went to Staples, got a printer. Called the phone company, got a phone line. We had a business," says Arnold. Opti soon relocated to a small office downtown, but the do-it-yourself ethos continued, with Arnold crawling above the ceiling to hook up the computer network and buying used furniture at auctions. "If it went past $50, I stopped bidding."
Using Ormat's OrCrude technology as a foundation, Arnold became the co-developer of a process to exploit the two outputs, oil and asphaltenes.
First, the oil. Opti turned to licensed technology belonging to hydrocracking specialist Chevron Lummus Global LLC. (Hydrocracking is a refining method that uses hydrogen to turn semi-processed oil--the kind OrCrude produces--into an upgraded product ready to become gasoline and the like.)
The major challenge, however, lay in the "bottom" of the barrel, in that heavy junk where Ormat had seen untapped energy. Because OrCrude pulled out asphaltenes as a liquid, rather than in the usual solid form, the stuff was suitable to be fed into a gasifier. The gasifier process takes hydrocarbon-based materials and, using high temperatures and oxygen, produces gas. To get its hands on this technology, Opti obtained a licence from Shell.
While the focus on the oil sands industry is on shallow oil that can be mined using open pits, most of the resource--including that at Long Lake--sits deeper, requiring drilling. The standard method, steam-assisted gravity drainage, involves drilling two wells. In one, steam is injected, heating the thick oil below ground until it flows and can be collected via the second well, which is loc-ated a few metres below the first.
Steam-assisted gravity drainage's biggest downside is the huge amount of natural gas required to power the process; it's the single biggest cost, and an unpredictable one to boot. But Opti's technology promised a one-plus-one-plus-one equation that looked like it might add up to a lot more than three:
- The asphaltenes, turned into gas, would be used to power an OrCrude unit.
- The gas would also provide the hydrogen to be used in the hydrocracker, which produces refinery-ready oil.
- Finally, there would be enough gas, on paper, to also produce power to generate the steam that is injected into the ground to get the oil.
The possibility of a perpetual motion machine began to take shape. Each barrel pulled from the ground would be used, in part, to fuel recovery of the next one. (Efficient as this sounds, OrCrude's use of the bottom of the barrel actually increases greenhouse gas emissions, about which more later.)
As the pieces started to come together, an emboldened Opti moved quickly. Just six months after Arnold set up his basement office, Opti announced a $450-million project to produce 30,000 barrels of oil a day by 2004.
With his science project coming to life, Yoram Bronicki moved to Alberta to oversee the demonstration plant. The first goal was to produce 5,000 semi-processed barrels of oil at the plant, which opened in May, 2001.
But as Opti ramped up, Suncor bowed out, choosing to focus on its expanding open-pit operations and a wholly owned steam-injection project near its main base north of Fort McMurray.
Nexen jumped back in. It held lots of land in the oil sands that required steam injection, and was keen to ease its dependence on natural gas. "We have a belief that the thing that opens new doors is technology," says Fischer of the decision.
But the odds of driving the technology toward commercial reality weren't Fischer's biggest worry. Rather, it was Opti's size. "That was a bigger pill to swallow," he says. "We liked the technology, but you're dealing with a start-up: Are they going to be able to raise the money to keep pace? These things aren't cheap."
CALGARY'S REPUTATION AS A TOWN of risk takers bears an important rider. "We tend to think about it as a swashbuckling, balls-to-the-wall-type industry, guys out there wildcatting," says Robert Puchniak, chief financial officer at James Richardson & Sons Ltd. in Winnipeg. "But the business tends to be a little on the conservative side when it comes to new technology."
Puchniak is in a position to know. His investment house has made a lot of money on new technology; it's also one of Opti's first key outside investors (Puchniak is also a member of Opti's board). Since oil sands budgets run into the billions, "It's natural the industry would be conservative," Arnold says.
For Opti, having Nexen on board backing its technology lent momentum to its mission. And the demonstration plant was impressing visitors just as the company started to hustle for funding.
"It wasn't just a bench model, doing one or two barrels a day. Five hundred barrels a day is pretty serious," Puchniak says. "You could eat off the floor. It left a very good impression. It looked like it was run with military precision." (The plant was, in fact, operated mostly by young Israelis who had just finished their military training.)
Sid Dykstra, a veteran Calgary oil executive, was hired as CEO at Opti in 2001. After sealing the Nexen partnership, Dykstra's main challenge was to convince potential Opti investors that Long Lake wasn't a mystical "black box" of the sort that is occasionally touted in the energy industry. Many people in the oil patch remembered a 1990s start-up, Solv-Ex Corp., that received considerable attention when it marketed a mining and oil processing plant that would cut operating costs in half. It ended up half-built and bankrupt.
"There's been a lot of black boxes in heavy oil upgrading," Dykstra says. "Everybody wants to take heavy oil and magically turn it into light oil. ...Back in 2001, 2002, this [Long Lake] was just the fourth [integrated oil sands project], so people were naturally skeptical: Can it be done? Should it be done using any next-generation technology versus just doing something that's tried and true?"
In June, 2002, Opti raised $90 million in private equity for Long Lake, brokered by TD Securities Inc. By that time, Opti had even bigger ambitions: a $2.3-billion plan to produce about 70,000 barrels of bitumen a day.
Not long after, however, Long Lake's budget ballooned to almost $3 billion. Dykstra hit the road to calm rattled investors.
By mid-2003, another $102 million had been raised privately, including cash from Capital Research and Management Co. of Los Angeles, one of the biggest investors in the United States. Another early investor, also from the big leagues, was Boston's Fidelity Management & Research Co.
At TD Securities, managing director Robert Mason and his team wanted to capitalize on the momentum--and the rising price of oil. TD devised an audacious plan to raise the money all at once: $2 billion, an unheard-of amount for a start-up, with $400 million coming from an initial public offering of the stock. Mason remembers presenting the idea to Puchniak, in his role as an Opti director.
"He said, 'A $400-million IPO? That's horseshit!' " says Mason.
Mason and Opti executives embarked on what Mason calls "one of the longest road shows in history." Some 130 meetings were logged in an effort to privately raise hundreds of millions ahead of the IPO. TD "landed the whale" in Franklin Mutual of New Jersey, which plunked down $200 million.
It was early 2004, and the price of oil was cresting toward $40 a barrel. Opti officially decided to build Long Lake, and closed what it called "unprecedented" deals in the history of Canada's energy business, raising $750 million of private equity and $800 million of debt from bankers.
The cost of Long Lake had ticked up again, to $3.4 billion. The first raw oil was scheduled to be produced in 2006, and the first barrels of refinery-ready oil were to come out of OrCrude in 2007.
A $300-million IPO followed, and Opti debuted on the Toronto Stock Exchange as the oil sands gold rush was about to begin.
THE IDEA OF A PERPETUAL MOTION machine proved, alas, too good to be true. Nexen decided in February, 2006, to add more steam-generation capacity to ensure it could get enough oil out of the ground. About a quarter of the gas needed to power the process will have to be purchased externally.
Even as the budget surged, investors stood behind the vision for Long Lake. It helped, of course, that the price of oil was rising. The price of Opti stock more than doubled from the IPO in 2004 to a high of $25.26 a share in May, 2007. But last summer, when the budget hit $6.1 billion and it was announced that the debut of oil production would be delayed until this year, investors got upset. Opti's stock declined by almost 40%, bottoming at $15.30 in early January. Nexen, which was dealing with other problems besides Long Lake, also saw its shares knocked lower. "Project management has clearly faltered," analyst Justin Bouchard of Raymond James said in a report, wondering if $6.1 billion was indeed the final price tag and speculating that Opti might even have to sell part of its stake in Long Lake to raise more cash.
But with the price of oil flying higher by the day this year, investors soon forgot about the stumbles. Analysts are almost unanimously behind Opti, with not a single "sell" recommendation on the stock, which recovered to more than $20 a share in April. Nexen shares, too, moved higher. Among 26 analysts, only one, Kam Sandhar of Peters & Co., suggested selling. "The company will continue to struggle," Sandhar wrote in a March report. He doubts that future phases of Long Lake will be built on budget and on time.
Competitors are watching. "Everyone's anxiously waiting to see how it works," says analyst Bouchard. "If it does, it gives them a fairly significant operating-cost advantage." Every oil sands player, looking at the problem of what to do with asphaltenes, is considering constructing gasifiers. But no one has taken the leap that Nexen has. "If you look at the marketplace, it might tell you we haven't been rewarded for taking these initiatives," Fischer says. "The market is greedy--but it doesn't like taking risks."
This spring, as barrels were finally coming out of the ground at Long Lake, the months-long effort to turn on OrCrude, the hydrocracker and the gasifier was under way. How well the oil reservoir functions is still considered a big question, as is whether OrCrude, the hydrocracker and the gasifier will work in harmony.
And even as the first barrels of oil are set to emerge this summer, and the facility slowly rises toward full production (predicted for late 2009), another major challenge looms: Long Lake's immense greenhouse gas emissions.
At full production of 58,500 barrels of oil a day, Long Lake would emit 4.8 million tonnes of greenhouse gases annually. That's roughly the same as putting 960,000 cars on the road. In absolute terms, it's less than what a company such as Suncor emits--but on a per-barrel basis, it's about twice as much. The problem stems from the solution: Long Lake is conserving cleaner-burning natural gas by using the dirty bottom of the barrel to generate gas for power--a substitution that increases the amount of carbon dioxide spewing into the atmosphere.
It is technology, Nexen and Opti executives say, that will again come to the rescue. Emerging designs to capture greenhouse gases appear to be especially suitable for Long Lake, they say, and will be adopted as OrCrude is more widely used. Long Lake is seen as step one of six, on the way to producing as much as 360,000 barrels of oil a day.
SO: WILL IT WORK?
Mason, the oil sands banker who helped raise billions of dollars for Opti, acknowledges the question can only be answered by hitting the metaphorical "on" switch. "There's just more parts that need to go right for ultimately the whole thing to work properly," he says.
But for Fischer at Nexen, vindication over skeptics is almost at hand.
"When we bring Long Lake on, will it be optimal?" he asks. "Probably not. Are we going to have to play with the operating conditions to optimize it? Probably. But that's an easy thing to do. So, is it going to work? Yeah, it's going to work. I've never worried about that."
David Ebner