Thank you, Mr. Chairman, and good afternoon, honourable members of the committee and fellow speakers.
I'm pleased to be here today to discuss the current economic environment surrounding Canada's oil sands industry and some of the trends that are expected to impact its future development.
With recently high oil prices of $60 U.S. per barrel and above, and given the level of activity in the oil sands sector, one would think that the economics for oil sands projects are strong. However, I can tell you that the returns the project sponsors are seeing today are not materially different from those they saw seven years ago when oil was trading at $20 U.S. per barrel.
First, I work with TD Securities, which is the most active investment dealer in the oil sands. TD has led approximately $8 billion of debt and equity financings for new oil sands projects over the last seven years, is a top trader of oil sands stocks in general, is a leader on providing research on the sector, and has advised on over 25 oil sands financial advisory assignments over the past two years.
Canada's oil sands have recently taken on more significance as a result of security-of-supply concerns, low geological risk, and a growing scarcity of new oil resources worldwide. Given Canada's diminishing conventional oil production, the oil sands are expected to become an increasingly large percentage of Canada's overall oil production. Despite this increased significance and resulting rapid pace of development, the oil sands sector has recently been showing signs of slowing, including delays in announced development plans, with the start-up of a number of projects being pushed back one or more years, weakening equity capital in M and A markets, and asset transaction prices that have declined from the pace of a year ago.
This slowdown has been the result of a number of factors, including: increasingly overheated construction and labour markets; higher capital and operating costs; higher natural gas costs; reduced diluent supply, which is used for blending with bitumen from oil sands for transportation; concerns over water access; concerns over the potential costs of complying with a future carbon dioxide emissions system; concerns over our changing fiscal regime, both in terms of royalties and taxes; and a higher Canadian dollar.
These challenges to the development of the oil sands have resulted in increased risks of significantly lower returns. Assuming long-term oil prices in the $40 U.S. per barrel range would render many of them uneconomic, and that sort of number is what a number of companies will use in their long-term planning.
Although no new projects have yet been terminated, continued pressures resulting from these factors will most likely yield that result. At the very least, a number if not the majority of announced projects or expansions will not proceed according to their currently disclosed time frames.
Oil prices have been a significant catalyst to the growth in the oil sands; however, they have weakened over the last 12 months, and industry cannot rely on continued increases in commodity prices to justify billions of dollars of investment in the sector.
Furthermore, the gap between light and heavy oil prices has widened significantly over the past three to four years, and therefore the price the oil sands producers receive for their bitumen production has not kept up with increases in global oil prices. While the future growth of oil sands production may provide assurances of a secure source of long-term supply for Canada, that production may also further depress heavy oil prices as the market adjusts to the significant increase. Oil sands producers will also have to bear this risk.
Along with increasing prices, capital costs have increased dramatically, with the last three major projects completed experiencing cost overruns of their initial budgets of 60%-plus.
Among oil sands projects with abilities to upgrade bitumen to synthetic crude oil that were completed between 2001 to 2004, capital costs averaged approximately $33,000 per daily flowing barrel of synthetic crude oil production. The average announced capital costs for similar projects that have been recently built or are currently under development has increased 125% from that level, to $74,000 per daily flowing barrel of synthetic crude oil production.
The cost increases for some projects have been well above that level. For instance, the industry's latest project to start development, Shell's Athabasca oil sands project, announced capital costs on its next expansion phase, expected to be producing by 2010, of over three times the cost per barrel of daily production in its first phase, which was completed in early 2003.
In situ projects that used to cost $10,000 per barrel of bitumen production now cost $25,000 to $30,000 per barrel of bitumen production. Project returns of 10% are now difficult to come by, and with the continued increase in costs, they're becoming harder still. Capital cost pressures have become particularly damaging for oil sands projects in the past, with projects such as Fort Hills and Petro-Canada's Edmonton refinery conversion being mothballed three to four years ago, primarily as a result of higher capital costs.
Likewise, operating costs have also increased dramatically over the last several years. Suncor, for instance, announced cash operating costs in 2006 of approximately $22 per barrel, which is approximately 80% higher than its operating cost of about $12 per barrel in 2004.
Based on the various oil sands projects that have been announced, the Construction Owners Association of Alberta has estimated that the number of construction craft personnel among industrial construction projects over $100 million is expected to increase from 16,000 people currently to 36,000 people in 2010. This is expected to result in continued pressure on operating costs.
In conclusion, while several factors have encouraged the development of Canada's oil sands, after many years of largely remaining dormant, significant cost increases and other industry pressures are already threatening the survival of a number of these projects. Through TD Securities' capacity as a financial advisor to a number of these companies, we are seeing these pressures continue to mount, and they will ultimately result in only some of these projects getting built. We are seeing huge warning signs in the industry--not necessarily public--that convince us that the pace of development is going to be much slower than currently anticipated. The continuation of existing federal tax and provincial royalty regimes, which have been key to encouraging development of Canada's oil sands in the face of much longer project lead times and much higher capital costs, typically, than conventional oil projects face, may therefore continue to be very significant to assuring the industry that a stable fiscal system exists in Canada and that it is worth bearing the risks of these increased economic pressures.