Suncor Energy Inc.'s $1.5-billion writedown on its stalled Voyageur bitumen upgrader project is evidence that the oil sands' serious transportation and pricing issues are more than just a passing nuisance. They threaten to choke the life out of an industry.
An impairment writedown is, in essence, a public acknowledgment that a project can't generate the future returns to justify the value assigned to the asset on the company's books. Suncor's assessment of the future cash flows it can expect from Voyageur prompted it to peg the carrying value of the project – on which more than $4-billion has already been spent – at just $345-million.
Suncor raised the possibility that it and its project partner, Total SA of France, may scrap the project altogether. They're also taking a close look at whether to proceed with their high-profile Fort Hills oil sands development.
That's a pretty damning statement about the state, and the future, of oil sands economics.
Suncor's specific issue speaks to the profound and rapid changes that have hit the oil sands in the past few years. The sudden boom in shale oil production, mostly in the United States, has clogged pipelines with a lighter grade of oil against which the heavy crude from oil sands is struggling to compete.
Prices for oil sands heavy crude have plunged due to a lack of pipeline capacity to the refineries equipped to handle it. Multi-billion-dollar upgraders can upgrade that oil to a lighter grade, but with all the light crude from shale around, it just doesn't pay to do it. Profit margins on upgrading have evaporated.
And Suncor doesn't think this is a short-term problem. In a speech in December, Suncor CEO Steve Williams questioned whether the upgrader makes economic sense "five, 10 or 15 years out."
There's no reason to think Suncor is the only oil sands producer in this boat. We have already seen billions of dollars shaved from capital spending plans in the Canadian oil patch for this year, as companies scale back their investments on properties that simply can't be profitable at current prices. New oil sands projects typically need prices north of $80 a barrel to break even on their combined capital and production costs; the benchmark price for Alberta heavy crude has averaged less than $70 for the past five years.
And it's far from certain when, or if, the situation will improve. Shale oil production is growing in leaps and bounds. Pipeline proposals such as Keystone XL and Northern Gateway, which offer the promise of opening up major new markets and reviving prices for oil sands crude, are bogged down in politics, environmental concerns and public opposition.
As weak prices persist, it's inevitable that more companies are going to have to take writedowns on the book value of oil sands assets; write down the value of reserves in their oil sands properties; and delay and reduce their investment in oil sands projects. Prudent accounting and business strategy will demand it.
And once the investment dollars are pulled out, it will take a long time to bring them back. It's a global industry; money will flow to projects in other parts of the world with better economics. When we're talking about projects that are of a similar size, cost and long time frame as those in the oil sands, once decisions are made we could be facing a long dry spell in oil sands investment.