Monday, May 26, 2008

The Canadian Oil Sands Are a Bottomless Sink for Canadian Natural Gas Production

26 May 2008, updated 5 June 2008

170 billion barrels of oil from Canada's Athabasca, Peace River and Cold Lake oil sands are presently economically recoverable - about 10% of the total reserves of all known Alberta bitumen, which, at 1.7 trillion barrels, are approximately equivalent to the combined total of all of the world's conventional oil reserves.

That's potentially a lot of oil.

So 10% of all of Alberta's total oil sands reserve (with today's production technologies and at current production costs) is still the largest reserve of oil in the world after that of Saudi Arabia - which explains why Alberta today bears so many resemblances to the booming Middle East.

It became economical to produce this "heavy" oil about $100 ago, at today's $130 US or so price per barrel of oil.

A rough estimate is that 2007's production of about 700,000 barrels of oil per day from the Alberta oil sands will swell to about 5 times that figure by 2028 (3.3 million barrels per day).

Less often discussed is the huge amount of natural gas that is required to process the heavy oil into commercial crude - 700 to 1200 cubic feet of natural gas per barrel of oil.

As of today, the oil sands industry consumes about 4% of the natural gas production of the Western Canada Sedimentary Basin. By 2028, that will be on the order of 20% of this region's natural gas production - assuming that natural gas production can be sustained at current levels.

Natural gas has been cheap from the birth of the oil industry 150 years ago. The reason is simple. Natural gas is formed when the underground conditions for the storage of oil are unfavourable - specifically, when underground conditions are too hot to allow the oil to rest in a stable state without volatilizing. When oil is too deep or too hot for too long - every drop is eventually transformed into natural gas.

From one perspective, that is a great gift. Natural gas is the cleanest of all the hydrocarbon fuels, for the simple reason that an atom of methane (which constitutes 70-90% of natural gas) consists of only one carbon atom and four hydrogen atoms. Thus, more energy is produced through the combination of hydrogen with oxygen, and less through the combination of carbon with oxygen. That is the definition of a smaller fossil fuel carbon footprint.

Component wt. %
Methane (CH4) 70-90
Ethane (C2H6) 5-15
Propane (C3H8) and Butane (C4H10) <>
CO2, N2, H2S, etc. balance

The downside is that natural gas is too easy to find. When you're looking for oil - all too often - natural gas is what you get.

Natural gas was treated as a waste product for decades. Further, oil is easier to transport, and more versatile than natural gas, in that it can be broken down into many more products, whereas natural gas is an ultimate breakdown product - you have to put it back together to synthesize anything else with it.

Because we find natural gas more readily when we're looking for oil, it has been plentiful for the past 150 years of the "oil age." That is, because natural gas is so easy to find, it has been in surplus relative to scarcer oil, and so we are depleting it rapidly. Yet, we're going to need far more of it than we use today to produce oil from unconventional sources, such as Canada's oil sands.

So... what is my prediction? Alberta oil sands development will proceed apace - whether environmentalists (or anyone else) like it or not.

Personally, I'd rather develop better transportation systems for relatively much cleaner and more efficient natural gas. I honestly think that oil sands development is not a particularly great idea compared to capitalizing on the many favourable properties of natural gas.

However, my opinion has no bearing at all on the matter. The oil sands will be developed, because we have a global fixation on oil - period. This means that oil sands natural gas demand will grow on the order of fivefold over the next 20 years.

It is no secret that Canada's natural gas reserves are limited. The current estimate for Canada's proven reserves is 57.9 trillion cubic feet. Annual production runs at a level of 6.5 trillion cubic feet per year, of which Canadians presently consume about 3.3 trillion cubic feet per year, exporting the balance to the United States.

Canada's reserves to production ratio has fallen from about 35 years to 10 years since 1986, with exports to the United States almost quadrupling during that same period - approaching 4 trillion cubic feet per year.

57.9 trillion cubic feet may sound like a very large amount of natural gas, but at the present rate of roughly 1000 cubic feet of natural gas per barrel of oil form the oil sands, diverting every one of these almost 58 trillion cubic feet of natural gas to the oil sands would still leave over 100 billion barrels of present planned oil sands production undeveloped, let along the remaining 90% of heavy oil reserves that are not presently considered economic to exploit.

It has been widely reported that Canada's known (proven and probable) natural gas reserves will be depleted prior to the production of half of our planned oil sands reserves. To be honest, that projection appears optimistic, given what we presently know about our natural gas reserves and their present rate of exploitation.

There will be additional sources of future natural gas production, including offshore sources and coal bed methane, not to mention imported liquefied natural gas (LNG). But this natural gas will be more difficult and more expensive to produce. Bear in mind that 2028's projected 3.3 million barrels of heavy oil per day will require roughly 3.3 billion cubic feet of natural gas production per day to develop. Multiplied times 365 days each year, that will make up 1.2 trillion cubic feet per year, representing 1/3 of Canada's present domestic consumption.

At some point in the development of Canada's oil sands, the continued and growing - in fact bottomless - demand for natural gas will bring the price of natural gas towards parity with oil (it is presently much cheaper) - based on the simple law of supply and demand.

When that happens, the price of natural gas will spike upwards in a manner analogous to the recent surge in the price of corn due to its use in the production of ethanol (another policy I happen to oppose, but that is neither here nor there).

It is a simple equation. Oil sands production will keep growing in response to the inevitable decline in conventional global oil reserves. Each barrel will require 700-1200 cubic feet of natural gas.

When this equilibrium point is reached - and I have no idea when that will occur, whether sooner or later - the market price of natural gas will spike upwards (as the price of oil itself has recently done in response to a topping out of oil supply against still growing international demand).

Consider the following 9-year chart of Canadian Oil Sands Trust as an example of how the market has treated Canadian Oil Sands resources:

Referring to the present international oil boom, Richard Russell recently commented that he would rather invest in an idea that is not yet popular than in an idea that is popular right now.

My wife Susan thinks like Mr. Russell. She has been investing in Canadian natural gas producing companies over the past 6 years. She is in no hurry. She has gradually been accumulating dividend-paying shares in natural gas producing companies in Canada during this entire period. When natural gas attains parity with oil - she will be there. The move of natural gas towards price parity with oil will be of great benefit to Susan, because she chose to invest in Canadian natural gas when oil was by far the more popular energy product.

I suggest that you be there too.

The following 5-year chart makes clear that so far, Canadian natural gas producers, such as Paramount Energy Trust, have received far less enthusiastic treatment by the market than have Canadian oil sands companies. (This decline in market value has been largely abetted by the backward thinking of the Conservative Party of Canada and their misguided Finance Minister, Jim Flaherty, who have instituted policies to punish Canadians for investing in Canadian energy trusts, while simultaneously rewarding international investors for taking these prize assets out of our hands. See my previous blog post for more information on Canada's self-defeating policy impacting natural gas income trusts.)

What is unpopular today will be popular tomorrow. So long as you're in no particular hurry, you can bank on this idea - that Canadian natural gas assets will continue to appreciate in value over time, and at some point, perhaps dramatically.

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