Thursday, September 23, 2004

Unconventional Oil
Yesterday I looked at the debate concerning a possible early peak in conventional oil production. Today I'd like to cover one of the wild cards that might avert a peak. With the world’s spare oil capacity currently perilously close to zero, and with prospects of creating a safety margin anytime soon looking dim, “unconventional” oil is becoming increasingly important.

This term covers of ground, especially for those who recall the abortive and costly US experiment with oil shale in the 1970s. Generally speaking, it describes oil that either does not flow out of the ground readily through conventional drilling, or oil that requires significant processing after production. The two main forms of unconventional oil in wide production today and with good prospects for expansion, oil sands and ultra-heavy oil, fit one or the other of these criteria.

The reason these resources are so important now is that large deposits have already been identified, essentially eliminating the exploration risk associated with expanding conventional oil production. Bringing them onstream is a matter of deciding to invest in the industrial plants to handle their unique characteristics. While this sounds trivial, keep in mind that these are massive investments, running in the billions of dollars for each facility.

Recently, Canada has made a bid for recognition as having the world’s second largest oil reserves, after Saudi Arabia. With all due respect to my Canadian colleagues, this is a bit disingenuous, since the largest share of those reserves would not qualify as such under the SEC’s definition. The Oil and Gas Journal reports Canadian reserves of 180 billion barrels, while World Oil indicates only 5.5 billion. Oil sands—which were formerly known as “tar sands”, and the extraction of which is more like mining than oil drilling—account for the difference. Oil sands production already comprises about a third of Canada’s oil production and has staved off a decline in that country's overall production and exports. A number of firms are considering adding oil sands capacity, including Suncor, one of the main producers.

The other leading form of unconventional oil being produced today comes from the Orinoco Belt of Venezuela. It is extremely heavy, with a density greater than that of water, and is both difficult to extract and requires a good deal of expensive pre-refining before the resulting synthetic oil can be shipped off to a refinery for processing into gasoline and other products. But like Canada’s oil sands, the quantities available are enormous. Several plants, including the Petrozuata and Hamaca facilities, have been built in recent years, with more in prospect. Their combined production will soon rival Venezuela’s conventional oil production.

The biggest problems with both of these forms of oil are the capital required to produce them and the time required to construct the necessary mining and processing hardware. As a result, I’ve always been skeptical that they are quite the silver bullet that some suggest. For example, the Canadian industry will spend between $30 and $50 billion between now and 2012 to add under a million barrels per day of new synthetic oil capacity. You'd have to multiply this by a factor of three or four to make a dent in the global oil production profile.

At least until the recent price spikes it hasn’t been clear that the industry could attract this kind of incremental capital and provide attractive returns over the lives of these investments. But if the pessimists are right about the challenges the Saudis face in just maintaining their current production capacity, we had all better hope that there are lots and lots of new oil sands and heavy oil projects coming down the pike.

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