Joining the Party Up North

Marathon's announced acquisition of Western Oil Sands Inc., a Canadian firm with a significant stake in the Alberta oil sands play, extends a sequence in which most of the large integrated oil companies have expanded their portfolios to include these unconventional hydrocarbons. With the notable exception of BP, the majors have all either been there from the start, decades ago, or bought their way in, as access to other opportunities around the world dried up. Marathon's move could signal a further shift, however, in which the next tier of the industry also looks north; this might not be limited to integrated firms or independent producers, either.

A decade ago, Venezuela's Orinoco Belt looked like the place that everyone had to participate, for many of the same reasons that Canada's oil sands now look attractive: enormous potential reserves with minimal exploration risk, a friendly government, and a big technology component that fits the international firms nicely. Like the Orinoco, oil sands exploitation involves big, upfront investments that pay healthy returns as long as oil prices are high. Unlike Venezuela, however, it's hard to imagine a scenario in which Canada would unilaterally change the terms of access or nationalize these resources. Political risk was always the Achilles' heel of the Orinoco, and the only risk in Canada that comes close to the same importance is climate change policy, given the high greenhouse gas emissions of oil sands extraction.

When you consider the characteristics of these projects, there is little that would prevent a company with no current upstream exposure or expertise from getting involved. Much of the capital of these facilities is tied up in the refinery-like processing hardware that turns the gooey bitumen into a synthetic crude suitable for pipeline transportation and handling in a conventional oil refinery. To the extent that upstream expertise is required, Canadian partners can provide it. So might an oil sands investment appeal to one of the big independent refiners, Valero or Tesoro?

On the face of it, the idea of a pure-play refiner integrating upstream might seem unlikely. These companies largely built their portfolios from the divestitures of majors that saw little benefit in integration. Part of their appeal to investors is their lack of exposure to the above-ground risks that bedevil the majors in places like Nigeria, Russia, and Venezuela. But in a scenario in which crude oil became not only expensive but hard to get, integration could again pay big dividends, and independent refiners could find themselves under-running their multi-billion dollar assets. One needn't even believe in imminent Peak Oil to imagine such a scenario. Unwillingness on the part of OPEC to boost oil output, the continued growth of Asian demand, and a wave of new refinery construction in the Middle East and Far East could combine to leave US refiners scrambling for feedstock. Companies with their own equity crude to run or trade would have a real edge, as we saw in the early 1980s. Having a lock on a supply of pipeline crude from Canada might be worth a lot in such an environment.

Please note that this idea is entirely speculative; I have no reason to believe that either Valero or Tesoro is pondering such an investment. But if I were in charge of strategy for either firm, this option would now be high on my list for consideration.