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IEEFA Canada: Ill-advised oil sands project faces rough future

October 10, 2018
Tom Sanzillo and Kathy Hipple

Teck’s $20.6 billion Frontier Oil Sands Mine Project, now before the Canadian Environmental Assessment Agency Joint Review Panel, faces an extraordinary and alarming combination of risks.  The project will face financial distress for its entire 41-year life cycle. According to our report, Significant Financial Risks Confront Teck’s Frontier Oil Sands Mine Project, neither oil price increases nor production cost declines for the project are likely to be sufficient to improve its financial prospects.

Teck Resources Limited is ill-equipped and ill-prepared to take on such a mega-project due to its relative inexperience in oil sands, limited bandwidth for such a project, and the sheer scale of the project itself relative to Teck’s market capitalization and capital investment budget. The Frontier project represents an investment ($CAD21 billion) far in excess of its total market capitalization (US$13.4; CAD$17.7 billion) of Teck, which is the sole owner of the project. (Suncor and ExxonMobil have, respectively, market capitalizations of US$66 billion and US$330 billion.) Teck’s recent filings suggest it is ill-prepared to begin the capital-intensive mega-project, as it would need to find a partner or raise funds – neither of which it appears to have done.

Beyond Teck’s own internal issues, the broader market factors affecting Canadian oil sands production add financial headwinds, including high costs to produce oil sands and pressure on revenues, as described below:

  • Costly oil sands extraction. On the cost side of the equation, the Frontier Project, like most oil sands extraction, is expensive. Despite aggressive company and industry efforts to lower costs to a competitive range, many large global suppliers of oil and gas remain far more competitive than Canada’s oil sands producers.
  • Continued low price of Western Canada Select (WCS) oil. WCS oil is currently discounted against market competitors, specifically West Texas Intermediate (WTI), because of its low quality and the distance it must be transported to market.
  • New sulphur rules for maritime fuel users. Regulations requiring that shipping companies use cleaner burning, lower sulphur fuel will go into effect between 2020 and 2025. That will further depress the price of high sulphur WCS and weaken the revenue generating potential of the investment.
  • Chronic shortfall of pipeline capacity. Pipelines connecting Canada’s oil sands with ports and markets continue to face legal, regulatory and political challenges that create bottlenecks. This challenge was exemplified by a federal Court of Appeal ruling in August that halted construction of the Trans Mountain pipeline, which would connect oil sands to Canada’s West Coast. Teck’s own 2017 annual report notes these bottlenecks are expected to widen price differentials between WCS and WTI.
  • Competition from the expected surge of new investments in cheaper, lighter and sweeter oil grades. These new oil products, coming principally from the Permian Basin, will exert ongoing pressure and erode Canada’s WCS exports to the U.S. for the foreseeable future.
  • Unrealistic plans to export oil sands to Asia. Canadian oil producer plans to export oil sands to Asian and other major importers face stiff competition from oil producers with existing trade relationships and lower cost structures. These competitors will win out over Canadian oil sands producers in Asia and other markets.

A selling point for the project has been economic benefits to the people of Alberta. But faced with these market realities, Teck has already had to reduce its estimates of economic benefits and royalty revenues that the project will generate in Alberta. Projected benefits to Alberta household incomes have declined by more than 60% from the initial filing of the project. And even this lower level may be optimistic.

Beyond traditional market forces, the Frontier project faces mounting public opposition. The depth of popular opposition to fossil fuel projects has surprised corporate leaders in Canada. Projects once thought to be in compliance with regulatory standards and part of a political consensus are being cancelled or delayed as citizen opposition mounts.

Another surprising outcome of citizen activism is that companies like Kinder Morgan, which sold its unfinished Trans Mountain pipeline and related assets to the Canadian government for $4.5 billion, find that their credit rating improves when they rid their balance sheets of financially distressed new projects. That provides a strong incentive to drop uneconomic projects.

Now the question is when will Teck and the project’s supporters accept reality.

Tom Sanzillo is IEEFA’s director of finance and Kathy Hipple is an IEEFA financial analyst.

Tom Sanzillo

Tom Sanzillo is Director of Financial Analysis for IEEFA. He has produced influential studies on the oil, gas, petrochemical and coal sectors in the U.S. and internationally, including company and credit analyses, facility development, oil and gas reserves, stock and commodity market analysis, and public and private financial structures.

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Kathy Hipple

Former IEEFA Financial Analyst Kathy Hipple is a founding partner of Noosphere Marketing and the finance professor at Bard’s MBA for Sustainability.

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