Energy Companies Face Crude Reality: Better to Leave It in the Ground

Sarah Kent, Bradley Olson and Georgi Kantchev, Wall Street Journal, Mar 2 2017 - 06:00
A new era of low crude prices and stricter regulations on climate change is pushing energy companies and resource-rich governments to confront the possibility that some fossil-fuel resources will remain in the ground indefinitely.

In a signal that the prospect is growing more likely, Exxon Mobil Corp. has said that as many as 3.6 billion barrels of oil that it planned to produce in Canada in the next few decades is no longer profitable to extract. A disclosure is expected in the coming week. 

The step stems from U.S. regulations that require companies to take oil reserves off their books if they aren’t profitable at existing prices or can no longer be included as part of five-year development plans. 

The company said it still expects the reserves will be developed and again be added to its totals if prices rise, costs fall or its operations improve. It has stopped short of taking a financial write-down on its Canadian assets.

The acknowledgment by Exxon, after the company spent about $20 billion to put the oil sands at the center of its growth plans, highlights how dramatically the prospects of the region have dimmed.

Once considered a safe bet, Canada’s vast deposits are emerging as a prominent case of reserves being stranded by a combination of high costs, low prices and tough new environmental rules.

“For a lot of reasons the oil sands look like a prime candidate for eventual abandonment,” said Jim Krane, an energy fellow at Rice University’s Baker Institute. “One problem is that costs are persistently higher. The high carbon content only makes it worse.”

In addition to the oil sands’ high costs, extracting and refining the region’s heavy oil or bitumen is on average a more carbon-intensive process than almost any other type of extraction. The Alberta and Canadian governments have introduced new rules, including a cap on emissions and a carbon tax

During most of the past decade, Exxon and other giant oil companies spent billions of dollars in Canada as part of a global quest for new sources of supply, as analysts cautioned about “peak oil,” or the idea that production would start declining as resources ran out. Prices surged to $140 a barrel.

Companies worked feverishly to replenish their reserves of oil and gas, especially as investors have traditionally considered reserves a key indicator of future success.

But now, the worry is more about “peak demand.” Amid a glut of supply that led to a price collapse in 2014 and a tepid recovery, investors and executives at some of the world’s biggest energy producers are considering the possibility that oil demand will top out in the coming decades. 

The shift from a preoccupation with future supply to worries about demand has altered investment priorities away from high-cost opportunities in the Arctic, ultradeep waters and the oil sands.

Such projects can require billions of dollars in upfront investment and seven to 10 years, or even more, to bring returns. Now companies are turning to new sources of crude oil, such as shale, that don’t require the same massive investment of time and money to bring to production.

“Barring some geopolitical catastrophe that really changes the outlook…all these other projects are going to take the wind out of the oil sands,” said Amy Myers Jaffe, executive director for energy and sustainability at the University of California, Davis.

Canada was once thought to hold the world’s third-largest trove of crude, enough to meet U.S. demand for almost 30 years, largely due to the oil sands in northern Alberta—giant deposits of crude with the consistency of a hockey puck. Today, only about 20% of those reserves, or about 36.5 billion barrels, are capable of being profitable, according to energy consultancy Wood Mackenzie.

In the decade leading up to the 2014 price collapse, companies spent as much as $200 billion building megaprojects to extract heavy oil in Alberta’s boreal forest.

Canada, despite its high costs, was attractive to companies like Exxon for its stability and proximity to the U.S.

For its Kearl oil sands project in Alberta, Exxon invested more than $20 billion, designing a less carbon-intensive process by which the oil could be extracted without the use of a high-emitting plant called an upgrader.

The project was supposed to unlock 4.6 billion barrels of crude over 40 years and produce as much as 300,000 barrels a day. Production came online in 2013 and was expanded significantly two years later. The plant produced an average of about 169,000 barrels a day last year, according to an Exxon subsidiary.

The reserves Exxon is about to take off its book are a casualty of the price collapse that has foiled more than 17 oil sands projects, representing about 2.5 million barrels a day of production, according to ARC Financial Corp.

Global companies such as Statoil ASA and Royal Dutch Shell PLC that raced to build massive industrial projects in Canada have been forced to lower the value of their oil sands investments. Since 2012, the write-downs from those companies and Canadian producers have exceed $20 billion.

Exxon isn’t forecasting an oil demand peak through 2040 despite the action it is taking on its reserves.

“Even though we make that transfer, there is no change to our operations or how we manage the business, those assets, going forward,” Jeff Woodbury, Exxon’s vice president of investor relations, told investors last month.

U.S. Securities and Exchange Commission rules require companies to evaluate their prospects based on the average oil price in the previous year—about $43 a barrel in the U.S. for 2016. 

Exxon isn’t the only company taking steps that underscore the tenuousness of oil reserves. In its annual energy outlook published earlier this year, BP PLC warned that an abundance of already discovered oil resources and slowing demand growth will likely mean some barrels are never recovered.

Exxon Mobil, along with Chevron Corp., is pouring billions into expanding their footprint in shale oil, turning to projects that can ramp up quickly to fill the void left by a lack of larger, costlier developments.

Many of Canada’s biggest producers are planning to rein in spending this year, even as spending in parts of the U.S. is starting to rise.

According to the Canadian Association of Petroleum Producers, capital investment in the oil sands fell about 30% in both 2015 and 2016 and is expected to slide another 11% this year.

To be sure, oil output isn’t expected to fall in Canada as it has in the U.S. Fully invested oil-sands projects may go forward because the cash cost of producing barrels once a project is up and running is low.

Write to Sarah Kent at sarah.kent@wsj.com, Bradley Olson at Bradley.Olson@wsj.comand Georgi Kantchev at georgi.kantchev@wsj.com