Alberta's sticky oil costs

Summary

 

• Shell may have under-estimated the true cost of improper planning

• Because of the magnitude of the infrastructures required for oil sands projects, a little mistake could cost millions (if applicable, billions as might be the case here) to fix

• Canada’s oil sands projects are still the safest supply source to help with North America’s ever growing energy demands

Analysis

Alberta’s Oil Sands projects in Fort McMurray are in a league of their own in all aspects, including the costs/finances. The oil sands project costs are typically 50% capital and 50% labor.  Expenditures forecasts vary from one oil sands exploration company to another.  It is beyond the scope of this brief analysis to go in-depth into the reasons why these partners’ forecast was inaccurate.  However, no matter how close to the actual expenditures, forces outside the company’s control could potentially pose major risks to the entire project, as one may speculate might have been the case here.

In order to mitigate risks, companies must begin the process by putting good procurement processes in place [although contract law applies to any awarded contracts].  This ensures that contractors/suppliers will not ‘run-out’ on the company, once their costs are over what they actually bided for.

Next, companies must ensure they actually have available labor to carry-out all parts of the expansion project for each projected time period.  Based on analysis I’ve conducted, leading overtime can greatly affect the economics of an oil sands project.

Finally, companies need to monitor the project’s development and make sure that all parts being built remotely can be connected to the ones on-site.

Western went through the trouble of informing the market that their costs might double for this expansion project in order to prepare the market for even higher revised numbers, most likely to be announced at a later date.  That is a smart move, in my opinion.  Why Shell on the other hand would play ‘ignorant’ when it is fully aware of all of the partners’ assumptions/costs, remains a mystery.  The market may be surprised by this announcement, but not the companies involved, nor the industry as a whole.

How does this announcement impact other oil sands companies?  Investors/the market in general will begin to pay closer attention to how oil sands project costs are estimated, the bidding processes of companies (lump sum bids are less risky as contractors/suppliers must perform as per the cost they stated), but most importantly, keep an eye on the project’s development. 

With geopolitics as they currently are, oil sands companies should be minimally impacted by that announcement, since projects currently underway must still be executed/completed.