CALGARY, Alberta - Producing heavy oil in Canada, much of which comes from the big oil sands deposits of northern Alberta, is a tough business and it's getting tougher.
The tar-like crude trades at a discount to lighter varieties. That wasn't a problem in July, when benchmark oil prices climbed above $147 a barrel, but after prices slid by more than $100 a barrel in the months that followed, some heavy oil producers are beginning to feel squeezed.
On Monday, small producer Connacher Oil and Gas Ltd (CLL.TO: Quote, Profile, Research, Stock Buzz) said it would restrict production of bitumen, a form of heavy oil, at its Great Divide thermal project in the oil sands to 5,000 barrels a day (bpd) from 9,000.
"Should oil prices continue to trade in the $40 to $50 range and differentials remain wide, then we will start to see more companies make a hard decision," said Menno Hulshof, an analyst at Dundee Securities. "I think it's inevitable."
Connacher said that prices are so low it can no longer cover its costs and is unwilling to keep pumping out its reserves at a loss. Thermal operations such as Connacher's Great Divide project, in which steam is pumped into the ground to liquefy bitumen, are expensive to run with smaller firms more likely to make cuts.
"Everybody's on a knife edge right now," said Martin Molyneaux, an analyst at FirstEnergy Capital. "But the bigger your balance sheet the less likely you are to shut in ... With $40 (oil prices) and bitumen prices in the high teens or low C$20 range you're in a rough place. Heavy oil is a big boy's game."
Connacher was the first Canadian firm to cut production in the wake of falling oil prices. It is not expected to be the last as oil prices plunge on the global economic slowdown and fears of over-supply.
Some Canadian producers are receiving $20 a barrel or less for their heavy oil, according to some estimates, making it tough to cover costs, particularly when, like Connacher, they also need to buy natural gas to produce the steam that's pumped into the ground to liquefy the bitumen.
Analysts at Merrill Lynch said earlier this month that 800,000 bpd of Canadian oil production could be shut in if oil prices fall below $38 per barrel, with 800,000 more to follow if price drop below $30.
Canadian oil companies produced an average 1.05 million barrels per day of heavy oil this year, including nearly 570,000 bpd of bitumen stripped from the oil sands using mining or thermal steaming methods and the rest mostly conventionally produced heavy oil.
Heavy oil production accounts for 38 percent of the country's total oil output, according the National Energy Board, and is growing in importance as conventional supplies wane.
The figure does not include bitumen processed into synthetic crudes at oil sands projects or stand-alone upgraders.
Most of that production is blended with lighter grades of oil for shipping on pipelines and sold to refiners in Canada and the United States that have equipment such as cokers that can process the heavy crude.
It's also used to produce asphalt during paving season, which boosts demand and narrows the differential, raising producers' profits, though prices can vary widely according to the quality of the heavy oil.
Refiners often have more Canadian heavy oil than needed, which increases the discount at which it sells. However new pipelines are in the works that will allow producers greater access to the U.S. Gulf of Mexico Coast, where refineries are looking for additional heavy oil to offset declining supplies from Mexico.
The economics of heavy oil production can vary widely, with conventional producers still able to turn a profit at current prices while the thermal oil sands operations may struggle.
Ray Chan, chief executive of conventional heavy oil producer Baytex Energy Trust, said his operations are still profitable at current prices but "if you were to layer on the cost of a (thermal) project or an oil sands mine it just doesn't work," he said.
Chan said refiners are offering to pay $12 less than benchmark prices for Baytex's heavy oil output in January. After royalties operating and transportation costs, the company sees a gross profit of C$13 per barrel when benchmark oil prices are at $44.
"These prices still offer us a healthy rate of return," he said.
The tar-like crude trades at a discount to lighter varieties. That wasn't a problem in July, when benchmark oil prices climbed above $147 a barrel, but after prices slid by more than $100 a barrel in the months that followed, some heavy oil producers are beginning to feel squeezed.
On Monday, small producer Connacher Oil and Gas Ltd (CLL.TO: Quote, Profile, Research, Stock Buzz) said it would restrict production of bitumen, a form of heavy oil, at its Great Divide thermal project in the oil sands to 5,000 barrels a day (bpd) from 9,000.
"Should oil prices continue to trade in the $40 to $50 range and differentials remain wide, then we will start to see more companies make a hard decision," said Menno Hulshof, an analyst at Dundee Securities. "I think it's inevitable."
Connacher said that prices are so low it can no longer cover its costs and is unwilling to keep pumping out its reserves at a loss. Thermal operations such as Connacher's Great Divide project, in which steam is pumped into the ground to liquefy bitumen, are expensive to run with smaller firms more likely to make cuts.
"Everybody's on a knife edge right now," said Martin Molyneaux, an analyst at FirstEnergy Capital. "But the bigger your balance sheet the less likely you are to shut in ... With $40 (oil prices) and bitumen prices in the high teens or low C$20 range you're in a rough place. Heavy oil is a big boy's game."
Connacher was the first Canadian firm to cut production in the wake of falling oil prices. It is not expected to be the last as oil prices plunge on the global economic slowdown and fears of over-supply.
Some Canadian producers are receiving $20 a barrel or less for their heavy oil, according to some estimates, making it tough to cover costs, particularly when, like Connacher, they also need to buy natural gas to produce the steam that's pumped into the ground to liquefy the bitumen.
Analysts at Merrill Lynch said earlier this month that 800,000 bpd of Canadian oil production could be shut in if oil prices fall below $38 per barrel, with 800,000 more to follow if price drop below $30.
Canadian oil companies produced an average 1.05 million barrels per day of heavy oil this year, including nearly 570,000 bpd of bitumen stripped from the oil sands using mining or thermal steaming methods and the rest mostly conventionally produced heavy oil.
Heavy oil production accounts for 38 percent of the country's total oil output, according the National Energy Board, and is growing in importance as conventional supplies wane.
The figure does not include bitumen processed into synthetic crudes at oil sands projects or stand-alone upgraders.
Most of that production is blended with lighter grades of oil for shipping on pipelines and sold to refiners in Canada and the United States that have equipment such as cokers that can process the heavy crude.
It's also used to produce asphalt during paving season, which boosts demand and narrows the differential, raising producers' profits, though prices can vary widely according to the quality of the heavy oil.
Refiners often have more Canadian heavy oil than needed, which increases the discount at which it sells. However new pipelines are in the works that will allow producers greater access to the U.S. Gulf of Mexico Coast, where refineries are looking for additional heavy oil to offset declining supplies from Mexico.
The economics of heavy oil production can vary widely, with conventional producers still able to turn a profit at current prices while the thermal oil sands operations may struggle.
Ray Chan, chief executive of conventional heavy oil producer Baytex Energy Trust, said his operations are still profitable at current prices but "if you were to layer on the cost of a (thermal) project or an oil sands mine it just doesn't work," he said.
Chan said refiners are offering to pay $12 less than benchmark prices for Baytex's heavy oil output in January. After royalties operating and transportation costs, the company sees a gross profit of C$13 per barrel when benchmark oil prices are at $44.
"These prices still offer us a healthy rate of return," he said.
