Contrary to the myth that Canada's oil sands are "high cost," they have a cost advantage over conventional production, according to a new report from the C.D. Howe Institute.
In Last Barrel Standing? Confronting the Myth of "High-Cost" Canadian Oil Sands Production, author Kent Fellows argues that the cost advantage will give them staying power if global demand for oil falls in the future.
"Much of the public discourse on Canadian oil and gas – specifically, on oil sands production – has characterized domestic production as "high cost" and "uncompetitive" in a future with reduced fossil fuel demand," says Fellows. "Most of the oil sands bitumen production is exported, either directly or following domestic processing. The logic then runs that, as Canada and its international trade partners begin to decarbonize, substituting away from crude oil as an energy source, Canada's own production will quickly become uncompetitive and will decline."
However, the oil sands are not high cost, especially in a way that matters for the relationship between global demand and domestic production, according to the report.
The oil sands sector will continue to weather short-term price dips, says the author, as long as the expected price doesn't dip persistently below C$40 (and even then, some producers will continue to produce at any expected price above the C$15-C$20 range). "In contrast, non oil-sands producers have shown that they will generally stop or dramatically slow investments in new production at West Texas Intermediate (WTI) prices below US$45 – roughly equivalent to a Western Canada Select (WCS) price of C$40, adjusting for the exchange rate and quality and transportation differences between WCS and WTI."
The author explains that oil sands operators will continue producing as long as the prevailing price is above their marginal cost while conventional producers will continue producing as long as the prevailing price is above their average cost. Oil sands producers invest capital up front in their projects, making only marginal investments thereafter. Conventional producers make ongoing investments in wells to maintain or increase production, so average costs are key.
Regarding world demand, he argues that OPEC's continued exercise of market power (if the cartel remains stable) should likely allow for stable and higher pricing in the face of potential demand declines compared with a global market in which no market power exists.
Emissions reductions by the industry will be key given the federal government's announced goal of reducing national greenhouse gas emissions to 40 percent below 2005 levels by 2030 and net-zero emissions by 2050.
"Although there is an open question as to how the recently announced oil and gas emissions cap will affect the viability of legacy oil sands producers, the current carbon-pricing system is a strong incentive to reduce emissions intensity while protecting exports," he says.
"The likely durability of oil sands production in a low-price environment means we cannot rely on potential global demand reductions to reduce Canada's emissions footprint through changes in the quantity of production. Emissions reductions in the oil sands will have to rely on reductions in emissions intensity or some policy that expropriates assets or otherwise enforces reductions in production," says the author. "The oil and gas emissions cap might end up an example of the latter, depending on how it is implemented. But if emissions reductions occur though reductions in production, Canada will forgo the significant economic potential of continued production from legacy oil sands assets.
Dr. G. Kent Fellows is Assistant Professor, Department of Economics and The School of Public Policy, University of Calgary; Fellow-in-Residence, C.D. Howe Institute.