Wednesday, July 22, 2009

Alberta worming out of upgraders

The Calgary Herald and Deborah Yeldin is the ink barrel for the Alberta Conservatives. Their article, Bitumen-processing rationale needs an upgrade can only be a direct quote from the Government. It was after all, the consensus of opinion when they started this BS to get elected.

Bitumen-processing rationale needs an upgrade
By Deborah Yedlin, Calgary HeraldJuly 22, 2009
The provincial government, despite advice to the contrary, is forging ahead with its bitumen-in-kind initiative as a way to increasing the amount of bitumen processed in Alberta. The latest step toward achieving this goal came in the form of a draft request for proposal soliciting comments from industry released Tuesday.

The intent, of course, is to kick-start the moribund upgrading projects that have been iced in recent months, thanks to high costs, lower prices and more capacity for upgrading and processing in the United States.

By being able to supply a stand-alone upgrader (can you say Northwest Upgrading?) through this policy, the government will make good on an election promise to see more value-added to Alberta's natural resources --in this case, bitumen.

But the entire idea remains misguided and ill-advised.

Let's start with the fact that if the economics made sense, there would be more upgrading going on in the province, not less. Access to the bitumen molecules is not the problem--there are other issues preventing this from happening.

Point 1: It's cheaper to modify and expand existing facilities instead of building them from scratch. And this is exactly what's been going on south of the border. Capacity has increased as a result of refineries reconfiguring themselves to handle the increasingly heavier barrels being produced in North America, as well as the fact there isn't as much crude flowing from Mexico and Venezuela and finding its way into the U. S. facilities. More capacity means lower processing fees, even with the cost of sending it south.

There's also the advantage of being closer to markets that gives the economics a boost.

The reality is if the market thought it could compete with that, more upgraders would be moving ahead in Alberta; but that's not the case.

"These decisions are usually made by the market," said David Collyer, president of the Canadian Association of Petroleum Producers.

"I understand the government's desire to increase investment in the province, but it needs to be mindful of the potential downside of market intervention."

And it's market intervention that is the second factor that should cause anyone in the energy business to be very worried; this includes pipelines as much as it does producers.

As things look right now, the initiative is aimed at companies whose operations are not integrated in Alberta. This potentially means companies the likes of En-Cana, with agreements to upgrade bitumen in the U. S., could be negatively affected by this policy.

It also could have an adverse impact on pipeline companies committed to building capacity to ship the bitumen into the U. S.

Either way, it's not good from a free market perspective; any time there is market intervention, the consequence is market distortion.

Nor do these undertakings necessarily play out the way they were initially intended.

Anyone with a bit of grey hair out there will remember all too well the outcome involving the last provincially owned upgrader; the jointly owned Lloydminster upgrader was ultimately sold to Husky--and not for a price that remotely covered the cost of construction and operating it up to that point.

The third factor to consider is that more upgrading in the province will increase greenhouse gas emissions. Given the direction in which climate change policy is headed, one has to question why the Alberta government would move in this direction.

Finally, there is the issue of managing the commodity price risk associated with the policy.

The economics of stand-alone upgraders -- those that depend on bitumen being supplied by other producers -- is difficult at the best of times. See aforementioned reference to Lloydminster.

Whether the facility makes money is dependent on what is known as the differential between light and heavy oil.

This differential--also known as the discount to which the price of a barrel trades relative to the benchmark light crude--varies according to refining capacity.

If there is lots of capacity, the differential--or the discount-- is low. This means the barrels are more expensive because they can be processed. Conversely, if there is a shortage of capacity, there are more raw barrels and therefore the price falls.

This inherent volatility means these are tough businesses to finance--especially on a standalone basis.

Finally, while it's noble to want to create jobs in the province, it has to be pointed out that the job-intensive aspect of an upgrader is during construction; the facility doesn't require a huge labour force to keep it running. Moreover, didn't the province just announce a 12-person panel aimed at determining how to diversify the economy? By pushing this upgrading agenda, it appears the government might not be as committed to economic diversification as it wants the electorate to believe; this is clearly the easier route.

Alberta's oilpatch has already had enough challenges in the past 18 months and the last thing it needs is more uncertainty as a result of ill-conceived initiatives solely for political gain. The possibility of market distortion as a result of this policy will be one more reason for outsiders to stay away from investing in Alberta. Given the current economic climate, it's the last thing we need.
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