THE ENERGY FINANCING AND DEVELOPMENT CONFERENCE BUSINESS INFIIW CENTRE MIMI SEP 30 1950 IMPERIAL OIL LIMITED FINANCING AND BUSINESS OPPORTUNITIES IN ESSO COLD LAKE PROJECT BY G.E. COURTNAGE J.F.C. DE SOUZA DENVER, February 28/29 The constantly rising price and the declining availability of oil has sent importing countries of the world scurrying to develop alternatives in terms of both renewable and non-renewable energy sources. In the latter case, we are on the threshold of an era of rapid deveIOpment of a variety of energy sources collectively termed "Synfuels", embracing large ventures in oil sands,* coal conversion and oil shale. Esso Resources Canada Limited is an acknowledged leader in the develop- ment and commercialization of crude projects based on the oil sands resources of Canada. It is the major participant in the 125,000 barrel a day Canada Ltd. oil sands mining Operation and is now sponsoring an even larger venture, the 140,000 barrel a day Cold Lake insitu project. Esso Resources is a wholly owned subsidiary of Imperial Oil Limited, the largest integrated oil company in Canada. Imperial Oil is the second largest company in Canada and is celebrating its 100th anniversary this year. Exxon. Corporation is a Inajor shareholder' of Imperial Oil and, as a result, Imperial has access to the considerable expertise of one of the world's leading energy companies. This paper will describe the Cold Lake Project and highlight some of the more important aspects relating to business opportunities, financing and interaction with governments. First, it is useful to put the project into the perspective of the overall Canadian energy scene. CANADIAN OIL SUPPLY AND DEMAND Canada has changed from being a net exporter of oil in the early 1970's to being a net importer for the last few years. The latest published data from the National Energy Board (Chart 1) shows that established conventional oil reserves are projected to decline rapidly. Even with forecast additions to conventional reserves, Canada is expected to face a deficit of 700,000 barrels a day in 1985 and twice that amount in 1995. These volumes are small in comparison with those of the United States but they have similar and serious implications in terms of security of supply and balance of payments. See end of paper for definitions The most reasonable strategy for Canada is to reduce, and hOpefully eliminate, the oil deficit by a dedicated effort to conservation and simultaneously by rapid development of the oil sands, where the chal? lenge is not discovery but recovery. This plan, in addition to an aggressive exploration and development effort in established and fron- tier areas, is the best approach to keeping Canadian energy options open. The governments of Canada over the past few years have recognized the potential seriousness of the energy situation and appear dedicated to reducing the supply deficit and attaining self sufficiency by 1990. It is thus an area where both governments and the petroleum industry have the same objectives. The most effective way to increase the domestic supply of oil is to concentrate on. areas of greatest potential. In Canada, this means development of the oil sands (Chart 2), in the U.S. it is primarily coal and oil shale. A comparison of approximate reserves is given in Chart 3. It is clear that the reserves of conventional oil in Canada, the U.S. and Venezuela are very small in comparison to the enormous resource base of oil sands and oil shale. It is also obvious that the future oil supplies in these countries must be tied to the develOpment of these unconventional energy sources. However, this will be a long and costly endeavour, for while it costs only a couple of dollars to produce a barrel of oil in Saudi Arabia, it will cost more than ten times that amount to produce oil from oil sands or oil shale. Unique recovery processes have been developed to extract the bitumen from the oil sands and to process it. Oil Sands Recovery and Processing Methods In Canada, the oil sands deposits lie almost wholly in the province in Alberta at depths ranging from 50 feet to 2,000 feet below the surface. About 82 of the deposits, representing some 75 billion barrels of oil indplace, are close enough to the surface to be recovered by conventional strip mining techniques. Two commercial scale plants are already in operation using this method. The bulk of the oil sands, more than 90%, lie at depths in excess of 500 feet and have to be recovered by insitu techniques, all of which have the same objective of mobilizing the heavy, viscous, high sulphur con" tent oil so that it can be pumped to the surface. Even when it has been recovered, the bitumen in its natural state is not much use. After all "cold molasses" is not much good in a gas tank of a car. The bitumen has to be further processed to make it tranSportable and amenable to refining in existing refineries. There are several methods for accomplishing this upgrading; essentially all involve reduction in the carbon content and/or an increase in the hydrogen content of the bitumen. The final product of processing bitumen is a crude oil which is very similar to light, 10w sulphur content oil that is in ever diminishing supply and commands a premium price on the international market. The recovery and upgrading technologies now being used for oil sands projects have 'been developed over a long period of time and it is instructive to examine the lead times and costs for this develOpment. HISTORY OF OIL SANDS DEVELOPMENT Although scientific interest in the oil sands of Alberta dates back to 1890 and was pursued almost continuously between about 1910 and about 1950, work by major oil companies now in existence began about the late 1950's. Although both insitu and mining recovery schemes were tested through extensive field pilot operations, the mining technique offered the first promise of commercialization. Two major projects have been based on this method, the Suncor plant built in 1968 and the plant completed in 1978. Their combined output at full capacity will be about 200,000 barrels a day of crude oil. The long lead time and the enormous cost are exemplified by the develop? ment of Esso Resources' Cold Lake project (Chart 4). -Geological and laboratory' bench studies commenced in 1963 and have continued ever since. The first field pilot was commissioned in 1964 and was used for data collection until 1970. Another new field pilot program was started in 1972 with a projected capacity of about 1,500 barrels of bitumen a day. This pilot, based on the conclusions and best ideas from earlier studies, was intended to provide basic data for scaling up to a commercial recovery level. However, within about a year of operation results indicated a need for a larger pilot to obtain improved statistical data. To meet this need a larger 5,000 barrel a day prototype field pilot was built and started Operation in 1975. Both of these pilots are continuing in operation and their results have been incorporated into the planning basis for the commercial scheme. An expansion of the prototype pilot is due to be commissioned this year at a cost of about 50 million dollars. It will provide detailed operating parameters for the commercial plant. The capital and Operating costs for laboratory, geological and field pilot studies in the period 1963 to 1980 is about 180 million dollars. In 1977 ?530 Resources felt that it had enough confidence and experience to justify the application for a major commercial venture based on the technology it had developed in the prior 13 years. Accordingly, a team was assembled and environmental, socio-economic, cost benefit and tech- nical studies were undertaken in order to support an application for a permit to build such a plant. The application was submitted in 1978 and in the fourth quarter of 1979 Alberta's Energy Resources Conservation Board indicated it would recommend approval. The government of Alberta is expected to confirm the recommendation of the Energy Resources Con- servation Board by mid 1980 and give final approval for the project. Esso Resources has continued with engineering develOpment work and is planning to have a control cost estimate and budget by the end of this year. The project develOpment costs from 1977 to 1980 inclusive will amount to about 135 million dollars. Construction of the plant will take place between 1981 and 1986 and initial production of crude oil is expected in late 1986. Construction costs are estimated to be 7 billion dollars, allowing for the effects of inflation during that period. In the commercialization of synfuels technology, lead times of 20 years are not uncommon. During this period companies have to pour millions of dollars into research and development in the hope that they will develOp a sound and economically viable technology. Overview of the Cold Lake Project The project configuration as preposed by Esso Resources, and approved in principle, is based on the large scale combination of three well known technologies (Chart 5). The production technology, using steam stimu- lation has been deVelOped for use in specific parts of the Cold lake deposit by Esso Resources but the concept and much of the hardware have been tested in several other areas, notably in the heavy oil region of California. fhe upgrading scheme is based on Exxon's FLEXICOKING and hydroprocessing technology that has been well proven in refinery operations. The FLEXICOKING process is an extension of Exxon's well known fluid coking technology that has been successfully implemented on a large scale in refinery operations for over a decade. The plant uses two of the largest fluid coking units in the world and a third oil sands mining plant proposes to use this same technology. A large scale oil sands venture in Venezuela will be using Exxon's FLEXICOKING technology which has been successfully demonstrated in the commercial service in Japan. The FLEXICOKING process converts the bitumen into lighter intermediate petroleum streams and essentially sulphur?free fuel gas. These inter* mediate streams are then hydrotreated, again using Exxon's patented and proven technology, and blended to yield a premium quality, light tic crude oil that can be processed in existing refineries. The production and upgrading parts of the project are jointly served by a utilities complex comprising water treatment and the generation of high pressure steam. This technology is well developed and proven as part of conventional thermal power generation. The technology to be employed in the Cold Lake project is therefore well proven. Hardware of similar size has been successfully Operated for extended periods in similar conditions. The challenge is to have the maze of ?huge, complex, interconnected units and processes operating simultaneously at high efficiency. Similar challenges were faced by the Trans?Alaska Pipeline system project and the project and have been successfully overcome. The Cold Lake project, because of its immensity, will have a significant impact on Alberta and Canada (Chart 6). The detailed engineering phase in 1981 through 1984 will require 2,000 engineers and support staff. The construction period of 1981 to 1986 will require thousands of skilled tradesmen at the Cold Lake site, as well as in Edmonton, the Supply and pre-assembly base. At the peak, close to 7,000 1manual workers will be employed. This gigantic effort will result in the cost of the plant being in excess of 7 billion Canadian dollars, including an allowance for inflation, but not for interest, during the construction period. If the plant could somehow be built instantaneously today, the cost would be between 4 - 4-1/2 billion dollars, in 1980 terms. The Operations phase of the project commencing in 1986 is also impressive. The annual operating cost in 1980 terms will be more than 350 million dollars, part of which will be for the permanent staff of over 2,000. Expenditures of this magnitude will have a significant ripple effect in the equipment manufacturing and servicing industry in Canada where it is estimated that about 8,500 permanent jobs will be created. Addition? ally, the production of 140,000 barrels a day of crude oil will reduce imports and have a positive effect on the balance of pay? ments of over 1.5 billion dollars per year in 1980 terms. The objective of this conference is to discuss policy issues as well as legal, business and financial implications of energy development. Some of these issues are addressed in the rest of this paper. ECONOMIC VIABILITY In Canada, the Federal Government sets the price of crude oil as well as the tax regime that will be applicable to oil sands projects. The provincial government, as owner of the resource, sets the royalty formula; historically it has been negotiated on an individual project basis. The establishment of suitable business terms and conditions is thus a three?way affair, involving two levels of government and the developer. The basic principle, which is easy enough to agree on, is that each party must get a reasonable share of the net revenue. The challenges are.to arrive at a consensus on what is reasonable, and further, to design and implement a scheme which will yield the desired results. Under current rules, which include the present level of international price, a royalty formula based on profit-sharing after pay?out and tax incentives that will reduce front-end costs by up to 50%, the Cold Lake project 'has an internal rate of return. which 1narginally' exceeds the minimum expectation of 10% in real terms. Esso Resources 'believes the Cold. Lake project is economically 'viable under the current perception of rules that are applicable to oil sands plants. There are good reasons why the rules should be formally put in place and not changed to erode the developer's return. The price of the product is the most critical factor affecting the economics. Esso Resources maintains that access to international prices is vital for new energy sources as that is the cost of an incremental barrel of oil that has to be imported. Furthermore, the high costs of synfuels can only be accommodated with these levels of price. Not too long ago when oil was less than $10.00 a barrel there just was not the incentive to seriously consider large?scale synfuels develOpment without government subsidies and/or guarantees. Another important factor is capital cost, specifically the inflation component. Since these projects take so long to develop and to build, inflation effects on materials and labour have to be projected several years into the future. While the level of future cost inflation is uncertain, it is generally projected to be higher than it has been historically. Further, in areas of high growth like Alberta there is likely to be higher local inflation. In fact, inflation. in non? residential construction over the last five years in Alberta has been approximately 4% higher than general inflation measured by the Consumer Price Index. We believe this trend will continue through the 1980's. FINANCINE Financing is perhaps the single most important issue facing industry sponsors of large energy projects. Generally, the whole cost of the project is not fully funded by the develOper. The government assists through the tax system by allowing certain ?write?offs, for example, depreciation, depletion allowance and investment tax credits. The front-end cash. cost to the developer is significantly reduced. In Canada, if industry sponsors can take full advantage of the tax write- offs immediately, the cash required for an oil sands project can be reduced by up to 50%. It is often thought that government incentives are just plain subsi? dies. The fact of the matter is that governments can be, and usually are, hard?headed investors. Their stake in the financing of the project will earn them a return when the project becomes profitable. Government tax incentives are thus investments. Government participation could also take the form of direct equity ownership. As Esso Resources wants to have a reasonable mix of assets in the total energy business it has decided that it would be prudent to invite equity participation in up to 50% of the Cold Lake project. Esso Rescurces eXpects to finance its share of the lake project through retained earnings from existing petroleum Operations, supple- mented by conventional debt which will be secured by the current assets of the company. Other industry participants would likely take the same approach. We do not anticipate difficulties with financing as the financial community, both in Canada and the U.S., appreciates the company's proven record and leadership role in both conventional and Oil sands deveIOpment. Reference was made earlier to the benefits of the project. While there is substantial scope for increased employment, there is also a consider- able range of business Opportunities associated with the project. pus mass OPPORTUNITIES In the financial area there are Opportunities for equity participation and also for the involvement of the financial community in arranging the substantial amount Of debt that will be required. There are also many Opportunities in the technology area, for example, licensing of process technology, sale of Specialty chemicals and contracting work involving engineering, procurement and construction. ldanufacturing is another major area where there i?ill ?undoubtedly' be considerable Opportunities. The project will require vast quantities of bulk commodities for example 15 million feet of wire and cable, 4?1/2 million feet of insulation and 3-1/2 million feet of conduit. Addi- tionally, there will be a demand for fabricated equipment, for example, 500 heat exchangers, 210 compressors, 1,000 pumps and 80,000 valves. In support of the Canadian government's objective of maximizing Canadian participation in large energy projects, Esso Resources will be attempt- ing to utilize Canadian. materials and labOur to the fullest extent practical. However, there will be specialized equipment, heavy- walled pressure vessels, that will have to be imported. The Opportunities Offered by the Cold Lake project and other large scale projects that will inevitably be built in the quest for energy self- sufficiency in Canada and elsewhere cover a very wide spectrum. Companies that intend to take advantage of these opportunities must take the long-term View and commit themselves to growth now while they still have the lead time. The criteria to be used in assessing potential vendors of equipment and services are quality, service, delivery and price, so it is important that these aspects of a vendor's bid be eaten blished well in advance of tenders for project requirements. Major petroleum and other energy projects in Canada such as uranium mining and giant hydro~e1ectric power stations share a common character~ istic. They tend to be located in areas remote from major labOur and manufacturing centres. The supply of general labour is usually small and that of specialty trades is often even more limited. The remoteness of the location usually means that there is no town nearby, or if there are towns, they are too small to adequately accommodate the rapid population growth that results from the construction of very large projects. This situation in Canada is similar to that for the likely areas of synfuels deve10pment in the U.S. Esso Resources is familiar with the development of several large projects and has acquired some valuable experience which should be applicable to the develOping synfuels industry in the U.S. CRITICAL AREAS Among several important aspects, there appear to be a few which are critical to the success of the giant non-conventional energy projects being contemplated today (Chart 7). The first area is public acceptance, more specifically, acceptance and support by the communities upon which the project will likely have the most impact. In develoPing the Cold Lake project, we established offices in the surrounding communities and encouraged the formation of a community association as a focus for the dissemination of information as well as for the reception of suggestions by local residents. Senior company representatives attended Open meetings with this association on a regular basis and company experts in environmental and socio-economic matters spent a great deal of time with various interest groups in the community explaining what we wanted to do and why we wanted to do it in the way proposed. Business and employment opportunities were diSCussed at length. We learned that reSpect for the sensitivities of the local residents was of paramount importance. A case in point is that while we obtained wide general acceptance of the project in the communities, we were unable to obtain support for taking fresh water for the project from nearby Cold lake. The alternative of going to a much further and lower quality water source will cost Esso Resources an extra 80 million dollars. The recognition and understanding of emerging native aspirations to participate in projects adjacent to their lands is the first step to finding a mutually acceptable solution. 3530 Resources is devoting a great deal of time and effort to working with native bands and appropriate government agencies on these issues. Experienced and knowdedgeable people of native origin on our staff greatly facilitate communication with the native administration in the reserves and on the settlements. The second critical area is ir?eraction with governments, municipal, provincial and federal. We need to be closely involved with governments to obtain approvals, business terms and conditions, commitments for the provision of infrastructure facilities and services and agreement on the plans for labour supply and labour stability. The regulatory process for obtaining approvals can be time consuming and very expensive for the developer. The main regulatory agency in Alberta, the Energy Resources Conservation Board, administers the pro- cess fairly and with a concern for speedy progress. The petroleum industry's relations with the Board are excellent. We have found that cooperation and understanding between the develOper and the regulatory agencies during the preparation and public hearing of applications go a long way towards avoiding undue delay. A straight forward and efficient regulatory process is absolutely essential to rapid synfuels development. As discussed earlier, governments play a major role in determining the economic viability of synfuels projects since they establish the business terms and conditions. It might be Optimistic, but we believe that with the priority of reducing imports, governments in Canada as well as in the U15. will develOp satisfactory fiscal packages without delay. These packages will also have to take into account large social expenditures required to lna made either by the government or by the developer. Governments are also intimately involved in the area of labour supply and labour stability. The peak. requirements for skilled labour for large energy projects are very high and, if shortfalls are expected in particular trades, corrective action must be initiated immediately, usually with the involvement of governments in areas such as apprenticeship programs, manpower retraining and immigration. Work stOppages on major projects can cause costs to rise dramatically; for example a 60?day strike during construction of the Cold Lake Project would cost over 250 million dollars. It is for this reason that developers justifiably want an assurance of labour stability, some forms of which can only be arranged if appropriate legislation is in place. Under the terms of recent Alberta legislation, the contractor for the Cold Lake project will be allowed to negotiate a no?strike no?lockout arrangement with the labour unions for the duration of the constuction period. The last critical area is project execution. Efficient procurement and careful scheduling are even more critical in large energy projects such as in oil sands, oil shale and coal conversion. The contractor must have excellent cost control and manpower control systems as there will be thousands of workers and thousands of tons of equipment and supplies on site. Construction of the Cold Lake Project will involve an average expenditure of 4 million dollars a day for each day of the 5-year period of construction. There is also a need to implement measures to maintain labour productivity in these remote areas as well as to reduce labour turnover. The contractor for the Cold Lake project will be a joint venture com? posed of up to five contractors. Fluor Canada Limited, an affiliate of Fluor Corporation of Irvine, California, will be the lead contractor in this joint venture. This company? was the prime contractor for the Trans-Alaska Pipeline and has had extensive experience in the constuction of Specialized equipment involving many thousands of workers in a remote and hostile environment. The other contractors in the joint venture will be Canadian and will bring their specialized experience of construction in Canada. Their participation in the Cold lake Project will further the Canadian government's objective of building local expertise to construct future oil sands plants. Additionally, Esso Resources' eXperience gained from the construction of the plant will be valuable input to the project execution plan for the Cold Lake project. eraser. Synfuels deveIOpment is gaining impetus in major oil importing countries of the world. DevelOpment centers around the major indigenous resources. In Canada it is the oil sands, in the U.S. oil shale and coal. The projects are immense, have multi?billion dollar price tags and take an incredibly long time to develop and construct. Governments have the ultimate power to make or break large synfuel projects. In Canada, the petroleum industry does not require subsidies but rather reasonable and sound, long?term policies that will create an atmosphere of stability and confidence. Frequently there are clamours for even more stringent control of the already highly regulated petroleum industry' but this would be counter-productive as it will result in loss of incentive and inefficiency. Our view is that profits should not be viewed in absolute terms but rather within the perspective of the substantial capital already employed and the massive reinvestment necessary for new energy supplies. In essence, Sponsors of large energy projects must be financially healthy if they are to take the considerable risks associated with these ventures. Having taken the risks it is fair that the potential rewards must be commensurate with them. Esso Resources' commitment of millions of dollars over nearly two decades has brought the Cold Lake project to the verge of construction. Not only will it be the first Canadian, and indeed North .American, insitu oil sands project, but it will be the largest and most sophisticated technological project in the oil sands. Significant benefits will accrue from the project to regional, provincial and federal constituencies. The tough challenges for the Cold Lake project are to build :1 safe, environmentally and socially acceptable plant within the proposed schedule and budget and to operate it successfully in a relatively harsh environment. Esso Resources has the experience and confidence to meet the challenges and we are eager to proceed. DEFINITIONS Oil Sands or Tar Sands Sands and other rock materials containing crude bitumen. Surface Mineable Area That part of an oil sands deposits overlain by 150 feet or less of overburden. The depth of overburden limiting surface mining operations today is based on recovery economics and technology that may reasonably be anticipated in the near future. . In?Situ Areas Those portions of the oil sands deposits overlain by more than 500 feet of overburden. Such deposits are too deep to mine by surface mining methods and therefore require production by Special drilling and "flushing" methods designed to reduce the viscosity of the bitumen. Crude Bitumen or Bitumen A naturally occurring viscous mixture, mainly of hydrocarbons heavier than pentane, that may contain sulphur compounds, and that in its naturally occurring state is not recoverable at a commercial rate through a well. (Alberta and Gas Conservation Act 2. The crude bitumen occurs in beds of sand, usually partly cemented together. The sand grains are usually covered with a film of water, and bitumen occupies most of the remaining pore space, along with fine clay particles and other mineral matter and, occasionally, some natural gas. The bitumen when separated from the sand usually has a density of between 6? API and 12? API. Upgrading Refinery?type processing of bitumen that: at the minimum, reduces its viscosity so that it may be transported through conventional oil pipeline systems Upgrading (Cont'd) (ii) subjects it to severe treatment to reduce the sulphur, nitrogen and metals contents and yields a crude oil which is easily transportable in existing oil pipelines and may be used as a feedstock in conventional refineries to give a variety of finished petroleum products produces finished petroleum products gasoline, diesel and aviation fuel Crude Oil The upgraded product obtained from crude bitumen. It is defined as a mixture, mainly of pentanes and heavier hydrocarbons, that may contain sulphur compounds, that is derived from crude bitumen and that is liquid at the conditions under which its volume is measured or estimated, and includes all other hydrocarbon mixtures so derived. (Alberta and Gas Conservation Act 2. (1) 41.) CHARTS thaw (1/8 NOITIIW Ff. Aymw .3me ?Hg?p? 2-: - . . Ammo 1.1 a rd!- Iul . - In,? A, Trfi xi I Alf?rk \l.lf?\z?ml? .rr I\m1 Is .Hlx xx, \mx, .l . Ammo nl\ rk/ aV mm. 39?403 LOWER CRETACEOUS . MAJOR Oii. SANDS DEPOSEB LN . (all u; A if @3013 g) mo AMERICA *5 a 9% i 6 3: ATHABASCA SK: BITUMEN IN PLACE BILLION BBLS COLD LAKE TOTAL - ATHABASCA i rwwuNG 74 V1 IN snu 646 3 com LAKE 159 ?may PEACEIUVER 64 I VVABASCA 33 i 200km i TOTAL 931 ATM: m?gm 03m b?bdn?u _.ms .E. mmwti ??wwmw mmeFmemm Gm3m. Zozuoox