FINANCIAL TIMES: COMPANIES UK: Shell muscles in on energy's wild frontier: “… as Shell struggles to regain its footing after last year's reserves scandal, it is eager to show that the Alberta oil sands, which by some estimates contain as much oil as Saudi Arabia, are as viable as conventional sources of oil such as drilling in the North Sea.” (ShellNews.net) Posted 6 March 05

By Henry Tricks

In the frozen wilderness of northern Canada, where Cree tribesmen still hunt for moose, the world's biggest trucks are at work digging Royal Dutch/Shell out of a hole.

Diggers with shovels that tear 100-tonne chunks out of the landscape load up giant Caterpillar trucks with scoopfuls of tar sands so heavy with oil that it squelches underfoot.

Each truck can carry 400 tonnes at a time - or the equivalent of 200 barrels of oil. Once loaded, they tear across the terrain at speeds of up to 70 km/h.

The speed, though hair-raising, was vital this week as output of bitumen - the black tar distilled into oil - reached record highs of 200,000 barrels a day, delighted company officials told visiting journalists.

The production of crude from oil sands has been gloomily hit-and-miss since Shell, through its 70 per cent-owned subsidiary Shell Canada, begun digging near the Athabasca River in 2003.

Like other oil sands projects, it has been hit by cost overruns and the occasional mishap.

Now Shell Canada is planning an expansion that will cost it and its partners at least C$12bn (£5bn), raising maximum oil output from 155,000 b/d - which it has not yet reached on a sustained basis - to 500,000 b/d over an unspecified period.

To achieve that, it needs to negotiate with aboriginal people worried about pollution and the despoiling of their traditional hunting grounds as well as import huge numbers of foreign engineers to live in sub-Arctic temperatures. It also needs oil prices to remain above $20 a barrel to be profitable, Shell Canada officials say.

Yet as Shell struggles to regain its footing after last year's reserves scandal, it is eager to show that the Alberta oil sands, which by some estimates contain as much oil as Saudi Arabia, are as viable as conventional sources of oil such as drilling in the North Sea.

Shell plans to increase production of unconventional oil to 750,000 b/d by 2014, or 15 per cent of the group's 5m b/d production target, up from 5 per cent last year.

"It is my intention that in the 2010 to 2020 decade, Shell will become a world leader in the responsible production of unconventional oil," says Malcolm Brinded, head of exploration and production at Shell. "For now, the Athabasca Oil Sands Project remains the cornerstone of our delivery of more unconventional oil."

Less than a decade ago, it was a different story. In 1998, the Alberta government threatened to rescind Shell Canada's 1956 oil sands lease because it had been left idle for too long.

Stung into action, Shell became an enthusiastic convert. Even though oil prices were at record lows, it became the only oil major to make a big bet on oil sands. It provided its share of C$6bn in start-up investment between 1998 and 2003.

Now it estimates there are 6bn barrels of recoverable crude near Athabasca. Under Securities and Exchange Commission rules, Shell says, none of that could be counted as proved reserves.

However, they would make up a portion of Shell's 60bn barrels of oil equivalent in total discovered resources, and would provide stable long-term earnings if oil prices remain high.

"This is a monster project," says Clive Mather, chief executive of Shell Canada. It is, however, one that moves Shell deeper into terrain where rivals, such as BP, have feared to tread.

For one, oil sands are a mining, rather than a drilling, venture.

Compared with pumping oil, digging for it is extremely expensive. Neil Camarta, who heads oil sands for Shell Canada, says last year operating costs during peak production were C$20 a barrel, plus about C$5 a barrel to renew plant and machinery. The company aims to cut costs to between C$12 and C$14 a barrel but will not be pinned down on the timing. For the majors, pumping oil often costs about $5 a barrel.

Labour shortages mean cost pressures have soared. Wages for welders, for example, have risen by 30 per cent in five years. For expansion, skilled employees may have to be shipped in from overseas, which will put further strain on local resources - already Fort McMurray, a former fur-trading outpost nearby, has grown by a third in five years to 50,000 people.

Natural gas costs have also surged. Turning bitumen into synthetic crude requires huge quantities of gas - about 15 barrels for every 100 barrels of crude produced, according to Mr Camarta.

The intensity of carbon use means the process produces twice as much carbon dioxide as conventional drilling. Shell has pledged to halve emissions by 2010, a costly process that may involve buying carbon credits and burying greenhouse gases in underground oil wells.

The pollution and its impact on human health is already a serious concern for the aboriginal people who live in wooden houses across the Athabasca River, says Jim Boucher, their chief. On the other hand, he says the village generates C$100m of revenues a year from its co- operatively owned businesses working with the mine. He praises Shell Canada's efforts to improve schooling in the community and is working with it to return the land back to its original state once the company has squeezed the bitumen out.

On part of the land, he wants to build a golf course.

For Shell, such demands come with the territory. The aboriginals "have been here for thousands of years", says Mr Camarta. "We're going to be here for generations. So it's a huge issue."

Though the complications mean digging for oil may be costlier than conventional drilling, Shell claims the long-term benefits could be considerable, provided oil prices remain high.

That is because there is no exploratory risk in oil sands and cash flows would be assured for decades.

Mr Camarta describes oil sands as "a portfolio bet" - it works better with high oil prices, whereas drilling for oil in Nigeria, for example, has tax advantages at lower prices. He says oil sands become particularly compelling if conventional oil wells dry up. But if that happens, Shell will need more than Athabasca to keep it afloat.

FROM SAND TO LIQUID GOLD IN 300 MILES Most of the excitement of oil sands is on the shore of the frozen Athabasca River, where large Caterpillar trucks tear around like Schwarzenegger-style playthings, writes Henry Tricks. All the profit, however, is made 300 miles downstream, near Edmonton, Alberta. The diluted bitumen is pumped from the Muskeg River Mine down an underground pipe that takes three days to flow through. When it reaches the Scotford upgrader, the heavy, sulphur-rich bitumen is worth $15 a barrel. By the time it is converted into light synthetic crude, it fetches prices as high as $55 a barrel - more than West Texas Intermediate. The upgrading process is hydrogen and natural gas intensive. The hydrogen "fluffs up" the oil, meaning 100 barrels of bitumen may become 103 barrels of crude. The sulphur is recovered and sold as fertilizer. Meanwhile, the project produces about 3.5m tonnes of carbon dioxide a year. In the control room at Scotford, there was a relaxed, almost bored, air this week. But excitements do happen. In December, a pipe froze and broke, and leaking gas caught fire. A prolonged stoppage caused oil production - and profits - in the fourth quarter of last year to plummet. Now they are back on track.