Kate Mackenzie New sources of pressure on Shell’s oil sands projects

Some investors are getting riled that the prospect of Shell’s investment in expensive oil sands production could run foul of both the moral and economic costs of the high-emissions fuel source.

Greenpeace last year put together an interesting report arguing that the confluence of cost factors – both direct and as a result of carbon pricing – could make the oil sands projects uneconomic. Now it seems a number of investors in Shell are picking up on the theme.

The Guardian reports that 141 individual and institutional investors have added a resolution on the agenda for the oil major’s AGM, in May.

Only one institutional investor – Co-operative Asset Management – is identified, so it’s not clear just yet what percentage of shares they all represent. Under UK company laws, shareholders wishing to add a resolution must total either 5 per cent of issued share capital, or exceed 100 in number, with each owning on average at least £100 worth of shares.

The resolution is for a review of the risks involved with Shell’s oil production in Athabasca, Alberta.

The Guardian quotes Co-operative Asset Management’s head of sustainable investing, Niall O’Shea, saying the company should reassure shareholders that it could cope under “a number of scenarios”:

“What if carbon capture and storage proves too costly in the oil sands? What if sustained high oil prices and carbon regulation lead to switching away from marginal, high-cost, high-carbon sources? And then there’s the cost of cleaning up the locality. Companies must be more rigorous and transparent with their investors,” he added.

The point is that if negative externalities such as the price of carbon (or of removing it via expensive CCS) are factored in, oil sands can get onto pretty narrow margins.

It’s probably safe to bet that Shell has considered the possibility of some price on carbon affecting its North American operations in the not-too-distant future.

But exactly how much will it cost – and how effectively it can be offset by CCS and other measures?

Last year Shell told analysts it needs about $70 a barrel for its oil sands projects to pay.

Merrill Lynch-Banc of America Securities commodities analysts last week forecast that oil sands projects in Canada will require prices of $80 a barrel to profit.

They add:

Despite the extreme volatility of spot crude oil prices over the past couple of years, our view on the marginal cost of supply remained in a relatively narrow band of US$70-90/bbl, depending on the level of cost inflation. Anecdotal evidence together with the sharp drop in steel prices points to a 20-25% reduction in capital intensity from the peak in 2008. With input costs starting to show some stabilisation, we now estimate that integrated mining-upgrading greenfield oil sands projects in Canada will require $80/bbl oil to generate double-digit after tax internal rate of return (IRRs).

Incidentally, ML-BAS raised their forecasts from $75 to $85 in 2011 and $80 in 2012+.

However in less heartening news for NGOs, the analysts signal that Canadian oil sands projects could effectively set a floor for oil prices:

In our view, long-term oil pricing dynamics are determined by the marginal cost of supply and we remain focused on new Canadian oil sands projects from a marginal supply standpoint.

But they are also wary of rising production costs for these projects, pointing out that as activity begins to pick up, some of the now dormant factors in the once overheated Canadian oil sands market, such as logistical difficulties and labour shortages, could again arise, leading to even higher costs.

And this was the same team that last year pointed out that higher oil prices (most recently, $100/barrel) could threaten the world economic recovery.

Related links:

Do oil sands plus peak demand spell doom for oil majors? (FT Energy Source, 27/07/09)
Shell’s outlook for oil production and why $70 a barrel matters (FT Energy Source, 12/06/09)