Economic analysis

Who wins and who loses from more upgrading in Alberta?

Andrew Leach on extra upgraders

Jeff McIntosh/CP

The NDP put forth a motion in the House last week which states that, “the Keystone XL pipeline would intensify the export of unprocessed raw bitumen and would export more than 40,000 well-paying Canadian jobs, and is therefore not in Canada’s best interest.”

Where do they get 40,000 jobs? This jobs number seems to be sourced from evidence tabled by Informetrica (PDF) in the application for the Keystone (not XL) pipeline in 2007. This study states that, “expansion of the Canadian refining industry as a source of demand for 400,000 barrels per day of heavy oil would add approximately 18,000 jobs per year to the Canadian economy as compared to the additional jobs generated by export of the crude.” If you take that number, scale it up in proportion to the capacity of Keystone XL, you get 40,000 jobs.

However, adding that extra upgrading capacity would take both capital and labour, and both of those have to come from somewhere. At the very least, increasing demand for oil and gas sector workers by 18,000 people would increase wages across the sector and the economy, which would decrease employment in other sectors and decrease corporate taxes and royalties. Further, the capital to build the refinery would come at the expense of investment elsewhere (perhaps in Canada or perhaps not) or at the expense of shareholder dividends—if you force an oil company to build a refinery, that doesn’t pay for the steel or the labour to do so.

Suppose you had a fixed amount of capital to invest in the oil sands. Would you generate the largest return on investment in terms of total wages, royalties, taxes, and profits with extraction or with extraction and upgrading? And how would these returns be distributed?

I looked at the amount of capital it would take (about $42 billion over the life of the project) to build a mine the size of Suncor’s Fort Hills project combined with an upgrader to process the produced bitumen into higher-value synthetic crude oil. I then compared the financial outcomes from this hypothetical project to the construction of a larger, standalone bitumen mine shipping diluted bitumen.

The `economics’ for the two projects for the investor look remarkably similar at first glance (You can read about all the pricing assumptions underlying the analysis here). The standalone mine provides an after-tax rate of return of 12.3% and earns a conventional minimum rate of return on capital of 10% at a West Texas Intermediate (WTI) oil price of $70.57 per barrel. The upgrader and mine combined earns a slightly lower rate of return, at 11.66%, and requires an oil price of $78.24 to reach a 10% rate of return. Subtle differences, but not huge and certainty not large enough that you could say that one would proceed while the other would not.

On a per-barrel basis, the numbers are equally ambiguous – in fact, you’d probably say that the upgrader looks better. Revenues per barrel of bitumen extracted are higher with the upgrader, at an average of $80.80 per barrel vs. $62.93 for the mining project alone. Average costs (capital, debt, and operating costs combined) are higher for the integrated project, at $43 per barrel of bitumen produced and upgraded versus $29.15 for the mine, while royalties and taxes are similar at around $19 per barrel of produced bitumen in both cases. The result is that the upgrader earns higher cumulative cash flows, by $4.10, per barrel of bitumen produced.

Case closed, right? On with the upgraders and the jobs!  Not so fast. First off, in 2012, despite 46% of the bitumen produced in Alberta being upgraded, the Petroleum Human Resources Council estimates (PDF) that only 20% of oil sands sector employment is in upgrading. The evidence that you’d have higher labour demand if you forced upgrading in a tight labour market is spotty at best.

There’s also a trick in the per-barrel numbers above – the project with an upgrader earns higher cash flow per barrel, but it produces far fewer barrels—1.7 billion fewer. So, over the life of the two projects, the total royalties and taxes collected from mining and upgrading combined versus bitumen extraction alone would be lower by $36.6 billion, while the profits to the producer would be lower by $13.4 billion. Combined, for a similar capital investment and with similar associated jobs, the bitumen extraction project returns $50 billion more in royalties, taxes, and profits.

Now, I know what you’re going to say – I’ve cooked the books against the upgrader. Well, as discussed above, I low-balled the costs. Let’s go one step further—let’s assume you can operate the upgrader at no additional cost beyond the energy used. This free value-added reduces the gap from $50 billion to $27 billion (but, of course, if you can operate the upgrader for free, it’s not employing a lot of people).

Bottom line: if you are willing to accept that both labour and capital markets in Alberta are tight, you can’t look at any new investment or job in a vaccum—you must think of it as displacing another job or investment somewhere else in the economy. If the displaced investment is one in oil extraction, you may be surprised to find that total profits, taxes, and royalties go down significantly and that you don’t create many (if any) additional jobs while producing a higher-value product. 

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