Bitumen Price Volatility, Supply Chain Complexity and Vertical Integration
2000 and December 2006. Alternative specifications of the error-correction model were investigated to determine whether the calibrated price relationship in periods with declining light oil prices was statistically different from the price relationship in the periods with increasing light oil prices. The investigations showed no statistical difference.
Bitumen upgrading costs
increase with the desired quality of the synthetic crude oil
product, as measured by the gravity and sulphur content.
Implications and Conclusions
The model predicts that the dominant effect of a light oil price change on bitumen price is immediate and amplified in both absolute and percentage price changes, thus quantifying expected bitumen price volatility. Historically, new natural resource industries respond to price volatility and a complex supply chain – raw material to a widely marketable final product – by vertical integration. In the case of Venezuela bitumen, all the extraction operations are tied to captive upgrading plants so there are no independent bitumen price data.
The high cost of bitumen production relative to conventional crude oil puts the producer at risk from production cost increases and unstable light oil prices. Upgraded bitumen competes with light crude oil and heavy oil at the refinery. A prolonged period of expanded supply of oil accompanied by declining light oil prices will initially trigger an even greater price decline in raw bitumen, perhaps sufficient to drive prices below operating cost for several periods (see Figure 2). Such perceived risk of loss led would-be producers during the 2007 to 2008 period to form alliances or acquire upgrading/refining capacity to ensure a market for the raw products.
The high cost of bitumen production relative to conventional crude oil puts the producer at risk from
production cost increases and unstable light oil prices.
The light oil/raw bitumen price differential is the spread from which owners of independent upgrading plants (merchant upgraders) must meet operating costs, capital costs and profit. This differential depends on a host of factors that include both bitumen and light crude supply
1. Attanasi ED, Volatility of bitumen prices and implications for
the industry, Nat Resources Res, 2008;17(4):205–13.
2. Alberta Energy and Utilities Board (AEUB), 2007, Alberta’s Energy Reserves 2006 and Supply/Demand Outlook
12
Basic research is currently focusing on the development of bitumen upgrading processes that can be carried out in the reservoir by in situ combustion or through biodegradation. The developments of such processes would dramatically change the cost structure of the industry
Basic research is currently focusing on the development of bitumen upgrading processes that can be carried out in the
reservoir by in situ combustion or through biodegradation.
and provide an extraction product that could be immediately used as feedstock for standard refineries. Even if assigned a low probability, this prospect elevates risks associated with construction of new upgrading facilities.
Hoping to spur economic development by encouraging the location of upgrade facilities in Alberta, the provincial government wants to implement a two-tier royalty tax system on bitumen producers. Such a system would encourage integration, but because upgrade plant requirements are so large it could lead to a reduction in the number of independent operators in the extraction sector. A small number of competitors will ultimately reduce competition at oilsands lease auctions. Furthermore, a highly concentrated, integrated industry would make it difficult for the resource owners collecting royalties to track the transfer price of the resource between the upstream and downstream segments. If the industry does evolve into a small number of highly integrated firms, progress in the development and implementation of in situ upgrading processes could be inhibited as these firms attempt to recover the large sink costs associated with current construction of new and expanded upgrading facilities. n
2006–2015, 2007;178. Available at: www.ercb.ca/docs/ products/STs/st98-2007.pdf
3. National Energy Board (of Canada), 2006, Canada’s Oil Sands, Opportunities and Challenges to 2015: An update,
Calgary, Canada, 2006. Available at: www.neb.gc.ca/clfnsi/ rnrgynfmtn/nrgyrprt/lsnd/pprtntsndchllngs20152006/pprtntsn dchllngs20152006-eng.pdf
conditions, crude oil inventories at conventional refineries and final product demands. In the long run, revenues must compensate for costs incurred in upgrading raw bitumen as well as the costs of purchasing bitumen. Merchant upgrade plants must formulate SCO specifications to assure access to a wide array of refinery markets or otherwise supply a single captive refinery for the upgrade plant to simultaneously exploit plant scale economies and operate at high utilisation rates. Acquisition of a captive refinery or the forging of an alliance reduces the upgrade plant owner’s market risks.
Merchant upgraders’ margins are constantly challenged. Competition from conventional refineries presents a major threat because such facilities can be re-tooled to accept heavier oil blends by adding additional ‘residual oil’ conversion stages to their operations, thereby increasing refinery feedstock options to accept bitumen blends. Expansions of existing facilities are typically much less costly and can occur more quickly than construction of a new upgrading facility.
EXPLORATION & PRODUCTION – VOLUME 8 ISSUE 1
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