Oil sands producers gird for Obama's Canada visit

WASHINGTON (Reuters) - Canada's oil sands industry, battered by collapsing oil prices, also faces the prospect of ballooning costs as the United States and Canada prepare to discuss energy security and efforts to fight global warming.

When U.S. President Barack Obama visits Ottawa on Thursday, energy will be a key topic in his talks with Canada Prime Minister Stephen Harper, who often touts Canada as an emerging energy superpower due to its massive oil sands resources.

Oil sands producers worry that Obama's plan for a cap-and-trade system to reduce emissions of greenhouse gasses could make their operations too costly -- especially at current depressed oil prices. Harper also has voiced support for a cap-and-trade system.

Environmental groups call the oil sands "dirty oil" and say its development is hazardous to air, land, water and communities. Some in the Obama camp appeared to agree with that message during the election campaign, and producers fret about the push for standards that reward low carbon emissions.

"This is a real test for how the administration balances energy security and climate change in its strategy," said Michael Levi, senior fellow at the Council for Foreign Relations.

The Obama administration has been mum so far on what official stance the president will take on oil sands. Both sides will closely monitor his first official trip abroad.

"We're watching it and we know that energy will be on the agenda. The real key for us is to set a framework," Greg Stringham, vice president of markets and fiscal policy for the Canadian Association of Petroleum Producers, told Reuters.

Green groups such as Greenpeace and Natural Resources Defense Council (NRDC) have mounted a publicity blitz ahead of Obama's visit. The group ForestEthics and northern Alberta native groups placed full-page ads in the newspaper USA Today decrying the environmental impact of oil sands production.

"Tar sands really don't fit in President Obama's vision for a clean energy future," said Susan Casey-Lefkowitz, director of the NRDC's Canada program. She said greenhouse gas emissions from oils sands production are three times higher than from traditional drilling.

Canada, the largest foreign supplier of crude oil to the United States, has been viewed as an energy-security ace in the hole -- a friendly neighbor with oil to spare, connected via the world's largest pipeline network.

About 75 percent of Canada's oil sands output are shipped to the U.S. market, and American refineries in the Midwest and Gulf Coast are being reconfigured to handle those supplies.

OIL STOREHOUSE

A spokeswoman for the U.S. State Department said the agency did not have a position on the oil sands. But the issue is viewed as so pressing by so many that Obama cannot ignore it.

At 173 billion barrels, northern Alberta's oil sands are the largest oil deposits outside the Middle East. But development is complicated and expensive, requiring open pit mines and carbon-spewing processing plants to make the tar-like crude suitable for refining.

If the United States sets up a cap-and-trade system, oil refineries and other industrial facilities would be required to buy and sell permits for the greenhouse gases they emit.

"Surcharges for U.S. refiners would make them less interested in buying Canadian crudes at market prices," said Kevin Book, a senior analyst of energy policy at Friedman, Billings, Ramsey and Co.

Book said U.S. refiners probably would seek cleaner crude fuel sources. In the short term, Canada's oil sands producers would find that "their market would be softer," he said. This would give Canada an incentive to make long-term deals with China and India.

Stringent national low-carbon fuel standards would also hurt oil sands producers, experts said.

"If we're asking for transportation to create less emissions and oil sands makes more, the harder it is for oil sands to be a player in the game," Levi said.

BOOM GOES BUST

Oil sands projects were being planned and built at a breakneck pace until oil and credit markets faltered last year. Now, major developers such as Suncor Energy Inc (SU.TO), Petro-Canada PCA.TO and Royal Dutch Shell Plc (RDSa.L) have deferred or canceled more than $80 billion of their plans.

As financial returns get squeezed, oil companies lament the high costs of meeting increasingly stringent federal and provincial regulations to limit emissions, restrict fresh water use and cut industrial waste.

Many analysts say developers need oil prices of at least $80 a barrel to start new projects, more than twice today's price.

Vincent Lauerman, president of consulting firm Geopolitics Central, said producers should be able to cope with additional costs, unless a prolonged recession slashes oil demand.

"In this case, the combination of lower prices and higher environmental mitigation costs would substantially slow the development of Canada's oil sands," Lauerman said.

Obama could offer some reprieve for oil sands by exempting them from some or all of his climate change regulations, although doing so would raise the ire of environmental groups.

"I don't think President Obama is going to agree to a scheme where we pretend that oil sands don't have unusually high emissions," Levi said. "But I think he will be receptive to the argument that we shouldn't unfairly burden the oil sands."

(Additional reporting by Scott Haggett; Editing by Jeffrey Jones and David Gregorio)