COLUMN-WTI slump takes Canadian oil to the edge -Campbell

Mon Aug 8, 2011 9:52am EDT

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-- Robert Campbell is a Reuters market analyst. The views expressed are his own. --

By Robert Campbell

NEW YORK Aug 8 (Reuters) - Canadian oil sands producers exposed to the heavy crude market are quaking as West Texas Intermediate crude oil futures slide dangerously near their break-even levels.

Although no production shut-ins have been announced and managers are likely to opt to ride out the storm in the hope the current downturn is short-lived producers operating at the margin will almost certainly trim investment budgets.

Oil sands bitumen is either upgraded or sold into the market as a raw product that is then blended with lighter crude oil or condensates to make it marketable.

The most common bitumen blend is Western Canada Select --a mixture of heavy conventional crude oil, bitumen and sweet synthetic produced by oil sands firms with upgraders.

WCS currently trades at a $17 a barrel discount to WTI in Alberta, but the bitumen component is far below these levels. (For Canada cash crude price reports click [CRU/CA]).

With the recent tumble in WTI prices, WCS sellers are looking at prices around $65 a barrel. Bitumen producers are getting even less.

A further slide taking WCS prices into the $50 range could well prove decisive and prompt producers to shut marginal wells and suspend development programs.

That could relieve some of the pressure on the spread between WTI and Brent crude futures although the spread is more likely to narrow as softening global oil demand pushes marginal Brent buyers out of the market rather than due to a supply response on the WTI side of the equation.

Heavy oil sands blends are expected to make up more than 40 percent of Western Canadian oil production this year, according to the Canadian Association of Petroleum Producers.

RAIL CANNOT SAVE THEM

At 1.2 million barrels per day, heavy oil sands blends are a significant chunk of North American crude output and one of the reasons, along with shale oil in North Dakota and elsewhere, that the continent's crude oil output is on the rise.

The biggest names in oil sands, such as Suncor (SU.TO), have upgraders that transform the heavy bitumen that is mined from the oil sands into sweet "synthetic" crude oil.

Others, like Cenovus (CVE.TO) and Husky (HSE.TO), own refining capacity in the United States that lets them offset weak crude prices with strong refining margins.

A few smaller producers have lined up rail shipping capacity that allows them to bypass clogged inland markets and sell their crude on the U.S. Gulf Coast, where refiners pay a premium due to the high cost of regional and imported crude that tracks the price of Brent.

For instance Rock Energy (RE.TO), a junior Canadian heavy oil producer, says rail boosts its realized crude price by around $8 a barrel.

But amid the continental frenzy for shipping crude oil by rail most, if not all, tank cars are already under contract.

In recent years most smaller Canadian firms have eschewed costly investments in upgraders and refineries, opting for a "pure play" structure as bitumen producers.

This business model was cheered by stock markets a few years ago when the price gap between bitumen and light crude was much smaller and when the cost of upgrading facilities was soaring.

Equity analysts argued, as they do today with the oil majors, that "pure play" companies, would achieve a premium value because investors would better understand their business.

For oil sands producers, that brief fashion among equity analysts is now coming back to bite them.

Pure play producers are now badly exposed to weak pricing with no option but to accept what the market is offering to pay or to curb production.

No doubt this latest episode of pricing weakness will redouble enthusiasm in Canada for new pipelines to new markets, such as the the U.S. Gulf and East Coasts, as well as routes that enable producers to sell to Pacific Basin refiners.

But these lines are at least two years off in the future. Should the present price weakness prevail oil sands producers will either have to roll with the market's punches or cut investment and production.

(Editing by Sofina Mirza-Reid)

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