Prices - Oil-Reserve Rules May Change

Regulators are on the verge of modernizing oil and natural gas reserve-accounting rules that could revalue much of the petroleum sector. The Securities and Exchange Commission yesterday finished posting public comments, which overwhelmingly support the agency's proposed rule revisions. The revisions were based on petroleum-industry recommendations.
If the SEC moves ahead with its proposals, it would be the first time in several decades the commission has updated its reserve-accounting rules. Modernized rules would create consistent valuation standards for unconventional resources such as tar sands and hard-to-produce natural gas.

This could allow some companies to officially book billions of barrels in tar sands or billions of cubic feet of natural-gas reserves -- declaring themselves to be more valuable in the process. The rules would take into account new technology and recovery methods.

Reserves accounting is a crucial investor metric to valuing petroleum businesses. As typical resources are becoming more difficult to find or develop because of limited geopolitical access, companies have been turning to unconventional oil and gas deposits. Oil prices at record levels also have made expensive, unconventional projects now viable.

Besides allowing companies to officially book billions of barrels of new oil sands and other unconventional resources, the new rules could help more accurately report the value of tar sands, or bitumen, by allowing companies to assess their assets at sale value. Current valuing of bitumen is based at year-end levels, when prices are typically at their lowest because of their link to asphalt demand.

Companies weren't allowed by the SEC to book many of those resources under the old rules, last updated in 1982. As a result, many companies were understating their reserves to the SEC and giving their own accounts directly to investors.

Pricing - Determination of bitumen prices

The North American bitumen market is immature and illiquid. The vast majority of bitumen is found in the Province of Alberta in Western Canada. There are no posted prices for bitumen; marketers rely on a number of pricing formulas that reference various posted crude qualities such as Edmonton light, Lloydminster blend, WTI etc. Market pricing is seasonal with lower prices in and around the calendar year-end being the norm due to lower demand for asphalt and other bitumen derived products.

By necessity, bitumen is regularly blended with diluent (typically in the form of C5+ or synthetic light crude) in order to facilitate its transportation via pipeline to North American markets. As such, the effective field price for bitumen is also directly impacted by the input cost of the diluent required, the demand and price of which is also seasonal in nature (higher in winter as colder temperatures necessitate more diluent for transportation).

Consequently, bitumen pricing is notoriously weak in and around December 31 and not reflective of the annual average realized price or the economics of the “business” overall.

Pricing - Light/Heavy Differentials

Canadian heavy crude oil prices are generally set by Midwest refining economics. Global light / heavy crude spread ultimately sets the price for oil sands blends.

According to Purvin and Gertz, a major independent energy consulting firm, The light/heavy differential significantly increases the profitability of upgrading the bitumen to a synthetic crude oil. The Lloyd blend heavy sour oil was worth $57 on November 2, 2007. NYMEX WTI was around $96. Upgrading of the bitumen to a synthetic crude oil (SCO) that is comparable to WTI would cost $12.

While SCO commands a premium price to WTI and is in many ways comparable to light sweet crude, the high aromaticity of bitumen from which it is derived limits its penetration into refineries that are not specially equipped to handle it. A typical refinery is limited to between 10-20% of SCO in its crude slate. Part of the solution lies in additional technical/infrastructure capability in existing or new refineries and another lies in producing a higher quality light sweet synthetic crude, something being planned by a few of the new oil sands projects.

According to the Canadian Association of Petroleum Producers:

Synthetic Crude Oil (SCO) trades at a premium to WTI
-Current: $ 1US/bbl
Bitumen Blends trade at a discount to WTI
-Current: $ 23 US/bbl

Unprocessed bitumen is also marketed, but for pipeline transportation reasons must be shipped in diluted form. It sells at a considerable discount to synthetic crude as can be explained by the light-heavy differential: because heavy oil is worth less to a refiner, it typically sells at a discount to light oil. This difference in price is referred to as the differential. When the differential widens, it means that heavy oil is trading at a larger discount to light oil and it fetches a lower price. Bitumen is discounted yet again with respect to heavy oil.

Therefore, refiners are able to profit significantly from the end products. Petro-Canada has calculated that the bitumen netback depends on value of bitumen blend and the cost of diluent.
The Canadian Association of Petroleum Producers state that in recent years, slower natural gas growth, a shift to producing drier gas with less pentanes and competing demands for natural gas liquids have constrained available supplies of condensate.

Escalating prices and insufficient condensate supplies combined with growing supplies of heavy/bitumen crude that need a source of diluent have forced producers to examine other options. As a replacement for condensate, producers of oil sands bitumen are starting to use light synthetic crude oil as an alternative source of diluent for blending to pipeline viscosity requirements. This trend to use synthetic crude have led to the evolution of a synthetic bitumen blend referred to as Synbit. Synbit is more leveraged due to the higher diluent ratio, lowering netback. Therefore, lower diluent costs increases the bitumen netback

There are a lot of proposed pipeline expansion projects that aim to be able to move the SCO to markets with significantly more refining capacity. This will decrease the amount to which bitumen is currently being discounted.

There are also a number of projects underway to increase the refining capabilities of bitumen and synthetic crude oil.