CALGARY — For 15 months now, Saudi Arabia’s 81-year-old celebrity oil minister, Ali al-Naimi, has taken on the role of the global oil market’s top disruptor and been a thorn in the side of emerging competitors such as Canada.

“Lower costs, borrow cash or liquidate,” he told delegates with his typical bluster at a Houston energy conference in late February, further inflaming the war for market share between Saudi Arabia and its North American competitors.

It wasn’t a new strategy for the Saudis, who have repeatedly played the role of global oil adjudicators when markets don’t work in their favour. This time around, though, the Saudis are contributing to the continuing oil glut by turning the taps at full blast and claiming they have the right to the biggest piece of the market because they can produce oil for less.

“Cutting low-cost production to subsidize higher-cost supplies only delays an inevitable reckoning,” Naimi said.

But it’s becoming increasingly obvious that Naimi is fighting yesterday’s war.

Oil’s future market share may be determined by a different competitive advantage, which is how much barrels have been decarbonized. Some people are even starting to talk about ‘carbon competitiveness.’

Indeed, Canadian companies, after tens of thousands of layoffs, extreme cost cutting, project cancellations and radical policy changes on environmental protection in the past year, are re-positioning themselves to win this market by taking carbon out of their barrels at the same time as reducing costs.

Those who have successfully reshaped their businesses are no longer talking about surviving an oil price war with Saudi Arabia, or resisting the global move toward greener energy.

“The challenge that we got from the Saudi minister was this: Cut your costs or get out of the way,” said Jeff Gaulin, vice-president of communications at the Canadian Association of Petroleum Producers (CAPP). “The (Canadian) industry’s response is quite clear: Just watch us innovate, because we are committed and we will get production costs down and maintain high environmental performance.”

It’s taken more than a decade for Canadian producers to accept the new carbon constraints, but few now doubt that tomorrow’s market will reward not only lower-cost but lower-carbon barrels.

Gordon Lambert, a former executive at oilsands giant Suncor Energy Inc. and member of the Alberta government’s climate change leadership panel, said Canadian producers have become the most motivated to clean up their oil.

“When you are the producer of the lowest-cost oil (such as Saudi Arabia), you don’t have the burning platform to innovate that you do if you are at the high end of that curve,” he said. “We have much greater urgency and much greater importance of innovating our way into the future. That innovation will lead to benefits in technology development and expertise. Carbon competitiveness is an important dimension of future success.”

The oil de-carbonization drive started with initiatives such as California’s Low Carbon Fuel Standard about a decade ago and gained momentum as a result of global commitments to reduce carbon like the Paris agreement to keep the rise in temperatures increases below 2 C.

Canadian producers fought hard against the idea at the beginning. But late last year, backed into a corner by new governments that made the environment a priority, they worked out a compromise that involved a cap on emissions.

Soon after that agreement, Murray Edwards, chairman of Canadian Natural Resources Ltd., Canada’s largest upstream producer, expressed hope that Canadian oil would gain acceptance as “clean oil” by embracing climate-change reduction policies.

“We understand this is an important issue to Canadians and to the globe, and we are going to start pricing carbon into the oilsands and we are going to start to incentivize to reduce our emissions,” Edwards said at the time.

As a result, Naimi’s diatribe scared market participants focused on the short term, but not those working on the long game.

For one thing, his premise that Saudi oil should not subsidize higher-cost oil is being increasingly questioned. Saudi Arabia is opaque about its oil costs, which many analysts say are much higher than the kingdom wants the world to believe.

Helima Croft, global head of commodity strategy at RBC Capital Markets LLC, said the Saudis are low-cost producers only if you look at their cost of getting oil out of the ground. But they are “an exceedingly high-cost producer” when you look at what their oil needs to fund.

“Saudi Arabia is basically a gas station that funds the whole state,” she said. “They are heavily oil dependent. So for the Saudis, oil revenue is responsible for keeping the entire system going.”

According to the International Monetary Fund, the Saudi government needs an oil price of US$95.80 a barrel to fund all its spending obligations for 2016. Because of the crash in oil prices that it induced, the Saudi government, which is 90-per-cent funded by oil, will run a US$98-billion deficit this year.

Saudi Arabia is basically a gas station that funds the whole state.

Until the oil crash, Saudi Arabia was socking money away in foreign exchange reserves and aggressively paying down debt. Those reserves declined by US$115 billion in 2015 alone.

By comparison, Alberta, Canada’s top oil-producing jurisdiction, is projecting a deficit of $6.3 billion for 2015/2016, and of more than $10 billion in 2016/2017.

“Below ground, Saudi Arabia and places like that have very low costs because the fields they operate are so prolific,” said Peter Tertzakian, chief economist at ARC Financial Corp. and a member of the Alberta panel that recently completed a review of provincial royalties.

“Therefore, you see those below-ground costs and go, ‘Oh my God, those guys are way cheaper than us,’ but it’s not necessarily true.”

Even operating costs in Saudi Arabia aren’t significantly lower than in the oilsands. Harold ‘Skip’ York, vice-president of integrated energy at energy consultancy Wood Mackenzie, said average operating costs in Saudi Arabia were US$11.35 a barrel in 2015, compared to US$18.45 a barrel in the oilsands — and that was before a full year of cost compression.

Canada’s barrels are more expensive to transport since they rely on pipelines — about US$15 per barrel compared to Saudi costs of about US$5 for transporting the oil to a dock and then by tanker — but using a pipeline produces few carbon emissions, while tankers produce a lot.

Costs in Canada’s highly regulated industry are studied in detail and include charges such as taxes, royalties, carbon levies, rents and regulatory fees. Under Alberta’s new climate-change plan, emissions from the oilsands will be capped at 100 megatonnes a year, from 70 megatonnes today, forcing operators to become more energy efficient or be out of business.

Meanwhile, there is little evidence Saudi Arabia is taking steps to decarbonize its oil.

“The Saudis are concerned about emissions,” York said. “They are piloting CO2 injection for enhanced oil recovery, which is a form of carbon capture. But that would significantly increase their costs. This is not a priority for them right now.”

Harrie Vredenburg, a professor of sustainable development at the University of Calgary’s Haskayne School of Business, said the Saudi answer has been protect market share rather than be stuck with a stranded asset.

“They want to be producing it while there is a market for it. They are still the incumbents. They still have low cost, and they can afford to play this price war longer than others,” he said.

The world taking on North America had better be ready, because this part of the world knows how to get efficient and you are seeing it every day

Their other strategy has been to invest in renewables, especially solar energy. Saudi Arabia consumes 900,000 barrels a day to generate power and is looking at renewables as an alternative to reduce domestic emissions and save oil for exports.

To be sure, Saudi oil has lower-emission intensity than Canadian heavy oil because it needs less energy to flow to the surface.

But just as Canada’s oil was vilified for being “dirty” before new governments in Alberta and Ottawa moved to price carbon, Saudi and other imported barrels could be the next to be taken to task for not pricing carbon.

Gaulin said the drive to clean up Canadian oil is adding costs and requirements for Canadian producers and increasing the debate with governments and consumers about whether imported oil should also be subject to carbon costs, rules and regulations.

During the price war, and as Canadian producers were being pressured to cut carbon emissions, Saudi Arabia increased its oil exports to Canada to 84,017 barrels a day in 2015, from 63,046 barrels per day in 2012.

“If you are going to be competitive, if you are going to apply that degree of calculation (on carbon costs), should it not apply to every source of oil that Canadians use?” Gaulin asked.

Far from heeding Naimi’s call to get out, many Canadian producers have been able to drive down their costs to levels the Saudis should be worried about.

The most efficient producers in the oilsands now have operating costs below $12 a barrel and dropping, according to data compiled by GLJ Petroleum Consultants in Calgary, while the mid-point is in the $15-to-$20 range.

“I think Canada can compete globally but costs still have to come down more,” CNRL president Steve Laut said. His company drove operating costs at its thermal oilsands projects down to $9.59 per barrel in the fourth quarter and $6.75 per barrel at its Pelican Lake heavy oil project at the same time.

The same efficiencies are being achieved in shale oil and gas production across North America.

“The world taking on North America had better be ready, because this part of the world knows how to get efficient and you are seeing it every day,” Doug Suttles, Encana Corp.’s chief executive, said in an earnings call last week.

David Zusman, founder of New York hedge fund Talara Capital Management, said oil production from shale is at an inflection point. “People have been surprised how well and how rapid, in the last 18 months, we have been able to improve efficiencies and take down costs in the U.S. I think lower oil prices have accelerated that.”

In the oilsands, meanwhile, the cost-cutting and carbon-cutting drives are progressing hand in hand.

“You have a convergence of innovation drivers: one is cost reduction and cost competitiveness, and carbon is the other,” Lambert said. “But in our language, carbon competitiveness captures both.”

That’s because energy is the biggest cost of producing oil from the oilsands, and reducing its use means reducing carbon emissions, he said.

The efficiency drive is also pushing the adoption of next-generation extraction technologies that don’t use as much energy or water, such as radio frequency and the use of solvents to replace steam, Lambert said.

Vredenburg believes the concept of presenting Canadian oil as “clean” is worth further study.

“It’s worked with Canadian diamonds … compared with diamonds that are conflict diamonds,” he said. “The big question is: Will the market accept that? The market is not necessarily individuals buying gasoline at the service station, but it’s political jurisdictions like the EU or California (that want lower carbon fuels). I can certainly see it happen at that level.”

So far, the global oil market hasn’t paid up for clean oil.

There is, however, recognition that it’s just a matter of time before jurisdictions pick clean oil as part of the push toward greener energy. Moderate environmental groups such as Alberta’s Pembina Institute, once a fierce critic of oilsands expansion, are now supporting Canadian oil producers in their efforts to reduce emissions.

Said executive director Ed Whittingham: “If Alberta can produce a barrel and comply with whatever global regime we have on carbon content, and do it in a cost effective way, then absolutely there is a role for Alberta oil in the future.”

Illustration by Mike Faille/National Post

Financial Post

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