Sweet Dreams: An Economic Assessment of the Opportunities & Risks of Government-Supported Heavy Oil Refining in Alberta
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2019-09
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Abstract
Alberta and its abundant bitumen resources have faced a barrage of regulatory and economic challenges in recent years. These problems have been compounded by limited takeaway capacity and a concentrated dependence on markets in the United States (US). The acute risks of these constraints became apparent through 2018, where restricted pipeline access and refinery outages in key markets led to a historic discount for Alberta’s oil and royalties collected by the province. As one of the policy responses to the widening price differentials and an extension of its “Made-in-Alberta” diversification strategy, the Government of Alberta issued a Request for Expressions of Interest in December 2018 to determine if the private sector would have an appetite to refine more heavy oil in the province (Alberta, 2018a). With inadequate takeaway capacity for Alberta’s bitumen and seemingly endless legal and regulatory hurdles for new transportation projects, heavy oil refineries have been marketed as a panacea to alleviate the province’s energy problems. However, given the province’s contentious history getting involved with refining ventures and questionable economics, this raises the question of whether Alberta should support expanded refining capacity within the province to maximize the value of its petroleum resources. To address the opportunities and risks of such proposals, this report is separated into three sections: 1. Price Decomposition – provides a technical background for the components and issues with fuel prices in Western Canada to isolate and understand refining margins; 2. Policy Considerations – details regulatory and policy implications across the energy supply chain with the potential to affect refinery proposals; and, 3. Project Economics – applies information collected from the previous sections to test the commercial viability and identify sensitivities of hypothetical refineries in Alberta. 10 Key Findings Constrained takeaway capacity and widened oil price differentials have motivated the Alberta government to explore refining options to add value to its raw resources. Refined products would also enable the optimization of existing transportation infrastructure, filling them with lower density products to make the most out of finite pipeline capacity. Given the challenges faced by Alberta’s bitumen resources, the benefits of refineries seem to be obvious; however, it is critical to recognize the significant costs to determine the net societal value of such projects, especially with government backing. Additional refining capacity in Alberta carries substantial risks and opportunity costs, often requiring government supports to make proposals viable, which have traditionally been in the form of long-term feedstock supplies and loan guarantees. As a result, there is an inconsistency between the net economic value of additional refining capacity in Alberta and gross benefits touted by proponents and politicians. Although proponents typically use input-output models to demonstrate gross economic benefits of a project, the economic impact assessment approach neglects the net costs and commercial viability of proposals. This misalignment of valuations is particularly concerning for Albertans, where such propositions can lead to inefficient government supports that lack consideration for cost overruns and ignores the opportunity cost of its resources. While proponents prefer to demonstrate only the perceived benefits of a project, they are often reluctant to provide proprietary information and robust scenario planning to illustrate the net value on public record. In order for Albertans to maximize the value of their resources, transparency is essential to determine the true value of projects and contribution to the public interest. 11 Undoubtedly, the economic viability of a refinery proposal can be increased with many different types of supports from the government. However, intervention can have unexpected effects and needs case-by-case analysis to find the most effective applications. The hypothetical refineries assessed in this report were found to have varying areas that could have supports tailored to their unique needs. Interventions that influence feedstock costs matter most to all types of refineries, while cost inflation and the cost of capital can significantly affect new refineries; expansion and acquisition projects were found to also be highly sensitive to the cost of capital, processing costs, and exchange rates. Governments eager to force expanded refining capacity and capture the ensuing economic benefits are susceptible to overlooking the costs and limitations of processing heavy oil into finished products in Alberta. Based on the economic modelling of hypothetical refinery proposals in this report, an inverse relationship was identified between the commercial viability and local economic benefits retained (e.g., jobs, gross domestic product, and taxes). The following are a summary of the results of the applied discounted cash flow modelling and supporting probabilistic Monte Carlo simulations for the hypothetical refineries: ? An expansion of an existing refinery in Alberta with the addition of heavy oil processing capacity was found to be the most efficient option, requiring the least government intervention, and found to deliver a net positive value about 65 per cent of the time; ? While larger and costlier greenfield projects can deliver higher macroeconomic benefits based on greater expenditures, such projects had a very low probability (less than 5 per cent) of being economically viable based on the scenarios presented in this report; ? An acquisition of an existing heavy oil refinery beyond Alberta was the most likely to generate net positive economic returns (about 95 per cent), but provided limited local economic benefits and did not relieve transportation limitations. 12 Recommendations 1. Consider whether Alberta refineries are the most efficient option to supply markets for finished petroleum products. Alberta should assess market fundamentals and opportunity costs of crude oil and refined products, transportation options and alternatives, and account for relevant policies that would affect the viability of refinery proposals. 2. Assess the potential effects of relieved transportation constraints in Western Canada on refineries’ economic viability. Alberta should consider the effects of looming long-term transportation solutions that can expand market access and generate value for the province’s petroleum resources, including both raw and refined products. 3. Apply a consistent evaluation of the opportunities and risks of refinery proposals to evaluate their net societal benefit. Alberta should develop a standardized cost-benefit framework for proposals to demonstrate net value, as compared to only gross macroeconomic effects commonly reported by proponents that increase alongside expenditures. 4. Maximize the return on supports and limit the risks of government intervention by focusing on incremental expansion projects. Alberta should tailor and cap project supports based on project merits and sensitivities; existing refineries with the addition of equipment capable of handling bitumen is the most reasonable option to increase heavy oil refining capacity within the province. 5. Ensure ongoing transparency and communication of the value of supported projects. Alberta should require proponents to submit ongoing detailed information for approved proposals, regularly report operating results of any projects supported by the government, and highlight challenges and successes to understand the return on investment.
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Hardie, S. (2019). Sweet Dreams: An Economic Assessment of the Opportunities & Risks of Government-Supported Heavy Oil Refining in Alberta (Unpublished master's project). University of Calgary, Calgary, AB.