Shell Abandons Sarnia Heavy Oil Refinery Plans in Canada

All Stop

Oil supermajor Shell yesterday announced that it has ceased all work on a proposed heavy oil refinery in Sarnia, Ontario. Citing a multiplicity of challenges, from cost inflation that has affected the industry as a whole, to the availability of raw materials, equipment, and manpower, to general market conditions, the company has asked its workers to stop all predevelopment work on the project. Shell has made a point of thanking the community and local government for taking part in its open-door discussions on the project, labelling the response as "unprecedented". The facility would have involved a refinery in Sombra, just south of Sarnia, capable of processing between 150,000 b/d and 250,000 b/d of heavy oil into high-quality, high-value products for markets in Ontario. The company already maintains an existing 72,000-b/d refinery in the area, known as the Sarnia Manufacturing Centre (SMC), and it had been speculated that Shell's proposed heavy oil refinery could be built adjacent to the SMC to yield economies of scale. While the new refinery will now not go ahead, the company has insisted that it has no plans to cease operations at the SMC.

Shell also revealed yesterday, via a media briefing, that it was no longer firmly committed to moving forwards with a proposed oil sands upgrader project in Edmonton, Alberta. Project costs here have been estimated at C$27 billion (US$26.5 billion) and involve building a facility with an ultimate upgrading capacity of 400,000 b/d, split equally over four phases. Instead, Shell has said that it could choose to invest in adding upgrading capabilities at two of its refineries in the United States: Martinez, in California, and Deer Park, in Texas.

The Wider Picture

The problems highlighted by Shell as driving its decision to cancel the Sarnia project have also been keenly felt across the North American energy sector. Several other companies have slowed the pace on previously ambitious plans, and in some cases cancelled projects outright. For example, Newfoundland & Labrador Refining said just a few months ago that market conditions and the drying-up of easily available and cheap credit would be likely to delay work on what would otherwise be the country's first new refinery built in over 20 years. Elsewhere, construction work on a C$4.2-billion oil sands upgrader in Alberta has been completely halted by North West Upgrading due to cost concerns, and could be delayed by several years. New regulations as well as fluctuating royalty regimes have also threatened project economics, with Total expressing concern over associated implications for its Joslyn project. Partly as a result of all these considerations, expectations of future growth in Canadian oil sands output have had to be trimmed back slightly. The country had originally been expecting to be producing around 3 million b/d by 2015, though it has recently reduced this figure to around 2.7 million b/d. The scale of the reduction is not high enough at this point to signal fundamental worries over Canada's overall output plans, but changes in market and regulatory conditions will obviously continue to prompt a reassessment of those projects with riskier investment profiles.

Outlook and Implications

It is clear from Shell's talk in recent days that while it remains committed to growing its investments in Canada, the company is also extremely hesitant to trace a course of action in the short term and adhere to it regardless of costs or consequences. For Shell, all options remain very much on the table, and, indeed, the company could yet choose, in the case of the Scotford upgrader, to pick a middle-of-the-road option where oil sands upgrading and refining is performed in both the United States and Canada, rather than exclusively in one or the other. Whatever the case, the talk appears to be a play for time; while increasingly high oil prices have made oil sands production very profitable, they have also squeezed downstream refining margins. With margins so low, Shell could be waiting for price volatility to decrease and for margins to recover before engaging in significant further downstream investments. Lastly, Shell considered Edmonton project costs to be high even prior to the global credit crunch—a tightening of credit conditions will no doubt have played a significant role in tipping the project's anticipated long-term rates of return below levels acceptable to the company.

Related Articles

United States - Canada: 18 March 2008: Shell Weighs Up Heavy Oil Upgrade Options Across North America

Canada: 31 July 2007: Shell Seeks Permit for C$27-bil. Oil Sands Upgrader in Canadian Province of Alberta

Canada: 23 March 2007: Shell Selects Site for Heavy Oil Refinery in Ontario, Canada

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