A new threat to investing in Canada’s oilsands

CNRL’s Primrose leak could lead to a crackdown on in situ operators

The Alberta Energy Regulator still regards the cause of the Primrose leak as unknown (Canadian Natural Resources Ltd.)

The Alberta Energy Regulator still regards the cause of the Primrose leak as unknown (Canadian Natural Resources Ltd.)

The mysterious oil leaks discovered at the remote Primrose/Wolf Lake Oil Sands Project in northern Alberta last year have slowed to a drip, and owner Canadian Natural Resources Ltd. (TSX: CNQ) says the cleanup is nearly complete. But the mishap has brought to light a new risk, and it’s one that could affect the valuations of many companies operating in Canada’s oilsands.

That’s because while the first oilsands projects were open-pit mines (and those still account for more than half the oilsands output), about 80% of the remaining oil lies too deep to mine. Hence in situ operations, which drill deep underground, represent the industry’s future. Until now, Alberta’s nine open-pit oilsands mining projects have endured far greater regulatory scrutiny than the more than 200 in situ projects, which are typically smaller in scale. However, the uncontrolled releases at Primrose threaten to change that.

CNRL, which employs a process called cyclic steam stimulation (CSS) at Primrose, attributed the spill to failed wellbores in abandoned wells, caused by faulty cement jobs or separated casings. The Alberta Energy Regulator, which is investigating the releases independently, regards the cause as unknown. The suggestion that CNRL steamed too aggressively at the site, possibly fracturing rock formations and allowing bitumen to migrate to the surface, was rejected by the company. Three intervening rock formations would prevent such seepage, it said.

But last year, academic and consultant Kevin Timoney argued that the rising use of in situ methods has outpaced Alberta’s ability to understand and manage what’s happening underground. “Due diligence dictates that all [CSS] operations should be suspended until major unknowns are addressed,” he urged.

Alberta’s regulators have traditionally been accommodative to industry. But the AER, formed last year to oversee all aspects of energy development in the province, is demonstrat­ing more resolve than its predecessors. In January, it opted to defer five recent applications for projects using another in situ method, steam-assisted gravity drainage (SAGD), while it drew up new requirements for the applications, which it said lacked sufficient geological survey information about the integrity of caprock. On March 18, one applicant, Ivanhoe Energy (TSX: IV), suspended work at its $1.37-­billion Tamarack project. On the same day, SilverWillow Energy (TSXV: SWE) announced it was considering “strategic alternatives,” including selling assets or even the whole company. The other affected companies include Southern Pacific Resource (TSX: STP), Value Creation and Grizzly Oil Sands ULC.

Officially, there’s no link be‑­tween Primrose and the SAGD rule review. “It’s a completely separate issue,” says AER spokesman Darin Barter.

Yet, when considered to­gether, they suggest rising concern about reservoir containment. “I think we can read between the lines here,” says Erin Flanagan, an analyst with the Pembina Institute, an environmental watchdog group. She says she believes years of international controversy, played out most visib­ly on projects like the proposed Keystone XL pipe­line, have prompted increased emphasis on managing environmental risks.

“There’s a recognition that the status quo is not going to cut it in the oilsands,” Flanagan says. “We’re starting to see some of that culture emerging now.” She argues that other in situ producers should prepare for more stringent regulation. Former CIBC chief economist and energy commentator Jeffrey Rubin recently made the same point in a written commentary advising oilsands investors to watch Primrose closely.

That’s not obvious to everyone, however. Michael Dunn, an analyst at FirstEnergy Capital, points out that Primrose is a high-pressure CSS project. “There aren’t that many projects, if any, that are applying to use high-pressure steam,” he says. He predicts any fallout will be confined to Primrose and possibly the other major user of high-pressure CSS, Imperial Oil’s (TSX:IMO) Cold Lake project.

As for the recent SAGD review, it applies only to shallow projects. “The companies affected were, as far as I can see, small players,” Dunn says. “I’m not aware of any large-scale project plans of any of the big guys that would fall under that category. So the implications to the industry as a whole seem negligible.”

The full ramifications of the Primrose releases will likely not become clear until their cause is officially determined. The AER regards it as an incident in progress and continues to restrict CNRL’s steaming at Primrose. That could ultimately lower the company’s production during 2014. The AER is also watching to see whether warmer weather will bring more bitumen emulsion to the surface. In that vigil, it’s undoubtedly not alone.