PUB – “We Shall Overcome”

By Dan Cronin and John Auers

“We Shall Overcome” is a protest song that is based upon a 1900 hymn composed by Charles Albert Tindley.  The song is most famously associated with the U.S. civil rights movement and has also been utilized throughout history by groups trying to overcome adversity.  Today, we continue with our investigation into Partially Upgraded Bitumen (PUB), identifying and focusing on some of the challenges that PUB will have to overcome to be successful.  As already discussed last week in Part 2 of this blog series, PUB will face challenges in all segments of the petroleum supply chain, the upstream, the midstream, and the downstream; however, we believe that these challenges can be overcome and in many instances will represent an opportunity to industry participants who can best understand and negotiate the specific complexities and peculiarities associated with the different PUB streams.

Challenge 1: Upstream Capital Cost Discipline

Some who are reading this blog will remember the early 2000s when no less than eight upgraders were scheduled to be constructed in Alberta.  A combination of runaway capital costs and the oil bust of 2008/2009 caused the cancellation of all upgrading projects except for one (the one project that did survive morphed into a refinery that more than doubled in price and required significant financial assistance from the Alberta Government).  The oil industry in Alberta has a notorious reputation for capital cost overruns – are things really different this time for the PUB players or to quote Yogi Berra, is this a case of ““déjà vu all over again”?

The key factor that makes project execution today different than in the past is that the Alberta economy is in an economic doldrum.  Not only will this influence costs to the downside but keep in mind that the cost of a PUB project is relatively small when compared to the cost and complexity of erecting a full-scale upgrader.  While we are not suggesting that capital cost overruns will not take place (this is Alberta after all), the extent of these overruns will most likely be minimal given the relatively small size of each project and the current economic condition in the Province.

Below is the 2018 outlook from the Alberta Energy Regulator with respect to capital expenditures associated with the oil sands (2016 data and beyond is a forecast).  As one can immediately see, the capital expenditure forecast in the oil sands is expected to be ~35% of oil sands capital expenditures at its peak – such an outlook bodes well to keep costs under control.  Also, consider that capital costs associated with a higher-end PUB facility is ~$C2 billion (Value Creation Inc) while a full-scale upgrader could cost upwards of ~$C12 billion (Suncor’s canceled Voyager upgrader).  A lower overall forecasted capital outlay in the oil sands, along with a lower overall capital cost of a partial upgrader versus a full-scale upgrader, should equate to better capital cost discipline. 

Challenge 2: Midstream Acceptance of PUB (“Cracked” Material)

Right now, pipeline companies can afford to be very selective in terms of the molecules it decides to transport on their respective systems as demand for space is high and spare capacity is essentially nonexistent.  The challenge with some PUB is that depending on the technology utilized, the PUB could be classified as cracked material due to the olefin content.  Many refineries avoid high olefin material due to the potentially negative impact on specific units at the refinery.  If the olefin content of a PUB exceeds pipeline specifications, the PUB will require buffers to be put in place between the cracked material and the batch ahead of it and the batch behind it.  The pipeline that performs this operation needs not only the capacity but also the necessary break-out tankage along its respective system to segregate this crude – a difficult task in today’s pipeline constrained world.

A PUB that requires buffers would find it challenging to gain acceptance on a pipeline today; however, a PUB that didn’t require buffers for transportation (i.e., the olefin content is low enough to meet pipeline specifications) should expect to gain pipeline access.  It is the expectation of TM&C that Western Canada will remain in a pipeline- constrained environment for at least the next few years and as a result, one could see PUB that does not require buffering attempt to access pipeline capacity and for PUB that does require buffering to perhaps be forced onto rail.  PUB players that are forced to rail and require diluent could offset some of the higher costs associated with rail transportation by further reducing the diluent component (potentially to zero), as the PUB would only have to meet the rail viscosity specification and not the more stringent pipeline viscosity specification.

In a scenario where Western Canada becomes “long” pipeline space, one could see a situation develop where pipelines are clamoring to transport even PUB that require buffers in order to fill their respective capacity.  In a “long” pipeline scenario, midstream companies should have the necessary capacity in both the pipe and at breakout tankage locations to handle even a PUB that require buffers.

In addition to pipeline logistics, one must also take into consideration PUB at merchant terminals when assessing the midstream.  Acceptance at a terminal (e.g., Cushing, OK) would be up to each individual midstream service provider.  If a PUB does not require buffers, one can most likely expect to be allowed into a terminal; however, if a PUB does require buffers, the terminal will have the added challenge to ensure that olefins associated with a specific PUB do not contaminate other crude within the terminal – the extent of this challenge depends on the configuration of each terminal.  Segregated storage will most likely be forced on PUB shippers that require buffers for pipeline transportation, and the purchase of additional buffer material might be required to exit the terminal.

Challenge 3: Refinery acceptance of PUB

Each refinery has limits to their respective crude slate that is determined by the various processing units within the refinery.  The potential hesitation of processing PUB at a refinery will center on the olefin content.  If a PUB meets pipeline specifications and does not require buffers, a refinery should have few issues in processing this crude.  However, if the olefin content of a PUB exceeds pipeline specification, a refinery would need the necessary equipment in place to ensure damage to the refinery does not occur.  If the price of PUB becomes advantageous and the volume substantial, refineries will most likely find a way to run this crude through either an investment at the refinery (similar to when many PADD II refineries invested in conversion capacity to process DilBit) or through blending operations.

Conclusion

Challenges exist for PUB to become commercially successful. The upstream will have the challenge of keeping capital costs under control.  The midstream will have the logistical challenge of accommodating PUB streams (especially those requiring buffers) into pipelines/terminals, and the downstream will have the challenge of processing a new crude which may have a higher than normal olefin content; however, we believe each of these challenges represent an opportunity for the industry as nothing appears to be a showstopper for PUB in the upstream, the midstream, or the downstream … “We Shall Overcome.”

In our fourth and final blog of this PUB blog series, we will assess PUB from a more macro level.  We will look at PUB and its potential impact on the Western Canadian condensate balance, identify where we see PUB being absorbed into the marketplace, and provide a general summary on PUB.

Due to the time and space limitations of a weekly blog, we have included only a high-level discussion of PUB here.  If you are interested in more information about PUB and how it could/will specifically impact your company’s future plans or strategies, please call or email us at 214-754-0898 or jauers@turnermason.com and dcronin@turnermason.com