Exxon hedges oil sands with offshore Hebron project

Exxon Mobil Corp. (XOM)’s plans to develop a $14 billion underwater oil field off Newfoundland’s coast allows the world’s biggest energy company to hedge against discounted crude from Canada’s oil sands.

“The better pricing is definitely an issue,” Brian Youngberg, an analyst at Edward Jones & Co. said by phone from St. Louis on Jan. 4. “While things could change in the time it takes to finish the project, it’s a great way for Exxon to hedge their pricing.”

The investment to capture 700 million barrels of heavy undersea crude at the field about 350 kilometers (218 miles) southeast of St. John’s rivals spending in Alberta’s oil sands, where the estimated 170 billion barrels of recoverable reserves attracted C$23 billion ($23.2 billion) in spending last year. Newfoundland and Labrador oil is priced off the global benchmark, almost twice as high as western Canada’s heavy crude, and will help Exxon add to profit growth.

As Exxon and global competitors seek to lock up reserves in increasingly hard-to-reach terrain, offshore Canadian oil in Newfoundland and the Arctic is becoming more attractive.

The Hebron project puts Canada’s offshore assets, not normally the subject of a lot of development “chatter,” back on the map, Jennifer Stevenson, a vice president who helps manage about C$100 billion at Dynamic Funds in Toronto, said on Jan. 4.

Gulf Spill

“It checks the box for that area meeting all the criteria for significant project investment from companies that can choose to go anywhere in the world,” Stevenson said by phone. “They could go to Nigeria, offshore Arctic, Mexico, Brazil. They can go anywhere and those guys are going to put $14 billion in offshore Newfoundland.”

Exxon, the world’s biggest energy company by market value, said it expects to begin production around the end of 2017 at Hebron, designed for daily output of 150,000 barrels. Hebron is the fourth oil project to be developed in the province’s offshore industry, which also includes the producing Hibernia, Terra Nova and White Rose fields.

Exxon, Royal Dutch Shell Plc (RDSA) and others looking to maintain reserves are returning to offshore drilling following the 2010 oil spill in the Gulf of Mexico when an explosion killed 11 workers at BP Plc’s Macondo well.

‘New Story’

While Canada’s oil sands in Alberta are among the world’s largest reserves, investors may be looking to other opportunities as well to help diversify their risks and assets, said Youssef Zohny, a portfolio manager based in Vancouver, said in an interview Jan. 4.

“This may be the beginning of a new story in East Coast exploration and something to watch out for,” Zohny, who helps oversee C$14.5 billion ($14.7 billion) at Stenner Investment Partners of Richardson GMP. “It’s definitely a big positive seeing foreign investors come in not only in Calgary but in Newfoundland as well.”

Exxon is operator of the Hebron development and owns a 36 percent stake, according to the project’s website. Other partners include Chevron Corp., Suncor Energy Inc. (SU), Statoil ASA and Nalcor Energy Corp. Newfoundland has a 4.9 percent stake in the project through its ownership of Nalcor.

Newfoundland, Canada’s most easterly province which is closer to London than Calgary, already produces about 190,000 barrels a day from offshore fields, a volume comparable to Louisiana’s onshore crude output. Production in the province fell 29 percent in the first nine months of 2012.

Alberta Bottlenecks

Previous plans to develop Hebron collapsed in 2006 amid a dispute with provincial officials over ownership stakes. Chevron later ceded control of the project to Exxon.

For Canada’s crude producers, who produce mainly in Alberta, a lack of pipeline access to markets has crimped prices, making drilling of higher-priced offshore oil more favorable, Youngberg said.

The estimated cost to build Hebron, nearly triple the original forecast of C$5 billion in 2006, has risen as drilling prices escalate and comes amid global competition for labor and equipment, Youngberg at Edward Jones said.

Output at Exxon, based in Irving, Texas, has fallen five straight quarters. Chief Executive Officer Rex Tillerson is working to reverse those declines with projects like Hebron, the Kearl oil-sands project as well as exploration efforts in Russia’s Arctic.

“Hebron is one of several large-scale oil developments that Exxon Mobil will bring on stream in the next five years,” Neil Duffin, president of Exxon Mobil Development Co, said in a statement on Jan. 4

Western Discount

At current prices, the approximately 700 million barrels of reserves at Hebron would be worth about $77.8 billion. Brent traded at about $111 on the London-based ICE Futures Europe exchange on Friday. That compares with $57 for Western Canada Select, the benchmark for oil-sands crude, according to figures compiled by Bloomberg.

While the Hebron project will be a small fraction of Exxon’s total production, it will be necessary for a company seeking multiple sources of new output to stave off production declines, said Timothy Parker, a portfolio manager at T. Rowe Price International Inc. in Baltimore, who holds Exxon shares.

“It’s all about reinvigorating its portfolio even if is comes in 1 to 2 percent increments like this project would be,” Parker said in a phone interview.
Growth Gaining

Exxon said as many as 3,500 people will be employed during Hebron’s construction.

“Hebron will support jobs, the economy and strengthens our province’s position as an energy warehouse,” Kathy Dunderdale, Premier of Newfoundland and Labrador, said in a Jan. 4 statement.

Newfoundland has traditionally been one of Canada’s least- developed and poorest provinces. In recent years, oil exploration has helped the economy grow at a faster pace than Ontario, the most populous province. The province expects growth of 2.8 percent in 2013, compared with 1.8 percent for Canada, according to the median estimate of 29 analysts surveyed by Bloomberg .

The technical challenges involved in drawing Hebron’s heavy crude from beneath the icy North Atlantic will draw on expertise Exxon honed while drilling in Arctic conditions at Norman Wells in the Northwest Territories since the 1930s and extracting heavy oil in Venezuela during the 1990s.

Arctic Drilling

Exxon’s pursuit of offshore Arctic oil stretches to the other side of the globe. In April, the U.S. explorer and Russia’s OAO Rosneft agreed to spend $3.2 billion on an exploration portfolio that includes wells in the Kara Sea, which can freeze over for as long as nine months annually.

“The economics work, it’s challenging, but the resource is there, so why wouldn’t you develop it,” Parker at T. Rowe Price International said, referring to the Newfoundland developments.

As climate change increases temperatures across the planet, the Arctic is warming faster than other regions, opening up undersea natural resources for exploitation as the ice melts. Arctic sea ice shrank to its smallest on record last year, according to a Nov. 28 report by the World Meteorological Organization.

Arctic conditions such as those off Newfoundland add an extra layer of difficulty for engineers and geologists accustomed to drilling for crude in ice-free zones such as the U.S. Gulf of Mexico or Africa’s Gulf of Guinea. Shell’s Arctic drilling effort off the Alaskan coast suffered a setback last week when a specially-designed, ice-proof rig ran aground during a violent storm.

Iceberg Patrol

Exxon has been studying the size, shapes and movement patterns of icebergs off Canada’s northeast coastline since 1981. At the 1.3 billion-barrel Hibernia field, the province’s largest single source of crude, the company uses radar and aircraft to detect icebergs that may threaten the 735-foot tall platform and dispatches specialized boats to tow or deflect them, according to the company’s website.

The decision to proceed with Hebron “shows there is life in these fields,” said John Stephenson, who helps manage C$2.7 billion at First Asset Investment Management Inc. in Toronto, including shares in Exxon and Suncor.