Oil and natural gas are abundant in the United States, and thanks to new advancements in drilling technology, domestic resources are more easily produced than ever before. This explains the massive ramping up of U.S. energy production in recent years. And yet, the biggest of Big Oil, integrated major ExxonMobil Corporation (NYSE: XOM), has set its sights on Canadian oil. In particular, the Canadian oil sands.

This article will provide a rundown of ExxonMobil’s huge project in the Canadian oil sands, as well as the highly-debated environmental benefits the company is counting on.

Introducing the Kearl project

In a joint venture with Imperial Oil (NYSEMKT: IMO), ExxonMobil is in the process of completing a major oil sands project located in Alberta, Canada. Known as Kearl, this is a truly massive undertaking. The Kearl project has already started production, and initial production levels stand at around 110,000 barrels per day. At full capacity, the site is expected to produce a massive 500,000 barrels per day of diluted bitumen. Based on current production levels, that will represent one out of every eight barrels produced in all of Canada. Over the expected 40-year lifespan of the project, it is expected that a total of 4.6 billion barrels are recoverable.

The Kearl project involves the production and use of heavy bitumen, a heavy, high sulfur product with heavy crude capabilities. Logistically, the Kearl project is situated perfectly. Kearl will be connected to the already-substantial North American pipeline system. The diluted bitumen coming out of the area will be easily transported straight to refiners, which are already fully equipped to handle and process heavy oil and bitumen. And, it will only take minor modifications to expand the reach of Kearl’s production to the U.S. Gulf, and even the far-east markets.

Environmental benefits are debated

From an environmental perspective, ExxonMobil claims it is utilizing a mix of existing and new technologies in a way that makes oil sands bitumen a relatively better source of energy than existing fossil fuels. For example, using proprietary technology to produce bitumen, ExxonMobil states that its process reduces energy requirements and environmental impacts by not needing an on-site upgrader. Furthermore, energy needs are reduced even more by the use of energy-saving cogeneration facilities. ExxonMobil reiterates it is effectively managing water use.

However, organizations such as the Carbon Disclosure Project, an organization that urges companies to disclose their environmental data, would beg to differ. ExxonMobil declined to issue water usage and management reports in each of the past three years. On its 2015 Climate Change report, the CDP issued ExxonMobil a grade of 88. While that was up from 76 the previous year, it still equates to merely a ‘C’ grade. ExxonMobil’s scores on its environmental practices could be labeled mediocre, at best, and it has not shown much willingness to participate.

Legal action was launched in Canadian federal courts several years ago, to overturn the regulatory approval of the Kearl open-pit mine. This effort proved futile, but there are other environmental concerns. The project requires transportation of what environmental activists have referred to as “oversized loads” of oil extraction modules. This is a major concern for residents of Idaho and Montana. The transportation route is close to rivers included in the National Wild and Scenic Rivers System.

Financial rationale

The Kearl project is critical for Exxon Mobil’s production goals. As Seeking Alpha analyst John Rhodes notes, “The project is estimated to account for about 13 percent of the Exxon Mobil production growth.” At first glance, it seems counter-intuitive for ExxonMobil to concentrate its efforts on increasing production, during a time in which commodity prices are collapsing. But just like many oil-producing nations, ExxonMobil does not want to cede market share to competitors. And, Exxon Mobil’s production strategy is one of the major reasons why its financial position has remained relatively intact, while so many of its competitors struggle to stay afloat.

ExxonMobil’s profits fell 47 percent last quarter, year over year, but production volumes on the upstream side of the business grew 2.3 percent from just the previous quarter. ExxonMobil’s profitability is getting squeezed—the company generated $26 billion in cash flow from operations over the first three quarters of the year, but spent $20.2 billion on capital expenditures and another $11.5 billion on shareholder cash distributions in the same time. Fortunately for investors, now that the Kearl project is up and running, it will transform from a use of cash to a source of cash, which will greatly help ExxonMobil’s financial condition.

As a result, while the proposed environmental benefits are still up for debate, the strategic and financial benefits of the Kearl project are clear. That is why ExxonMobil is plowing full-steam ahead into Canadian oil sands production.

Companies to Watch

Imperial Oil: Imperial and Exxon Mobil are in a joint venture for the Kearl project. Once Kearl is completed, Imperial will be one of the largest producers of Canadian heavy crude oil.

Canadian Oil Sands Ltd. (TSE: COS) is a major player in oil sands production in Canada. As such, the company and its investors should closely monitor the developments out of the Kearl project. Canadian heavy crude prices recently slumped to lows not seen in the past 10 years. Canadian Oil Sands is also fending off a hostile takeover bid from Suncor Energy (NYSE: SU).

Royal Dutch Shell (NYSE: RDS.B) is a major producer of Canadian Sands oil, through its Albian Heavy Synthetic crude produced at its Scotford, Alberta, upgrader. Despite the low price environment, Shell has notably resisted any calls to cut production there.

 

Bob Ciura is an independent equity analyst. Since 2012, his work has focused on fundamental investment analysis of publicly-traded companies in the energy, technology, and consumer goods industries. Bob has a Bachelor's degree in Finance and an MBA in Finance.