Chastko, Paul. Developing Alberta’s Oil Sands: From Karl Clark to Kyoto. Calgary: University of Calgary Press, 2004.
Reviewed for H-Energy by J.C. Herbert Emery, Department of Economics, University of Calgary.
Paul Chastko has written an outstanding book on the long run development of Alberta’s vast oil sands resource. Given the scant attention paid to issues related to economic development of sub-national jurisdictions and to energy resources since the collapse of energy prices in the 1980s, Chastko has made an enormous contribution. The book’s strength is its discussion of the evolution of the oil sands from being a resource to being a reserve. Readers will be struck how the issues that confronted the pace and scale of oil sands development in the early days, such as attracting a reliable and sizeable workforce to the region or establishing appropriate tax and royalty regimes, continue to be issues today. Similarly, Chastko convincingly shows that the size and scope of the oil sands are “inextricably linked to the United States and the world price of oil”. (page 245)
Chastko portrays the development of the oil sands to its current status as a relatively low cost source of hydrocarbons as a success of far-sighted government policy. The oil sands were identified early in the twentieth century as having enormous potential to diversify the Alberta economy and ensure the long term prosperity of the province. The Canadian government has viewed the oil sands resource in Alberta as a key to developing a secure energy supply that could result in the energy self-sufficiency for the nation. To that end, the Alberta and Canadian governments have engaged in a variety of initiatives to spur the development of the resource through support for research into solving the technical problems associated with extracting the bitumen to financial support to make synthetic oil competitive with lower cost, and lower risk, conventional oil sources. Publicly supported research between 1920 and 1950 was aimed at solving the problem of how to separate the oil from the sand. After 1970, research and development activity resulted in the reduction of production costs and the ability to mine harder to access oil sands through in situ production techniques. The cumulative effect of research and development seems to have enabled industry to compete with conventional crude oil supplies in the world market.
Chastko (page xvii) argues that “Current levels of technology and the world price of oil, rather than the level of government subsidies, now determine production levels and make the oil sands a viable alternative to supply North America’s voracious appetite for energy.” I believe that this positive assessment of the oil sands, which is an important theme in the book, may be premature. First, given the emerging debate over the continuation of the Alberta governments oil sands royalty regime which has oil sands producers paying little until their capital costs are recouped, it is debatable that the level of government subsidies are not as important as in the past. With historically high oil prices, oil sands producers in Alberta have claimed that their projects are only marginally viable with the generous royalty regime. If it is revised such that the Alberta government seeks to raise the public share of oil sands revenues, then producers claim that they will have to re-evaluate their continued participation in the region. If Chastko is correct, however, then the Alberta government would be justified in unilaterally re-writing its royalty arrangement for the oil sands just as Lougheed had done for conventional oil producers in the 1970s. Second, it is not obvious that the pipeline, upgrading and refining capacity is installed to support the scale of oil sands output that has been forecast. If energy prices continue to soften, then will the capacity be installed without further government support? Third, large challenges for the oil sands remain as the quality of reserves inevitably declines. Scoop and shovel technology works fine with oil sands that were close to the surface and accessible, but eventually, this technology will hits its limits. In situ mining technology requires energy inputs to generate steam to separate the oil from the sand. This technology has thus far relied on what had been plentiful supplies of cheap natural gas, but moving forward, natural gas is scarce and increasingly valuable as an end use energy source. Does it make sense to use natural gas to produce synthetic oil? Where will the necessary supply of energy to produce synthetic oil from the oil sands come from? Will the province need to adopt nuclear power generation as is proposed from time to time?
In reading the book, I was left with the question as to whether public intervention was necessary for the development of the oil sands to occur. It was not obvious that that resource would not have developed in the absence of government involvement. As world oil prices rise with the alleged growing scarcity of oil, why wouldn’t market forces have encouraged the development? This appears to have been the process by which technology for exploration, production and secondary recovery of conventional oil resources occurred, and more recently, coal bed methane resources. One interpretation of the lack of private initiative in the oil sands for most of the twentieth century is that it was not yet time for the oil sands to develop. From my reading of the book, public intervention was necessary to divert private capital from other sources of hydrocarbons like oil in politically volatile areas of the globe, oil shales in the US and from investments in renewable resources. It is striking that even with the oil shocks of the 1970s, the risk adjusted rate of return on the oil sands was apparently too low to encourage private interests to develop the resource without the Alberta and Canadian government taking on some of the price risk. With the current torrid pace of oil sands development it seems hard to believe that public support is necessary, yet oil sands producers claim that the projects are not viable without the royalty holiday even at historically high oil prices!
Public intervention may have been necessary to encourage the earlier development of the oil sands resource than would have been the case if development was left to market forces. It is not clear, however, that earlier development was worthwhile for Alberta or Canadian taxpayers. A common conclusion that arises from other historical studies of government supported resource development is that they were socially costly. Projects that are built “too soon” dissipate economic rents due to an increase in the number of unprofitable years of operation. Even if the current viability of the oil sands is due to the policies of the 1920s and 1970s, it has taken more than 30 years for success to occur. If we were to calculate the net present value of the public support over the past century towards oil sands development, would the size of the benefits going forward justify that use of funds? While it is difficult to do, I would have been interested in seeing some attempt by the author to evaluate the rate of return to the public investment in the oil sands. What did Alberta and Canada gain from the public support in terms the goals of the public intervention? Have the oil sands increased Alberta’s income in a sustainable way? Have the oil sands projects diversified the Alberta economy as hoped? Have the oil sands created a secure energy supply for Canadians and, compared to relying on imports of oil, what are Canadians paying for this security? If we think of the context of the National Oil Policy of the 1960s that was paid for by having Ontario pay more than the world price of oil to encourage the development of Alberta’s conventional oil resources, the pay-off for Ontario was the lower energy costs they secured in the 1970s and especially with the National Energy Program in 1980. What is the equivalent pay-off for Canadians and Albertans that can be expected from the oil sands?
Whatever gains in energy reserves that Alberta and Canada have achieved from the public support of oil sands development over much of the last one hundred years has come with an opportunity cost but it was not clear to me from reading the book, how large that cost could have been. On page 207, Chastko presents a key argument raised by economists William Baumol and Edward Wolff during the energy crisis of the 1970s in the U.S. that subsidies of new energy sources, including synthetic fuels such as the product from the oil sands, result in a net energy loss for the subsidizing government due to the inefficiencies arising from market distortions associated with the subsidies. Chastko raises this issue in the context of the perceived failure of government supported oil sands mega projects in the 1980s where the losses were clear, but it really applies the development of oil sands development in general. What was the impact of oil sands development on the development of conventional oil reserves, or alternative energy sources? Perhaps more importantly, to the extent that subsidizing oil sands development sustains the levels of North American energy consumption, what will we have lost over the long run with the diminishment of the market stimulus for energy conservation and reduced dependence on fossil fuels?
It is possible that public intervention in the oil sands was economically sound and welfare improving if the Alberta and Canadian governments were addressing a market failure as opposed to engaging in distortionary “industrial policy”. The Baumol and Wolff concerns about the welfare losses for society arising from subsidizing new energy sources are only valid if energy markets are sufficiently competitive and there are no market failures associated with energy markets. Chastko does not directly address the nature of the market failure that the Alberta, and Canadian governments, hoped to overcome with their interventions. Was the source of the market failure the high fixed costs associated with oil sands that would have reduced the viable degree of competition in oil sands production? Was the market failure one of a “positive externality”, where social benefits of a secure domestic supply of hydrocarbons exceeded the benefits that would accrue to private producers, in which case, private interests invest too little? This would make the public support for the development of the oil sands akin to the British strategy of using the Baltic Timber Tariff to encourage a secure supply of timber through the development of high cost British North American timber resources in response to Napoleon’s blockade. Was there a market failure arising from the “public good” aspects of oil sands Research and Development activity that solved the technical challenges of oil sands production? If it was the case that once the technology was known, anyone could adopt it, then there would be little incentive for a private interest to make this investment versus waiting for someone else to make the investment. If this “free rider” problem were severe enough, then it is possible that the oil sands may not have developed. Public support for, and public investment in, oil sands research and development may have solved the “free rider” problem associated with public goods.
Finally, while the book addresses how the oil sands developed, it does not speak to the debate as to whether the oil sands should be developed. Chastko addresses the implications of the Kyoto Accord for the viability of oil sands development, but he does not discuss the more direct environmental challenges arising from the oil sands development. For the most part, the oil sands are a giant open pit mine with a large ecological footprint. A relatively clean energy source, natural gas, is an input to producing a dirtier energy source. The oil sands producers use massive amounts of fresh water which is itself a resource that is becoming increasingly scarce and valuable. While efforts are underway to develop technologies for habitat restoration, it is not clear that the net loss of environmental quality in the Wood Buffalo region is not a large negative. Incurring such an environmental loss would be tragic if the oil sands, and even oil generally, go the way of coal as new cleaner sources of energy displace hydrocarbons as energy sources.