The RiskMetrics report details how much money, water, and energy it takes to get a barrel of usable crude from oil sands; how much toxic waste and degradation this causes; the greater carbon footprint of sands-oil compared to liquid crude; and perhaps most significantly, the “window” of the title. This describes the political and economic conditions under which oil sands projects are a viable investment.

The economics of oil sands are inherently risky, and politically, the spreading Gulf oil cloud may sow new doubts about further unconventional extraction methods.

“What is happening at the moment in the oil sands of Alberta is kind of like the Gulf spill, but playing out in slow motion,” RiskMetrics study co-author Doug Cogan told a conference call organized by Ceres. (The report was produced by a RiskMetrics ESG team led by Yulia Reuter that included Dana Sasarean, Mario Lopez Alcalá, Dinah Koehler, and Mr. Cogan.)

Canada Already Sells US More Oil than Saudis

For at least the past fifteen years, both oil companies and governments have believed that oil sands development is both necessary and profitable. The report explains that Alberta sits atop the world’s second largest hydrocarbon basin, after the fields of Saudi Arabia. Canada has already surpassed Saudi Arabia as the largest single supplier of oil to the United States. Average 2008 production of 1.3 million bbls of oil a day is expected to grow significantly, potentially meeting more than one-third of US demand by 2035.

Industry Assumes a Goldilocks Scenario

These projections are problematic. The RiskMetrics report explains how the costs of oil sands production, changes in the global energy market, and political factors could upend the industry’s expectations.

Production Cost Factors

From the report, a short description of the sands, and the oil extraction process:

Canadian oil sands deposits are a mixture of sand (73%), clay and silt (13%), bitumen (10%), and water (4%). …Bitumen is a heavy crude oil that cannot be recovered through a well in its natural state and hence needs enhanced recovery in the extraction process. Approximately 20% of Alberta’s oil sands are deposited close enough to the surface to be mined; the remaining 80% of the resource lies deeper underground and can only be recovered through in-situ processes.

“In-situ” extraction requires the injection of steam into the deposits. And as with extraction, the refining of liquid fuel from the extracted bitumen requires more energy, and generates more waste, than conventional crude oil refining. Finally, disposal of tailings, or mineral and liquid waste from extraction and refining, is an ongoing financial and environmental burden.

This extraction and refining process could face significant resource constraints in the near future. Risk factors include:

Water Shortages - RiskMetrics research found that this could emerge as an oil sands production constraint by 2014. Oil sands production is highly water-intensive. … Water withdrawals from the Athabasca River watershed are already restricted during winter months to protect fish habitat. If oil sands production volume grows according to companies’ estimates, some oil sands mining operations could exceed their wintertime allowances by as early as 2014, causing possible production interruptions. …Glaciers that feed into this watershed are already shrinking, and some scientific studies forecast that the Athabasca River’s water flow could shrink by 50% in winter months by mid-century.

Land Reclamation - The aftermath of oil sands extraction presents growing operating costs and liability for some oil sands producers. After 40 years of production, no oil sands companies have yet fully reclaimed tailings ponds created by development. That is because the fine particulates in toxic mining waste take decades to settle out in tailings ponds. Such tailing ponds—already covering an area the size of Washington, D.C.—pose risks of contaminating adjoining soil and water resources, and present health problems in downstream communities as well as the risk of a catastrophic breach.

Carbon Emissions - Oil sands development is replacing one of the world’s largest carbon sinks with a fast-growing source of carbon emissions. Development of Alberta’s oil sands is shrinking Canada’s vast  boreal forest. With continued expansion, oil sands operations are forecast to rise from 5% to 15% of Canada’s total CO2 emissions by 2020, working against national and global goals to achieve substantial GHG emission reductions.

Energy Market Factors

As noted above, it takes a lot of energy to make fuel from sand laced with bitumen. The energy return on energy invested (EROEI) for bitumen is 7:1. This means that for every unit of energy used to extract it, the bitumen provides seven units of energy. Conventional oil has an EROEI of 22:1, which means that it provides three times as much energy per unit of energy invested.

This makes oil sands profits especially vulnerable to the price of oil, as well as global demand for the natural gas used to produce steam for in-situ extraction. The report explains:

Producers of unconventional crude oil face volatile global energy markets and rising production costs. They need global oil prices to stay above at least $65 per barrel—and possibly above $95 per barrel—to justify $120 billion in planned expansion projects over the next decade. At the same time, global oil prices may rise to the point where they quash petroleum demand and permanently shift markets in favor of alternative fuels. This upper price limit may be in a range of $120–$150 per barrel. Such a relatively low ceiling combined with the rising floor price creates a narrow window for future oil sands development [and profitability]. …

Political Factors

Firms investing in oil sands are aware of the issues detailed above, but the report calls on investors to consider how politics could change the oil sands equation. For example:

Governments in the US and Canada are setting Low Carbon Fuel Standards (LCFS).

LCFS rules require a gradual decrease in the full life cycle carbon emissions of these fuels, which poses a particular challenge for oil sands because of their high carbon intensity and low energy return on energy invested (EROEI). Measuring emissions from the time of extraction through end use as motor fuels—a “field-to-wheels” analysis—oil sands derived fuels are 12% more carbon-intensive on average than those derived from conventional oil. California adopted an LCFS standard in 2009, and similar regulations are under consideration in more than half of the U.S. states and four Canadian provinces.

The US will continue to be the primary market for Canadian oil.

Efforts to build oil sands pipelines to Canada’s west coast for exports to Asia so far have been slowed by Aboriginal and community opposition. This leaves Canadian oil sands producers highly dependent on the U.S. market and the future course of its energy policy. Between the early 1980s and 2005, crude oil imports rose steadily in the United States, but have since leveled off. Many energy experts believe U.S. demand for imported crude oil has peaked. The US Energy Information Administration also projects that reliance on imported liquid fuels will fall from 57% of total consumption in 2008 to 45% by 2035.

Other stakeholders will compete with oil sands firms for access to water and natural gas.

As noted above, some Aboriginal groups of Canada have resisted new pipeline construction. They are not the only stakeholders who may object to the demands of oil sands producers. Consumers, governments and other businesses are expected to increase their use of natural gas in coming years, and other agricultural, municipal and industrial consumers will demand their share of scarce water supplies. Finally, the full cost of land reclamation as yet to appear on the oil producers’ books, but Alberta’s Directive 74 and other laws will compel them to pay more of their share.

Carbon pricing is coming.

The US is working to implement a form of “cap and trade” carbon pricing. This will both drive demand for natural gas and saddle fuel producers with the cost of their carbon emissions. This will exacerbate the penalty of oil sands fuel’s poor EROEI for its producers. The sands also face higher costs for mitigation, such as carbon capture and sequestration (CCS), than conventional oil.

What Investors Can Do

In her introduction to “Canada’s Oil Sands: Shrinking Window of Opportunity,” Ceres President Mindy Lubber describes its import for oil company shareholders:

Investors are right to be pushing oil companies to provide detailed explanations on how they are responding to these wide-ranging challenges. Shareholder resolutions requesting such disclosure were filed with many leading oil sands producers this year, including BP, Shell, ExxonMobil and ConocoPhillips.

These resolutions - and the report’s findings - are a wake-up call for oil companies to move quickly to examine and respond to these multiple challenges. Companies such as Suncor have shown a willingness to tackle these issues, both by improving their disclosure and attempting to address tough environmental challenges such as remediating the vast land areas now covered by polluted tailings ponds.

All oil sands companies should be tackling these challenges and we hope this report will expedite such action. Likewise, investors should be pressing companies to analyze and mitigate their potential risk exposure from this unconventional oil extraction project that has already attracted financial commitments of $200 billion, with potentially much more to come.