Oil can be derived from oil sands and oil shale, but the job is both economically and environmentally costly. How high must the price of oil be in order to make these alternatives cost-effective?Energy industries

Kristie M. Engemann

Michael T. Owyang

English

Research Papers in Economics

14   The Regional Economist  |  July 2010
H
ighly variable oil prices and increasing 
world demand for oil have led produc-
ers to look for alternative sources of trans-
portation fuel.  Two popular alternatives are 
oil sands (aka tar sands) and oil shale.  How-
ever, obtaining usable oil from oil sands or 
oil shale is more capital-intensive and more 
expensive than obtaining oil from conven-
tional reserves.  At what price of oil do these 
alternatives become cost-effective?
Oil Sands
Oil sands are a mixture of sand, water, 
clay and heavy, viscous oil called bitumen.  
The largest known deposits of oil sands are 
in Alberta, Canada, and the Orinoco Oil 
Belt in Venezuela.  As of 2005, the amount of 
oil in all oil sands deposits was estimated to 
be nearly 5.8 trillion barrels (about 2.4 tril-
lion barrels located in each of Canada and 
Venezuela), with about 0.3 trillion barrels 
estimated to be recoverable.
1  For comparison, 
an estimated 1.2 trillion barrels of conven-
tional crude oil are recoverable.
2
The process to obtain usable oil from oil 
sands is more complex than drilling the oil 
from the ground.  For reserves close to the 
surface (e.g., about 20 percent of Canada’s 
total reserves), the oil sands are extracted 
and transported to another location, where 
the bitumen is separated from the rest of the 
matter using a hot water process.  Because 
most refineries are not capable of using  
bitumen directly, the bitumen then goes  
to an upgrading facility, where it is turned  
into a product that refineries can use (such  
as synthetic crude oil).  For deposits more  
than 250 feet below the surface, the bitumen  
is extracted directly from the oil sands 
through various techniques, such as steam-
assisted gravity drainage, which is the most 
common method used in Canada.  In this 
process, producers drill two horizontal  
wells; the first is injected with steam to 
heat the bitumen, and the other pumps the 
heated oil to the surface.  In Venezuela, the 
oil is warmer and less viscous, and, there-
fore, steam is not necessary.  Producers com-
monly drill multiple horizontal wells and 
use pumps to send the oil to the surface.  The 
oil obtained by these underground methods 
is also sent to an upgrading facility.
3
Oil Shale
Oil shale is sedimentary rock that con-
tains organic matter—called kerogen—and 
mineral matter.  Kerogen is not actually oil, 
but it releases a substance similar to oil when 
heated.  An estimated 2.8 trillion barrels of 
oil existed in known oil shale deposits at the 
end of 2005, although not all of the kerogen 
is recoverable.  Seventy-four percent of the 
known deposits are in the United States, 
primarily the Green River Formation in 
Wyoming, Utah and Colorado, which is the 
largest deposit in the world.
4
As with oil sands, obtaining usable oil 
from oil shale is not simple.  For more- 
accessible deposits, the oil shale can be 
mined by either surface or underground 
methods.  The mined oil shale then under-
goes a process called surface retorting, in 
which it is crushed and heated to about 
1,000 degrees F, releasing the oil-like liquid.  
Because this “oil” is unstable, it goes to an 
upgrading facility, where it is turned into a 
stable oil before being sent to refineries. 
For less-accessible deposits, the oil shale 
may be heated where it is, and the liquid that 
is released is transported to a separate facil-
ity and upgraded to a stable oil.  A process 
developed by Shell Oil called the In situ 
Conversion Process could potentially cre-
ate stable oil directly and, thus, bypass the 
upgrading step.  In this process, the oil shale 
is electrically heated for two to three years 
until it reaches about 700 degrees F, and the 
released liquid is collected.  The company 
uses a “freeze wall” around the perimeter 
to keep out groundwater and to keep in the 
heated products.  So far, Shell has success-
fully tested its process on only a small scale.
5
High Cost and Other Issues
Because of the extra steps and capital 
needed to produce a usable product, the cost 
of producing a barrel of oil from oil sands 
and oil shale is higher than from crude oil 
reserves.  Therefore, the unconventional 
oil requires a higher price per barrel to be 
cost-effective.  Existing Canadian oil sands 
operations could continue even if the price 
of oil is less than $50 per barrel, according 
to a recent report.  But for the Canadian oil 
sands industry to grow, oil must be at least 
$70 per barrel to make production economi-
cally feasible.
6
A 2005 study examined the possible 
development of an oil shale industry in the 
United States.  For a new operation using 
the mining and surface retorting method, a 
barrel of oil must cost at least $70 to $95 (in 
2005 dollars) for the business to be economi-
cally feasible.
7  As shown in the chart, the 
real price of West Texas Intermediate crude 
oil has not regularly sustained a price of $70 
over the past 10 years.  Prices must consis-
tently remain greater than the cost-effective 
threshold in order for an unconventional oil 
industry to be feasible.
In addition to high production costs, envi-
ronmental issues pose a potential problem for 
e n e r g y
By Kristie M. Engemann and Michael T. Owyang
Unconventional 
Oil Production 
Stuck in a Rock and a Hard Place
Mark ralston/aFP/Getty IMaGes Oil sands are loaded onto trucks at the suncor mine near Fort McMurray, alberta, on oct. 23.these alternative oil production methods, as 
discussed in two studies from 2005.  Concerns 
about the effects on air, water and land quality 
have been raised.  For example, the green-
house gas emissions for oil sands production 
are three times higher than for conventional 
oil production in Canada.  Additionally, 
Alberta produces more air pollution than any 
other Canadian province, and the amount 
is expected to rise as oil sands production 
increases.  Much of the water used in the 
oil sands operations comes from Canada’s 
Athabasca River.  Some of the water—along 
with other matter from oil sands—ends up 
in designated ponds, where pollutants may 
harm aquatic life and seep into the ground-
water.  Oil sands production can also change 
the ecosystem.  For example, Canada requires 
that once operations are finished, companies 
must return the land to usable form, but the 
before-and-after uses need not—and likely 
will not—be exactly the same.
8
Some of the same types of environmen-
tal issues have been raised with oil shale.  
Greenhouse gas emissions are higher than 
for conventional oil production because 
of the extra steps needed to obtain usable 
oil.  Water quality may worsen because of 
the disposal of processed oil shale, which 
contains higher salt levels than the raw oil 
shale and also some toxic substances that 
could come in contact with water sources.  
As with oil sands production, the habitat 
for plants and animals would likely change 
permanently.  For instance, the oil shale that 
is left after retorting might be placed back at 
the original site, but the processed oil shale 
would take up 15 to 25 percent more space 
than the raw oil shale.
9
Increased environmental regulations 
could lead to higher costs for unconventional 
oil production and, thus, a higher price for 
which production would be cost-effective. 
Future Predictions 
A report from last year predicts that 
demand for liquid energy will increase by 
25 percent between 2006 and 2030.  During 
roughly the same period, the per-barrel price 
of light, sweet crude oil is expected to more 
than double ($61 in 2009 and $130 in 2030, 
in 2007 dollars).  At these higher prices, oil 
production from the unconventional sources 
becomes more feasible.  As a result, the report 
notes that total world production from oil 
sands should increase from about 1.8 million 
to 5.4 million barrels per day, and total world 
production from oil shale should increase 
from a small amount to about 200,000 bar-
rels per day.
10 
Michael Owyang is an economist at the Federal 
Reserve Bank of St. Louis.  See http://research.
stlouisfed.org/econ/owyang/index.html for more 
on his work.  Kristie Engemann is a research 
associate at the Bank. 
EndnOtEs
  1  See World Energy Council for definitions and 
information on resources and production.  
In Canada, the viscous oil is called natural 
bitumen; in Venezuela, where the oil is less 
viscous, it is called extra-heavy oil.  
  2  The estimate was calculated from the table 
“World Proved Reserves of Oil and Natural 
Gas, Most Recent Estimates” from the Energy 
Information Administration (EIA); original 
data sources were the EIA and the Oil & Gas 
Journal. 
  3  For information on oil sands production meth-
ods in Canada, see the Oil Sands Discovery 
Centre’s fact sheet.  For information on Ven-
ezuela’s methods, see World Energy Council.  
  4  See World Energy Council.
  5  See Bartis et al. for oil shale processes.
  6  See McColl.
  7  See Bartis et al. 
  8  See Woynillowicz et al. for potential environ-
mental issues for production from oil sands.
  9  See Bartis et al. for potential environmental 
issues for production from oil shale.
  10  See the Energy Information Administration’s 
outlook report. 
REfEREncEs
Bartis, James T.; LaTourrette, Tom; Dixon, 
Lloyd; Peterson, D.J.; and Cecchine, Gary. 
Oil Shale Development in the United States: 
Prospects and Policy Issues.  Santa Monica, 
Calif.: The RAND Corp., 2005.
Energy Information Administration.  Interna-
tional Energy Outlook 2009.  Washington, 
D.C.: Energy Information Administration, 
May 2009.
McColl, David.  “The Eye of the Beholder: Oil 
Sands Calamity or Golden Opportunity?”  
Canadian Energy Research Institute, Oil 
Sands Briefing, February 2009.
Oil Sands Discovery Centre.  Facts about 
Alberta’s Oil Sands and Its Industry.  Alberta, 
Canada: Oil Sands Discovery Centre, 2009. 
See www.oilsandsdiscovery.com/oil_sands_
story/pdfs/facts_sheets09.pdf
World Energy Council.  2007 Survey of Energy 
Resources.  London: World Energy Council, 
2007.
Woynillowicz, Dan; Severson-Baker, Chris; 
and Raynolds, Marlo.  Oil Sands Fever: The 
Environmental Implications of Canada’s Oil 
Sands Rush.  Alberta, Canada: The Pembina 
Institute, November 2005.
1970 1974 1978   1982   1986   1990 1994 1998 2002 2006 2010
140
120
100
80
60
40
20
0
Real price (deflated by CPI, 2005=100)
Nominal price
$70 per barrel line
D
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S
 
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soUrCes: Wall Street Journal (oil price) and Bureau of labor statistics (Consumer Price Index—CPI).
Spot Price of West Texas Intermediate Crude Oil
The Regional Economist  |  www.stlouisfed.org   15

Unconventional oil production: stuck in a rock and a hard place

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Unconventional oil production: stuck in a rock and a hard place

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