Unocal Tries for the Last Laugh : Sticks to Oil Shale Project in Anticipation of Rising Prices
Maybe you can’t get water from a stone, but there are several ways to get oil from it. One is the way Mike Callahan did it back in 1882 when, the story goes, he built his fireplace out of oil shale. The rock ignited and his new log cabin burned to the ground. That is how nearby Mt. Callahan got its name.
Another is the way Unocal did it back in 1981. The company struck a deal with Uncle Sam for $400 million in federal price guarantees. Today, Unocal has begun squeezing crude oil from the side of a mountain, shipping it to Chicago and selling it for a handsome $46 a barrel--more than double the prevailing market price.
Five years after Exxon, Chevron and other major oil companies abandoned this part of western Colorado and its oil shale promise, Unocal perseveres in a vast, controversial, troubled and, to some, heroic project.
The crude is high quality--technically better than Arabian Light, an industry standard for quality crude. And the huge mining complex carved into the bowels of an 8,000-foot mesa is the closest anyone has come to success in the long history of schemes to separate oil from what the Indians called “the rock that burns.”
Yet after an infusion of more than $650 million in stockholder money, and nearly four years after the intended start-up date, the plant hasn’t been able to produce at more than half its modest capacity and remains essentially experimental. And after Unocal’s $400 million in taxpayer price guarantees is exhausted--in as little as five years--the whole operation stands to be closed down unless oil prices rise sharply in the meantime.
In fact, these days the company’s expectations for the project have diminished, the original blueprint for a five-fold expansion put on the shelf indefinitely. Says Cloyd P. Reeg, president of Unocal’s energy mining division, tromping through the mine 500 feet underground: “This is just a technology demonstration, for all practical purposes.”
Nonetheless, as the nation peers out from the current perspective of plentiful oil at $18 to $20 a barrel toward a widely predicted future of expensive imported crude, there are those who say that Unocal might still have the last laugh. Perhaps taxpayers will even get their money’s worth.
“If the price of oil goes back up and we have another energy crisis, the rest of the oil industry would be criticized for not having done this. Several years from now, Unocal might look quite prescient,” says Eugene Nowak, a veteran oil analyst at the Dean Witter brokerage firm in New York.
Richard J. Stegemeier, Unocal’s president, declares: “We’ll be way, way out in front.”
That seems a fair judgment, as virtually everyone else in the industry has walked away from this oil-laden region that just a few years ago was touted as a major part of the answer to the nation’s energy problems.
The oil is locked in the shale underlying parts of northwestern Colorado, southwest Wyoming and eastern Utah, a geological formation created about 50 million years ago when two big lakes covered the land. The Colorado portion alone contains a tantalizing 1.2 trillion barrels of oil--about 40 times this country’s known recoverable reserves of conventional crude oil.
The first known extraction of oil from shale occurred in Scotland in the 1600s, and the Mormons are believed to have used shale oil as axle grease and lamp fuel in the mid-1800s in Utah. Then as now, heat was applied to soften the rubbery rock, which yielded the oil.
Many Attempts Made
But the lifting of ready-made crude with the first oil well in Pennsylvania in 1859 made oil from shale, as well as oil such as that found in tar sands, economically unattractive. It remains so to this day.
That hasn’t kept people from trying. In this part of Colorado, on the scenic western slope of the Rockies, there have been dozens of oil shale ventures since the turn of the century, leading to still-unresolved disputes over control of the land. Union Oil, now part of Los Angeles-based Unocal, has leases dating to the early 1920s.
During World War II, Unocal hauled oil shale by train to Los Angeles, where it had rigged up a small, experimental “retort,” the vessel in which shale is heated. The company has been monkeying around with the stuff ever since, driven in part by the early engineering work and personal interest in oil shale by its longtime chairman and chief executive, Fred L. Hartley.
During the 1960s, there were charges that the oil industry had set out to lock up the oil shale country in order to prevent development and keep shale oil from coming to market, fearing that opening up the huge reserves would flood the market and drive oil prices down.
But the picture changed dramatically when energy prices skyrocketed and supplies were interrupted in the 1970s. President Jimmy Carter declared the “moral equivalent of war” to assure long-term domestic energy supplies through conservation and the development of so-called alternative energy. Oil from shale was in the front ranks because, unlike wind or solar, it fits the world’s current energy system.
And that put Parachute, Colo., population 300, on the map. Big Oil rushed into the region and spent upward of $2 billion, employed 4,000, built schools and houses, and started burrowing into the mountains and erecting the elaborate equipment needed to produce oil on a scale large enough to make a recognizable difference in the U.S. oil picture.
It was over almost as quickly as it began.
Competitors Pulled Out
Exxon officially declared an end to the brief oil shale boom in May, 1982, when, after pouring $1 billion into the hills, it declared that falling oil prices had made the whole venture--its cost projections now swollen to $6 billion--a mistake. Chevron, Amoco, Occidental and others halted work as well, and the stretch of Colorado along Interstate Highway 70 from Grand Junction to Glenwood Springs was knocked for a loop. An estimated 10,000 jobs were wiped out in sparsely populated western Colorado.
Today, besides Unocal, the only major corporate presence here is Exxon, and it’s selling houses, not oil. The planned community of Battlement Mesa--designed to accommodate the 25,000 people once expected to be drawn to the remote area when production of shale oil would supposedly hit 500,000 barrels a day--is now being peddled by Exxon’s real estate subsidiary as a retirement community.
(One attraction, in addition to the beautiful setting in a mountain valley, is that the two half-empty new schools were built and paid for by Exxon and Unocal. So the local tax rate is the lowest in Colorado, boasts Rick Stonger, Exxon’s real estate man here. Today, after plummeting from 2,100 people to 600, the settlement’s population has risen to 1,500.)
Ran Into Problem
Unocal, lured by the promise of federal price supports that would bring it at least $42.50 a barrel if the company could produce the oil, decided to stick it out. The only way the company could recover its investment and turn a profit, Stegemeier says, was to complete the project and produce 10,000 barrels a day for 30 years. The up-front money--$650 million--was Unocal’s.
The construction project, which includes a massive retort 7,000 feet up the side of a mountain, a quasi-refinery nine miles away, and six miles of passageway inside the mountain so far, was ostensibly completed in the fall of 1983.
“We pushed the starter button,” recalls Stegemeier, “and it didn’t start.”
The main problem wasn’t wringing oil from shale, but cooling the spent shale afterward. Heated to as high as 900 degrees Fahrenheit, the inch-sized chunks of rock would ignite if exposed to the air unless the temperature could be dropped below 300 degrees. The consistency of the used shale was unexpectedly fine, and the cooling water tended to run off the material, Unocal says.
For three years, Unocal struggled with the troublesome technology and persuaded the government’s Synthetic Fuels Corp. to promise an additional $500 million in loan guarantees and price supports to modify and fix the plant. The hurried deal in late 1985 caused an uproar in Congress, which was rushing to put the scandal-ridden agency out of business.
The whole affair began to look like a fiasco to people such as T. Boone Pickens Jr., the oilman and corporate raider from Amarillo, Tex., who tried but failed to take over Unocal about this time. Calling it an example of the company’s squandering stockholders’ money, he says losses on the project exceeded $1 billion and that he would have “closed it by sundown” if his takeover campaign had succeeded.
(Stegemeier says the bill to date is no higher than $850 million, and the true cost is less than that because it qualified for 10% investment and energy tax credits while the plant was being built. Analyst Nowak concurs, adding that Unocal can afford it in any case.)
Late last year, Unocal began to produce oil in increasingly respectable amounts, and by the end of the year had made and stored about 200,000 barrels of so-called syncrude. By this spring, the production cycles that once lasted a few hours or days between problems had grown to several weeks in length. Production rose to 5,000 barrels a day and cumulatively stands at 400,000 barrels.
Getting Federal Payments
More importantly for shareholders, the Treasury Department this year has started sending Unocal a $27 to $35 check for every barrel of the oil that is shipped. That makes up the difference between the market price minus transportation costs and the inflation-adjusted $46 the company is now entitled to under its government contract.
The company has collected about $5 million in government funds so far, a Treasury spokesman says. The crude was originally intended to be refined into fuel for the exclusive use of jets at two Air Force bases in Utah, but the refinery that was to handle the syncrude went out of business. The current small volume is shipped by truck to Lisbon, Utah, where it is piped to a Unocal refinery in Chicago and blended with other fuels. It ends up in cars and furnaces.
Unocal refuses to discuss the likely rate of return on the project at a price of $46 a barrel. But a former executive of Tosco Corp. of Los Angeles, another pioneering oil shale firm that used a rival technology, guesses that Unocal originally expected a profit of $30 per barrel.
“They were extremely confident of their technology, and they made a political assessment that they would invest the money themselves up front, take the risk, and then ask for a very big number,” says John D. Lyon, a Los Angeles lawyer who headed up Tosco’s oil shale division until Tosco partner Exxon backed out. “The quantity of profit was going to be very large to finance the next phases of the project. They’d be making $30 profit per barrel if it had worked.”
Stegemeier scoffs that $30 is too high. In any case, the math has been long since skewed by the long delays, the costs of the ad hoc adjustments to the system and the low volumes of production that Unocal has managed to achieve. Indeed, some say Unocal’s intended capacity of 10,000 barrels was never enough to make economic sense without a subsidy. On its books, Unocal has already written down the project’s value by $125 million.
Large Plant Required
“A shale oil plant has to be very, very large to be possible economically. You’ve got to mine a ton of rock to get three-fourths of a barrel,” Lyon says. The Tosco-Exxon plant was intended to make 50,000 barrels a day--a level that Unocal would have reached in several stages.
Now, Stegemeier says the company would recover “most” of its investment in today’s oil price climate if it produced 10,000 barrels a day long enough to exhaust the loan guarantees, which would be about five years. “It wouldn’t be profitable, but we would recover most of what we put in the plant.”
Then, if market prices remain at today’s $18 a barrel, “We probably wouldn’t be able to continue.” But if prices rise in the meantime, Unocal will use up progressively less taxpayer money per barrel, the $400 million will last longer, and the company would at some point start to make money.
The payoff for taxpayers would theoretically come in the form of societal know-how for producing oil from shale.
Unocal now claims to have made “major progress” on its cooling problem, enabling the project to proceed without the fix envisioned for the extra $500 million. Last week, the company announced that it would forgo the controversial $500 million and the so-called fluidized bed combustion system it would have built to capture and use the plant’s excess heat.
Stegemeier says the project would cost more than it thought, the technology remained highly uncertain and the tax reform bill means there would be no investment-tax credits to be claimed. The decision also appears likely to defuse a pending federal lawsuit in Washington by Sen. Howard Metzenbaum (D-Ohio) and others who challenged Synfuel Corp.’s authority to make the extra $500 million available to Unocal.
The whole experience has lent itself to much philosophizing and finger-pointing.
“We’re disappointed, sure,” says Stegemeier. “But there was no reason to expect anything else if you look at the history of pioneering plants. This isn’t the grocery business, it’s a risk business.”
A congressional aide who worked against several taxpayer-funded alternative energy projects says: “We said again and again that these technologies are not proven and that we’re going to end up running R&D; (research and development) projects at a commercial scale. Now that’s being borne out. I’m sure Unocal learned a lot, and that’s great. But did they have to build it at that scale?”
If the project ends up costing $1 billion to produce 10,000 barrels of oil a day, then the half a million barrels once envisioned by the Energy Department might cost $500 billion--or about 20 times the tab for the Apollo moon program in the 1960s.
To the energy community, however, the potential for oil shale doesn’t seem to have lost much luster. Armand Hammer, the chairman of Occidental Petroleum, still calls the nation’s shale the best long-term answer to dependence on oil from the volatile Middle East. Exxon says it keeps a skeleton staff of 10 in Parachute to maintain its partially completed shale properties “in a state of readiness” for the next oil shock.
“Those of us in the business, or what’s left of it, have nothing but admiration for Unocal,” says R. Glenn Vawter, a vice president and petroleum engineer at the Western Research Institute in Laramie, Wyo., a nonprofit organization affiliated with the University of Wyoming. A former Tosco manager, he is one of hundreds of oil shale experts cut loose during the bust.
Turnover of People
“You can’t find people in any of the other major oil companies doing anything on shale. There may come a time in the next five years when we’ll all be called on to do the same thing all over again, but there’s been an almost total turnover of people. Many of them will probably say they never want to have anything to do with oil shale again.”
The hard fact remains, says attorney Lyon, the only company that ever made a profit on oil shale was Tosco--when Exxon bought it out for $380 million and shut the project down. But he expresses a “warm feeling” toward the dogged Unocal, and says everyone else is shortsighted.
“We’re like the proverbial hillbilly with the leaky roof,” he says. “You can’t climb up and fix it in the rain, and when it’s not raining you’re not inclined to go up there.”
