Our cash flows are impacted by changes in both the U.S. dollar denominated crude oil prices and U.S./Canadian foreign exchange rates. Over the last two years, WTI prices have experienced significant volatility, ranging from a low of US$42 per barrel in January 2005 to a high of US$77 a barrel in July 2006. In the past, management has hedged both elements to reduce revenue and cash flow volatility to the Trust during periods of significant financing requirements.
As Canadian Oil Sands’ management believed financing risks were not significant in 2006 and 2005, no crude oil price hedges were executed and revenues were fully exposed to WTI price fluctuations. As at February 22, 2007, and based on current expectations, the Trust remains unhedged on its crude oil price exposure; however, it may hedge its crude oil production in the future depending on the business environment and our growth opportunities.
In the past few years there have been increases to the supply of synthetic crude oil from various oil sands projects, and several additional projects are under development or being contemplated. If and when these other projects are completed, there will be a significant increase in the supply of synthetic crude oil in the market. There is no guarantee there will be sufficient demand to absorb the increased supply without eroding the selling price, which could result in a deterioration of the price differential that Canadian Oil Sands may realize compared to benchmark prices such as WTI. Based on the expected supply of light, sweet synthetic crude oil and the expected delivery locations for our product in 2007, we are forecasting a further weakening of our price differential to a discount of $4.00 per barrel relative to Canadian dollar WTI prices. In 2006, our average realized selling price reflected a discount of $2.57 per barrel, and in 2005 a premium of $1.05 per barrel.
In response to growing volumes of synthetic crude oil and Syncrude’s own expanding volumes following the Stage 3 completion, we likely will have to continue expanding our markets to achieve the price we expect for our quality product. Following modifications to the hydrogen plant scheduled for the third quarter of 2007, we expect to further upgrade our entire production into SSP. This higher quality blend is anticipated to be more attractive to refineries, which should enhance our price per barrel relative to SSB.
The demand for light sweet synthetics, including SSB, as a diluent is growing as a result of more volumes of bitumen and heavy crude oil being produced in Western Canada. However, this growth is expected to be limited due to condensate import pipelines being planned for Western Canada.
Purchased natural gas is a significant component of the bitumen production and upgrading processes. Increases in natural gas prices and/or shortages in the supply of natural gas therefore introduce the risk of significantly higher operating costs. Similar to crude oil prices, natural gas prices have also experienced significant movements, decreasing from a high of approximately $12 per GJ during 2005 to a low of $4 per GJ during 2006. To the extent crude oil prices and natural gas prices move together on a stable energy equivalent basis, natural gas price risk is mitigated as the Trust is significantly more levered to oil price increases. The main risk involves a de-linking of crude oil and natural gas price movements, such that gas prices are significantly higher than oil prices on an energy equivalent basis. De-linking of crude oil and natural gas prices does occur, but historically these situations tend to be relatively short-term. The Trust has previously used natural gas hedge positions to mitigate this risk and will continue to assess the strategy as a means to manage short-term operating costs. No natural gas hedges were utilized in 2006 or 2005 and as at February 22, 2007, we have no natural gas hedges in place.
The acquisition of Canadian Arctic’s natural gas interests, which are estimated to have approximately 927 billion cubic feet equivalent of natural gas resource, provides Canadian Oil Sands with a long-term hedge against significant future natural gas price increases; however, this resource is not currently in production and there are no development plans at this time.
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