Canada could become the world’s third-largest oil producer by 2025, led by oil sands production in Alberta, suggests Dominion Bond Rating Service in a new report.

With recoverable resources close to 178 billion barrels, Canada is second to Saudi Arabia in global oil reserves, DBRS says. The Canadian advantage is that the recoverable resources are known and well-defined, and represent only about 12% of total resources in place. This could grow considerably as technology improves, it suggests.

“The Canadian oil sands resources are massive, well-defined, and require virtually no further exploration — unlike conventional oil reserves with the associated risks,” says DBRS president Walter Schroeder. “The bitumen produced is located in a politically stable country, and can readily be shipped by pipeline to markets in the U.S. with the necessary infrastructure largely in place. The cash flow and economics of developing the resource is viable for oil prices above US$25-US$30 per barrel.”

Schroeder continues that the royalty regime in Alberta for oil is attractive at 1% of revenue, until the capital costs have been recovered. Technology is continuing to reduce the energy-intensiveness of the reserves, and is improving the economics of developing the oil sands, particularly in a low interest rate and high commodity pricing environment.

DBRS notes that Canadian oil sands production is expected to exceed two million barrels per day in the 2012-2015 time period, and will continue to expand as technology further improves. This contrasts with the declining, or potentially declining, trend in most producing areas globally – particularly the three largest producing countries, which provide about one-third of the world’s oil supply. Both Saudi Arabia and Russia, with current output of about 10.5 million b/d and 9.2 million b/d, respectively, are operating near peak production levels; U.S. production, currently at 7.2 million b/d, has been falling with similar decline in the formerly prolific North Sea.

“Over time, world production is shifting to countries in Africa and the Middle East, which are not as politically stable,” adds Schroeder. He points out that in Canada the extraction of bitumen from the oil sands goes beyond the “mining” method, which accounts for about two-thirds of current total production. The rest is based on alternative in-situ technologies which are being developed today, “and will likely account for the bulk of the production in the long term.”

Compounding the supply problems, DBRS notes that demand for crude oil is growing, especially from China and India. China is aggressively looking outwards for reserves/production sources. “This is evident in its recent acquisition attempts in Canada (and failed attempt in the U.S), which are expected to accelerate,” it notes.

However, there are significant challenges to overcome before the large production increases from the oil sands arrive: the high cots of natural gas which is a big part of the extraction process has significantly increased costs; the escalating value of the Canadian dollar; the quality of the bitumen produced is among the worst grades of oil on the market, requiring substantial blending for transportation, hydro-treating, and upgrading, which are increasingly costly; the capital cost is enormous; and, the shortage of skilled labour in Alberta has contributed to enormous cost overruns in recent years.

DBRS notes there is substantial global interest in Canada’s oil reserves. Substantial investments in oil sands will be fuelled by vast expansions and new projects projected at $60 billion in the next five-to-10 years spearheaded by, among others, Shell Canada Limited, Imperial Oil Limited/Exxon Mobil Corporation, Suncor Energy Inc., and Canadian Natural Resources Limited.

“Major crude oil pipeline expansions and greenfield projects are in process to meet rising transportation needs. Thus, with world oil demand escalating, the Canadian oil sands will likely become one of the world’s premier sources of oil for the next 50 years,” states Schroeder. “In the future, Canada could rank in the top three of the world’s oil-producing countries.”