In the AOSP, the Muskeg River Mine extracts the bitumen, which is sent via a pipeline to the Scotford Upgrader in Fort Saskatchewan, Alberta. After upgrading from the heavy bitumen to a lighter oil, the product is sent to refineries.

(The pipeline owner, Terasen, recently said it may spend as much as C$1 billion (US$826 million) to almost double daily pipeline capacity to 500,000 barrels by 2009. On 1 August, Houston-based Kinder Morgan agreed to buy Terasen for about US$5.6 billion (C$6.9 billion).)

“Costs are just getting mind-boggling,” said Glen MacNeill, who manages C$800 million in assets, including 105,000 Shell Canada shares, at Sentry Select Capital Corp. in Toronto. “It’s making me a lot more cautious. Investors just can’t go in and buy the models that the companies are giving you because they don’t work.”

Last month, Royal Dutch Shell—Shell Canada’s parent—announced that its Phase 2 costs for the Sakhalin oil and natural gas project in Russia may double to $20 billion.

The recoverable resource base in Sakhalin II is 17.3 TCF of gas and 1 billion barrels of oil—which, with the revised cost estimates, works out to a project development cost of some $5 to $6 per barrel of oil equivalent (in other words, cost of project divided by recoverable resource base).

Using a slightly different metric to view the development costs in the Athabasca Oil Sands Project (AOSP), Shell Canada estimates that for this first expansion, including the common infrastructure required to support the subsequent expansions, the cost could be up to C$200 (US$165) per annual barrel of production. In Shell Canada’s plans, the subsequent expansions will utilize the “pre built” infrastructure, lowering their expected capital requirements.

But even if the expansion cost is shared across the total volume of the subsequent planned expansions (essentially tripling the volume), that still works out to C$66.67 (US$55) per annual barrel of production—and that’s without factoring in any additional capital costs for the final two expansions.

In addition to higher materials costs, the increase in expansion costs include a number of design changes made to enhance reliability and produce less heavy oil, thereby improving the value of the synthetic crude oil blends. Because this expansion is the template for the subsequent two, it is critical for Shell—and its partners—to get it right.

The Athabasca Oil Sands Project consists of the Muskeg River Mine located north of Fort McMurray, Alberta and the Scotford Upgrader located near Edmonton and is a joint venture among Shell Canada Limited (60%), Chevron Canada Limited (20%) and Western Oil Sands L.P. (20%).

Shell is not the only oil sands producer seeing expansion costs rise. Syncrude, the world’s largest oil-sands miner, nudged up the estimated cost of its Phase 3 expansion to C$8.1 billion (US$6.6 billion) from C$7.9 billion—the third increase in 18 months.

Overall, the Canadian Association of Petroleum producers expects about C$45 billion (US$37 billion) to be invested in the oil sands between now and 2010.