OTTAWA, CALGARY — Alberta's juggernaut has run into a classic squeeze play.

Even as they cope with sharply lower crude prices, Canadian oil sands producers are confronting a deteriorating competitive position in the worldwide battle for increasingly tight investment dollars.

While the global industry has been squeezed between soaring project costs and lower prices, Alberta's oil sands producers are being hit harder because they are more capital intensive than other more conventional projects.

In a report released yesterday, New York-based management consultant McKinsey & Co. said the Canadian industry has been losing ground against other global producers, with whom they compete in the key Gulf Coast and Midwest markets in the U.S.

Of particular concern is the economic viability of building new upgraders, which process tarry bitumen into more valuable synthetic light crude, in Alberta.

McKinsey cites poor labour productivity, higher costs for the energy needed to extract the bitumen, and for transportation and materials, as well as a poor environmental performance and uncertain regulatory picture.

"Unfortunately, this structural cost disadvantage is expected to persist for some time even as the price for crude comes down," the report said.

McKinsey calculated that Alberta oil sands bitumen face a cost disadvantage of $15 (U.S.) a barrel compared with other heavy blends in U.S. markets, while Canadian synthetic blends have a $20-a-barrel disadvantage.

Yesterday, Royal Dutch Shell PLC became the latest company to announce a delay when it said it would put off a planned expansion of its Athabasca oil sands project. Shell's decision is yet another sign that the industry's long-running boom in the oil sands - which helped drive Canadian employment and income growth - is quickly cooling off.

Shell, which announced a 22-per-cent jump in third-quarter profit to $8.45-billion,was driven more by higher costs than by lower prices.

"We had in mind to decide on the second expansion in 2009," chief executive officer Jeroen van der Veer told a conference call. "But at this moment, if you look at the combination of inflated labour costs and raw material prices in the form of equipment, we felt that we had better delay that."

Shell is completing an initial $12.8-billion (Canadian) expansion at Athabasca that will raise production to 250,00 barrels a day from 155,000 barrels, but will suspend future expansions until conditions economic conditions improve.

Faced with falling prices and rising costs, other companies have also deferred decisions on projects that had been in various stages of planning. But many, including Imperial Oil Ltd. and Suncor Energy Inc., are plowing ahead.

One vexing issue for companies as they confront their higher cost structure: Should they build new upgraders in Alberta to process the tarry bitumen into more valuable synthetic light crude, or ship the raw bitumen to U.S. refiners? The economic case for Canadian upgraders is looking increasingly weak because of the expansion of the U.S. capacity to refine oil sands bitumen, says the report from McKinsey.

Petro-Canada, and its partners Teck Cominco Ltd. and UTS Energy announced last week that they may delay construction of an upgrader near Edmonton. Norwegian firm StatoilHydro ASA pushed back a decision on a proposed upgrader by two years, while privately held Value Creation Inc. has delayed an upgrader project by three years.

Canada's exclusive reliance on U.S. markets for crude oil exports will continue to undermine the financial case for building upgraders in Alberta, McKinsey principal Jiri Maly said. It is critical, he said, for the Canadian industry to access Pacific Rim markets, including California and Asia, by means of new pipelines to the West Coast.

U.S. refiners have invested heavily in new processing capacity, including the ability to handle heavy oil, which is a growing proportion of exports from Venezuela, Mexico, Brazil and Canada.

Canadian upgraders are most profitable when there is a large price differential between the bitumen that is extracted from the ground, and synthetic crude oil that the upgraders produce, which is then refined into gasoline, diesel and other products.

But if Alberta producers upgrade at home, they will reduce the supply of raw bitumen flowing to the U.S. market, and that reduction in supply will drive up its price and squeeze the all-important spread between bitumen and synthetic crude.

"Upgraders in Alberta are extraordinarily capital intensive," Mr. Maly said. "And if you don't have long-term comfort that those margins will be strong, you're going to take another look at those projects, and perhaps look for alternative markets instead of processing your own bitumen."

Many major producers say they will continue to boost oil sands production, albeit at a slower pace for some. Imperial Oil, for one, remains bullish on its 100,000-barrel-a-day Kearl oil sands project.

While the company will make a final decision on whether to build Kearl next year, it has 200 employees and 1,000 contractors working on the project, and is already spending $2-million a day on development.

"Kearl is a very strong project ... even in today's price environment," Imperial chief financial officer Paul Smith said in an interview. "What you may see is that this economic downturn will play to lower construction costs and make it more efficient."

Canada's key advantage is security of access to the massive resource for international oil firms desperately struggling to replace reserves and denied access to reserves in countries like Mexico, Venezuela and the countries of the Middle East.

There are some signs that the global economic slowdown has started to ease cost pressures, particularly for steel, and analysts expect wage inflation in Western Canada to subside as companies cut their capital budgets.

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Oil sands delays

Royal Dutch Shell has postponed a planned 100,000-barrel-a-day expansion of its 155,000-b/d Athabasca oil sands mine, although it will complete an existing $12.8-billion 100,000-b/d mine expansion project. The postponement of the future expansion - part of Shell's long-term plans to increase the mine's output to 770,000 b/d - means the company will almost certainly delay plans to build a new upgrader.

Suncor has slowed construction of its $20.6-billion Voyageur oil sands project, delaying the completion date of its upgrader to 2013 from 2012. Voyageur will nearly double Suncor's output to 550,000 barrels a day when complete.

The consortium behind the $23.8-billion Fort Hills development, which includes Petro-Canada, Teck Cominco Ltd. and UTS Energy Corp., will likely delay building the upgrader part of that project as it seeks a cheaper way of getting crude to market. Fort Hills would produce 140,000 b/d from 2012.

The partners behind the Long Lake project, Nexen Inc. and OPTI Canada Ltd., have delayed a decision to expand that operation. The first phase of the $6.6-billion, 60,000-b/d Long Lake development has just been completed; five more similarly sized stages are planned, with the next expansion expected to be on line in 2014.

Value Creation Inc. has pushed back its proposed $5-billion upgrader by up to three years as it seeks a partner. The company is prioritizing the development of its oil sands extraction project.

Total SA pushed back the on-stream date of its Joslyn mine to 2014 from 2013 because of regulatory delays and outlook uncertainty. The project was originally expected to be in service by 2010, but has suffered repeated delays.

StatoilHydro, based in Norway, pushed its upgrader back to 2016 from 2014 because of potential regulatory issues relating to the sale of oil sands crude in the U.S