Thought you all may like this article by Satnsberry and Associates posted in there March 2008 Oil Report.
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Canada's Untapped Oil Sands Province
By Matt Badiali
Big oil companies are about to dump the rest of the world to focus on Canada.
Maybe you've heard this story before, but this time it's not a prediction. It's a fact. It's happening... right now.
Let me explain. The global climate for oil exploration has undergone a huge change in the past five years. A wave of nationalization is going on across the globe. Major oil-producing countries – like Venezuela, Ecuador, Bolivia, and Indonesia now sit on unbelievable stores of wealth with oil at $100 a barrel... and they no longer allow Western oil companies to own reserves there. The Exxons and Chevrons of the world can produce the oil for a fee, but the right to sell it on the commodities market belongs to the country.
Consider Hugo Chavez. The big man of Latin America just stole billions of barrels of oil from a whole set of oil companies. ExxonMobil will spend hundreds of millions of dollars to take them to court – with little to show for its trouble even if it succeeds.
This wave of nationalism is a big hindrance to Big Oil's exploration efforts. Major oil companies take all the risk of exploring for oil... doing the geologic analysis, putting crews in the field, building camps and roads, and doing all the work that leads to the drill bit being put to ground. If they're wrong, they're left with nothing. But if they're right, they'll find a giant field that produces for years to come.
Nationalization changes that calculation entirely. Companies still take all the risk, and governments bank all the rewards.
Also, as an oil company, the market values you on your reserves. When a country takes away your reserves, it reduces the value of the company. In addition, the country controls the ability to pump that oil, and essentially the cash flow. In the end, the company is little more than a glorified salesman for the country.
At the same time major oil companies are relinquishing some of their promising oil fields, demand for that oil is rising... relentlessly.
China plans to build at least eight 200,000 barrel per day refineries in the next five years. That increased demand in China, about 1.4 million barrels per day by 2010, will compete with the U.S. refiners for supply. Interestingly, China's new refineries will specifically target heavy, sour crude, not the conventional light, sweet crude that is easier to refine and sets the benchmark for petroleum prices around the world.
Now much of the world – and its oil companies – turn to Canada for a solution. Canada holds some of the world's largest untapped oil reserves. It's in the most politically stable region of the world. It's protected by the world's greatest military power.
Even better, Canada still lets oil companies enjoy the rewards for taking risks. And the risks are low – the oil is easy to find. It's not like drilling through a mile of ocean and two miles of sediments... You only need to drill down about 500 feet... roughly a 50-story office building.
Canada is already the U.S.'s favorite oil supplier. We buy nearly 18% of our crude oil imports from Canada. In fact, by the end of 2007, Canada supplied more oil to the U.S. than all the Persian Gulf states combined.
Until recently, the industry's attention had been focused on Alberta, Canada, home of the famous Athabasca tar sands. However, the opportunities there are increasingly scarce for us as investors. The major players there – Suncore, Nexen, Shell – are well known and well covered. Plus, the Alberta government increasing its tax burdens on oil producers.
For the purposes of this report, we're not interested in Alberta. Instead, I want you to invest in a much cheaper alternative to Alberta. It shares Alberta's oil-rich geology, but has a much milder tax regime. I believe you need to invest in the next oil-sands boom that will take place in Alberta's neighbor to the east: Saskatchewan.
Saskatchewan is already Canada's second-largest oil producing province. It's home of the region's largest bitumen treatment plant, the Lloydminster Upgrader. And it has a tremendous network of pipes and infrastructure to support further development.
As I'll explain, the oil companies are waking up to the advantages of exploring Saskatchewan... but we'll beat them to it. I've found one company that has the most advanced oil-sands project in Saskatchewan. In addition, it controls vast swaths of oil-rich property – about 750,000 acres of oil-sand leases... That's why I call it "The Landlord of Saskatchewan."
Best of all, this company is small and it's cheap... which gives us the potential to make hundreds of percent as the rest of the world catches on to the Saskatchewan story. Investing in this company today allows you to buy up to 1.34 billion barrels of bitumen at 58¢ barrel – at time that bitumen trades on the open market for $45 a barrel.
As you'll learn, this is likely the safest, highest-upside investment in energy right now...
Why Saskatchewan Oil Sands Are Attractive
Two factors made Alberta the prime target when oil companies initially went looking for tar-sands projects. First, the province's bitumen is easier to access than Saskatchewan's. Let me explain...
Oil-sands bitumen has the consistency of Crisco. So, as you can imagine, you can't simply plunge a well pipe into a deposit and pull it out like you can with crude oil. You either mine the tar sands or you must heat it in the ground – essentially melting it – and then pump out the liquified bitumen.
Mining is easier and cheaper. And most Alberta deposits led themselves to mining. Saskatchewan fields don't accommodate mining as well, and require the heat-and-pump method (in the industry it's called in situ production).
Taxes were the second reason Alberta was the initial hot spot for oil-sands projects... Back when oil was $15 per barrel, Alberta set up a royalty system that rewarded companies for exploring the region and developing the oil sands. Alberta levied a 1% royalty on oil production until the company recouped its capital investment, then 25% afterward.
But times have changed and that's leading oil companies to de-emphasize Alberta in favor of its eastern neighbor...
You see, as oil prices roared past $50 to about $100 a barrel and oil-company revenues started to swell, Alberta's government decided it needed a bigger share of the wealth – shades of Hugo Chavez.
Alberta's premier decided to change the system. Beginning in 2009, Alberta will operate under a new royalty regime that upends the former incentive system...
The province will claim royalties up to 50% of production. The changes make Saskatchewan's royalty program look positively libertarian by comparison.
Alberta 2009 Rates
Saskatchewan Maximum Rates
Natural Gas
Rates up to 50%
Ramps up to ~28%
Oil Sand
Ramps up to 40%
Ramps up to ~29%
Conventional Oil
Ramps up to 50%
Ramps up to ~31%
And that is pushing companies into Saskatchewan.
What about the in situ hurdle? Of course, nothing will change the geography of Saskatchewan to make mining more feasible. However, oil companies continue improving the technology to make it more efficient – for instance, using dual pumping equipment so steam heating can continue without disrupting bitumen extraction. And that shift in Alberta's tax structure more than makes up the difference.
As I said, this migration from Alberta to Saskatchewan is happening now. Here's what I'm talking about...
The province periodically auctions off sections of publicly held land to oil companies looking to explore the region. The most recent sale, in February 2008, raised $197 million, more than doubling the old record of $85 million set in 1994. The average price per acre was nearly $1,000, well above the old record of $606.
In fact, 2007 broke all the records for land sales. Saskatchewan booked $419 million in 2007 land sales, again more than doubling the previous record of $202 million from 1994.
I've found one company that's beaten the industry to Saskatchewan. I call it the Landlord of Saskatchewan because it controls broad tracts of oil sands. It bought those acres when no one else wanted them, and now the value of the property – and the company – is about to skyrocket. Plus, it has the most advanced bitumen project in the province.
Prime Tar-Sand Acreage for 13% of the Cost
Oilsands Quest (AMEX: BQI), the Landlord of Saskatchewan, is an $854 million oil exploration company. An investment today in Oilsands Quest should make us triple figures through several scenarios.
Oilsands Quest is strictly an exploration company. It doesn't produce any oil, and it's not trying to be the next ExxonMobil. Instead, the company is focused exclusively on discovering new tar-sand deposits and evaluating its assets. The company wants a deep-pocketed partner to develop the site.
If that happens, a best-case scenario nets us nearly 500% with very little waiting.
Oilsands Quest owns 618,000 acres in the Lloydminster area of Saskatchewan. The average value of that land in the last sale was $132 an acre. Comparable land in Alberta sells for about $1,000 an acre. I expect the prime Saskatchewan oil sand to come up to Alberta prices. As I said, the geology is very similar.
The company holds a total of 750,000 acres of oil-sand leases between Alberta and Saskatchewan. If the average price of the acreage is $300 per acre, then the company has a third of its market value in the land alone.
If the acreage is valued at Alberta prices, then 77% of the company's market value is in the land alone... without the underlying oil taken into account.
I think that's significantly undervalued, and we'll make some money on that.
Oilsands Quest's primary asset is the Axe Lake project. The size of the project's resource grew exponentially since exploration began. The current best-case estimate by resource engineers is 1.34 billion barrels of bitumen. To put that in perspective, EOG resources has about that much oil equivalent in proven reserves... but a $30 billion market value.
So once Oilsands Quest converts that resource to reserves, we will see a significant increase in market value. However, that resource isn't the whole story. As you can see from the map below, the resource is only a small fraction of the company's total land package.
The management estimates those lands hold about 10 billion barrels of bitumen resource. I think that's probably true, but we'll treat it as "blue sky" in the analysis – in other words the potential is untested, so we don't want to pay for it. However, the company continues to explore and drill, so we could see the benefit down the road.
In the end, we're buying the actual best-case reserves for 58¢ per barrel, and we get the blue sky for free.
What Is Tar Sand Worth, Really?
It takes about 1.25 barrels of bitumen to make one barrel of oil. That means we are actually getting 80% of the resource of standard crude oil. So we're really paying 73¢ per barrel.
Remember, bitumen is really crappy oil. It's much harder and more costly to refine than light, sweet west Texas crude. Pure oil-sand producers must sell the bitumen to an upgrader, which turns it into useable oil. A recent economic evaluation of Canada's tar sands estimated that the bitumen price would be 45% of the benchmark oil price.
That means, if the oil price is $70 per barrel, each barrel of bitumen is worth $31.50. At 73¢ per barrel, we're still buying the resource for about 2% of the selling price. That price is so low, it should put a floor under our investment.
And the price will increase as the company progresses on the project.
Look at Opti-Canada (TSX V: OPC) for example. Opti-Canada is an Alberta-based company developing Alberta's next big oil-sand project, called Long Lake. Opti partnered with Nexen to build the giant project, which will produce 72,000 barrels of bitumen per day.
The SEC Could Make You Rich – All
You Need To Do is Own Tar Sands
Under current rules, publicly listed natural-resource companies trading on U.S. exchanges can’t record unconventional reserves (like tar sand). In other words, when you see the official proven reserve numbers, they include no bitumen reserves.
The market values most resource on their reserves, so that rule has put a significant damper on investment in the tar sands. U.S. companies are reluctant to acquire reserves there… if their market values can’t reflect the value of those assets.
But the SEC may soon allow companies to book those reserves. That would be a major change. When it happens, you won’t find bitumen reserves selling at 1% or 2% of the market price as they do now. You’ll see reserve prices leap to 20% or more of the market prices.
Here’s what that means to investors. Imagine a $1 billion company has 100 million barrels of unbooked bitumen reserves. The industry would probably set a value of only about $300 million on those reserves. As soon as the SEC changes the rules, suddenly those reserves would be worth $6 per barrel – that’s a 30% gain for the company and its shareholders.
Now lets think up another scenario. Say you are a cash-rich major oil company that needs to pad its reserve replacement. You could spend hundreds of millions of dollars drilling a few wells in the deep Gulf of Mexico. Or you could spend that money buying a few hundred million barrels of bitumen in Canada.
If the SEC passes these new rules, oil companies and the market are going to look at Canadian tar sands like debutantes look at breast implants. We all know its padding, but it sure looks good in the mirror.
Right now, investors are buying Opti-Canada's bitumen for $1.33 per barrel of resource. Oilsands Quest is about a 12 to 18 months behind Opti-Canada. I think we'll see Oilsands Quest's resource hit a comparable value. That means we should see about an 82% gain over the next year and a half.
Oilsands Quest's share price recently bounced off a 52-week low at $3.21 twice, which I think represents a hard bottom in the share price. In fact, the share price is supported by $2.35 per share of book value (that's equipment, land value, etc...). The share price is currently $3.85. That means we're risking about 16% downside to make 300%+ upside.
That's exactly the kind of deal we want, but rarely find. In addition, we can look for a nice gain in the short term.
The history of the company is a little different than most. It basically backed into being publicly traded entity. Oilsands Quest was a private company doing exactly what it does now. However, in October 2006, CanWest Petroleum, which was a publicly traded company, bought Oilsands Quest.
The combined companies went public on the American Stock Exchange under the symbol BQI. By the end of 2006, the company changed its name from CanWest to Oilsands Quest.
Also note: Oilsands Quest wants to initiate in 2008 a duel listing on the Toronto Stock Exchange. That may seem insignificant. But given the success of Canadian companies that listed on the AMEX after being public on the TSX, I think we'll receive an immediate 5% gain.
Our Best Case Exit Strategy Could
Give Us a 400%+ Gain
July 2007, Marathon Oil (NYSE: MRO) agreed to buy Western Oil Sands for $6.3 billion. At the time, I said I thought it was a good move for Marathon. I still think so. In fact, as oil prices hit all-time highs, it looks like Marathon's timing was perfect.
That deal worked out to $3 per resource barrel of bitumen.
If a company bought Oilsands Quest for $3 per barrel, investors would make between 328% and 492%, depending the estimated size of its resource. That's at $3 per barrel of bitumen resource... I think prices are going to come up.
In addition, a series of milestones should add value to our investment in Oilsands Quest, while we wait for a buyout and the huge payday.
First is a partnership for Axe Lake. The company wants to find a partner in 2008 to build Axe Lake.
Oilsands Quest currently has no debt. In fact, the company has about $36 million in cash. A cash-rich partner would be a tremendous asset to the company. It would eliminate the need to take on a huge debt to build the project.
That's the management's current plan, and I'm all for it. That would bring us one step closer to production, which would add value to the bitumen resource.
Action to take: Buy Oilsands Quest (AMEX: BQI) up to $4.75 and use a 30% trailing stop.
Published by Stansberry & Associates Investment Research
1217 St. Paul Street, Baltimore, MD 21202 888-261-2693
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