The Rising Influence of Rising Affluence

[DewDiligence]

Seeking Stability in the Oilsands

[This overview of the Canadian oilsands in the current issue of Barron’s does not mention what I consider the main risk of such investments, which is the likelihood of sharply higher taxes at some point down the line. See #msg-50493687, #msg-47509876, #msg-52158963, #msg-57938375, #msg-47103702, #msg-48659511, and #msg-51440253 for related stories. Comments?]

http://online.barrons.com/article/SB50001424052970204309104576118431631498172.html

›FEBRUARY 5, 2011
By ANDREW BARY

The turmoil in Egypt highlights the Mideast's volatility and the allure of Canada's oil sands, the vast crude reserves in Alberta, second in size only to Saudi Arabia's.

The oil-sands operators now look especially attractive, given high petroleum prices—$90 barrel in the U.S. and $100 in Europe. Commodity bulls may want some exposure because the oil sands are in a politically safe nation and offer reserve lives of 50 to 100 years.

There are many investment plays, ranging from notables Suncor (ticker: SU) and Canadian Natural Resources (CNQ) to lesser-known Canadian Oil Sands (COSWF), Cenovus (CVE), and Imperial Oil (IMO). And there are more speculative development plays traded mainly in Canada, including Athabasca Oil Sands (ATH.Canada) and MEG Energy (MEG.Canada).

These stocks trade at higher multiples of earnings and cash flow than international oils and American exploration outfits, such as Apache (APA), but they're probably worth that premium, thanks to their hefty reserves. Additionally, many oil-sands producers aim to significantly raise their output by 2020—the entire region now produces more than one million barrels per day. That's a big plus at a time when the energy majors are struggling to boost production.

The stocks have moved up in recent months, but many still look reasonable and trade well below their 2008 peaks.

"There's a lot more certainty with Suncor's profitability a decade from now than there is with any of the major oil companies," says Stephen Richardson, an oil analyst at Morgan Stanley, who is bullish on the stock, which trades at 42, or 14 times his estimated 2011 profits.

Says Brian Dutton, a Credit Suisse analyst in Toronto who favors Suncor and Cenovus: "These companies are managing their businesses with projects that last 30 to 50 years, not for the short term. The stocks are really investments, rather than simply trading vehicles for oil prices."

The stocks' oil-sands exposure varies. Suncor gets more than half of its daily 600,000-barrel production from them, and aims to boost total output to a million barrels by 2020, almost entirely from oil-sands expansion. Canadian Natural Resources' output is 15% oil sands; while Cenovus is at 25%, and Imperial Oil stands at 75%.

Canadian Oil Sands is the only sizable pure play, through its 36.7% ownership of Syncrude, an oil-sands partnership that includes Imperial Oil (25%), Suncor (12%) and China's Sinopec (9%).

There are some negatives, of course. [The obvious risk that isn’t mentioned here is higher taxes.] Environmentalists dislike oil-sands technology because it is energy- and water-intensive. They claim it is turning the oil-sands region into a wasteland with strip mines and toxic-waste ponds. But they aren't likely to derail the projects, given political and business support in Canada.

Oil-sands production costs $30 to $40 a barrel—two to three times the cost of conventional crude extraction [that’s the actual cash cost, not the accounting cost including DDA]—and capital costs are steep; new integrated facilities cost about $100,000 per barrel of capacity. And turning the tar-like substance called bitumen into crude poses operational challenges, especially when temperatures plunge to minus-40. Last month, a fire shut Canadian Natural Resources' Horizon facility, which produces 110,000 barrels of crude per day. It could be months before full production resumes.

Syncrude's output—an average 293,000 barrels a day in 2010—has consistently run below its 350,000-barrel capacity. That, along with high maintenance spending and a reduced dividend, has hurt Canadian Oil Sands, which, at $29, now yields 2.8%.

But most of the world's major energy companies are involved in the oil sands, including ExxonMobil (XOM), Royal Dutch Shell (RDSA) and Total (TOT). Chinese energy companies also are active. Last year, Sinopec paid a premium for a stake in ConocoPhillips' Syncrude interest. Canada is increasingly unreceptive to foreign ownership of key resource companies, having blocked BHP Billiton's (BHP) attempt to buy Potash (POT). But the foreign interest underscores the promise of one of the few regions that could be producing crude for another 100 years.‹