Fabrice Taylor is a chartered financial analyst.
ftaylor@globeandmail.com
Alberta’s oil sands are commodity non grata. Their enemies are everywhere and multiplying. Even the mighty National Geographic paints a less-than-flattering portrait of the projects that strip energy from earth.
But who cares. Forget the media noise. The fact is we – the industrialized world, and particularly the United States – can’t afford to burden oils sands producers too much. Oil depletion is relentless, and the media remind us every day of why we don’t want to rely on the Middle East, or Africa, or Asia for that matter, for supplies. Oil sands are the only stable source that can increase production.
Not everyone believes that, judging from the behaviour of investors: Oil sands shares are cheap. Canadian Oil Sands Trust, COS.UN-T for example, is quoted at an enterprise value of less than three bucks per barrel of recoverable oil, according to BMO Nesbitt Burns – forget $55 (U.S.) a barrel. (Disclosure: I own COS.UN). If you believe in the thesis that oil prices are inevitably heading much higher in time, you should buy some cheap barrels in the ground in and around Fort McMurray, Alta.
Should you believe it? As mentioned in this space occasionally, we’re running out of cheap oil quickly. According to the International Energy Agency, production from big existing fields around the world is falling by almost 7 per cent a year. The rate of decline, more importantly, is getting faster.
Demand may be falling too, but not that much. And anyway, demand will start to grow again once the world’s economies recover. That will require more development. In fact, it requires more development today given the long lead times for getting new projects going. But no one feels up to it at $55 a barrel. In fact, expansion is on ice. In the meantime, the best assets – the ones with the lowest costs – are being aggressively exploited.
At what price will marginal projects be pursued? It appears to be a lot higher than today’s prevailing prices. Non-OPEC production actually fell from 2004 to 2008 even as prices surged. A big part of non-OPEC production is in the developed world. We have all the money and technology, but apparently we want better returns than $100 oil offers. So OPEC’s influence is only rising, and OPEC says a fair price is $75 a barrel. They’ll need more than that to keep their regimes going though.
So assuming you’re sold on the thesis, what makes for a recommendation of Canadian Oil Sands? First, it could produce for a century or more. Or it could ramp up production and produce for almost a century. The point is COS escapes the problem faced by so many other producers, especially trusts: replacing reserves. Some trusts have a mere 20 years of production. They’re on a treadmill and they can’t get off it.
Oil reserves are cheap now, but these trusts/companies can’t get credit or use their depressed shares. It’s a tough game, and few win. COS’s resource is so massive that it effectively doesn’t need to worry about it.
Another reason is that COS is run for oil bulls. The company doesn’t hedge, so you are fully exposed to oil prices. Investors may have wished the trust had locked in prices a year ago, but you can’t time these things. COS’s asset is a stake in Syncrude, which is run by Exxon, probably the best oil manager in the business.
Another selling feature: COS pays its excess cash to investors. We don’t worry much about poor capital allocation (although it can happen). The trust’s debt load is reasonable.
And finally, established marginal producers are the biggest winners when prices start to move. (As an aside, COS is arguably not as marginal as it seems. If you factor in the cost of its wars and subsidies, the United States pays a lot more than apparent for Middle East oil. This is not lost on the administration.)
Given how cheap COS and other oil sands producers are, this will sound like a contrarian argument, which can be dangerous. I see it more as an opportunity for “time arbitrage,” which is how most rich guys get rich. Most investors are traders – they don’t hold stocks for a long time. So ideas that pay off over the long term tend to go for cheap, especially if they have short-term problems, like low profits.
This looks like a classic example.
*****
By the numbers
Company Enterprise value/ Recoverable barrel of oil equivalent (U.S.) Canadian Oil Sands Trust $2.58 Canadian Natural Resources $3.79 Nexen $3.05 Suncor $2.07 Source: BMO Nesbitt Burns, as of April 30
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Tags: BMO, Canadian Natural Resources, Canadian Oil Sands Trust, COS.UN, Nexen, oil, oil sands, OPEC, Suncor