Canadian Oil Sands Stocks Take a Hit, Recovery Uncertain

Canadian Oil-Sands stocks took a hit in Wednesday's trading. Shell Canada Ltd. said on Wednesday that its C$7.3 billion Athabasca Oil Sands Project [AOSP] expansion in northern Alberta faced big expense overruns. AOSP is a joint venture between Shell Canada Ltd. (60%), Chevron Canada Ltd. (20%) and Western Oil Sands Inc. (20%).

The design of this partnership was deliberated as follows: Shell holds the leases, Shell and ChevronTexaco share the upgrading expertise and knowledge of refining, and Western provides the mining and extraction skills.

Shell Canada did not give a target for overruns. Western said late on Wednesday that a planned expansion of the mine and upgrading refinery could cost close to C$11 billion, 50 percent more than estimated just a year ago.

Brian Straub, Shell Canada's senior vice-president, said in a statement:

We see signs of a heated market for labor, materials and equipment everywhere and we must assure ourselves that we can execute successfully. Right now our focus is on mitigating the costs and risks.

Western Oil Sands Inc. -11.9%
UTS Energy Corp. -10.2%
Synenco Energy Inc. -10.2%
Connacher Oil & Gas Ltd. -5.3%
OPTI Canada Inc. -4.3%
Canadian Natural Resources Ltd (CNQ) -4.1%
Canadian Oil Sands Trust -3.7%
Nexen Inc. (NXY) -2.0%
Suncor Energy Inc. (SU) -1.0%
Husky Energy Inc. -1.0%
Petro-Canada +0.2%

The list above clearly shows that diversified companies like Suncor Energy, Husky Energy and Petro-Canada were not as hard hit as the pure Oil-Sands companies like Western Oil Sands, UTS Energy, Synenco Energy, Connacher Oil & Gas, OPTI Canada and Canadian Oil Sands Trust.

The reason several of the companies included above have faltered is that several press releases about the cost overruns of major expansion projects of oil-sands companies have been published in the last 3 months. As noted earlier, Western Oil Sands recently announced that the planned expansion of the mine and upgrading refinery could cost close to C$11 billion, 50 percent more than estimated just a year ago.

Syncrude Canada, the world's largest producer of synthetic crude oil, also reported billions of overruns in the expansion of its oil-sands project. And UTS Energy already reported on April 20th that upgrading refinery for the C$10 billion Fort Hills oil-sands project could be 70 percent larger than first planned. Beside these cost overruns, Syncrude also reported delays in its expansion plan.

As it can be seen from the weekly chart of 10 oil-sands stocks below, the impressive rise in Canadian oil-sands stocks started in July 2003. Another oil-sands stock index is the Oil Sands Sector Index published by Sustainable Wealth Management.

Western Oil Sands Inc.
UTS Energy Corp.
Connacher Oil & Gas Ltd.
OPTI Canada Inc.
Canadian Natural Resources Ltd. (CNQ)
Canadian Oil Sands Trust
Nexen Inc. (NXY)
Suncor Energy Inc. (SU)
Husky Energy Inc.
Petro-Canada

The following chart tracks the 10 Canadian oil-sand stocks listed here.

(click to enlarge)

These 10 oil-sands stocks gained from July 2003 until April 2006 an impressive 370%. During the run-up to these high levels the industry sector had 4 consolidations. The first consolidation base was between October 2004 and February 2005 in which the sector lost -12% from its high in October to its low in November. The second one lasted from April 2005 until June 2005 with a correction of -14%. The third base was built between September 2005 and January 2006, which had a magnitude from the high in September to the low in October of -23%. The sector showed healthy breakouts of all these three consolidation phases. However, the breakout attempt out of the 4th base, which was formed between February 2006 and April 2006 (-16%) can be clearly classified as a breakout failure. The recent slump in Canadian oil-sands stocks was at the same time as all stock markets around the world began to give back some of their gains of the last three years. The loss from the high in April to the low in June amounts to 23%.

The first indication of a possible end of the up-move was given by the announcement of the launch of the Oil-Sands Sector Fund from MarklandStreet in February 2006, which began trading on March 15th. This announcement clearly indicated that this sector was hot and too crowded.

In addition to the rising projected capital costs, S&P also pays close attention to rising labor costs to get a more specific fix on the part labor plays in cost inflation. Michelle Dathorne, S&P’s director of utilities, energy and project finance, said that although the long-term credit profiles for oil-sands developers have strong potential, the near-term costs are a source of “very real concern” from S&P’s perspective and could put stress on balance sheets.

As oil-sands companies are facing higher costs for their projects, it is possible, even likely, that the Canadian oil-sands stocks will form a large consolidation base which could last from several months to a few years, as these huge projects devour more money than previously thought. However, the long-term outlook for oil-sands stocks remains positive, as they have the lowest geopolitical risk in contrast to other world-wide oil resorts. Given the currently high oil price, it is possible that the cost overruns will be compensated by higher profits from the sale of oil. However, the future return on investments from these projects will be lower than previously estimated as the costs have risen.