Back in 2003, after repeated urging from Don Coxe, the formerly great (but now irrelevant) visionary, we began following Canadian Oil Sands (OTCQX:COSWF)(COS.TO) which was then a Trust and now a Corporation.
We bought heavily. We also became investors in several Oil Sands companies, including Suncor, and actually visited the Oil Sands area - at one point a client was the 2nd largest shareholder in a nearby Oil Sands project. By the time we sold COS in 2008 the shares had peaked at over $60 and our cost basis, thanks to the fat dividend, was actually below $0. We like that.
However, we have never re-purchased COS and we suggest serious potential investors take a peek at this note as there appears to be some confusion:
1. Syncrude is bitumen. When an author writes "Syncrude does not suffer from a heavy discount that plagues Western Canadian oil or bitumen" it throws into question the entire analysis, for us at least, since (of course) Syncrude mines low-quality bitumen and then runs it through its $6 billion "upgrader", in order to produce a pure synthetic crude. This is a capital-intensive and very expensive process which explains why bitumen producers only get in the $50 per bbl. range.
2. COS is a high-cost producer. If there ever is a glaring 'red flag' in a company's presentation, it's when there exists not one single slide showing actual revenue and net earnings figures, anywhere. The company makes you dig for the numbers instead. In this regards, COS doesn't disappoint, using plenty of other 'stuff' highlighting its "compelling valuation to new mining projects".
Maybe we are a bit cynical, but that only tells us: "we'll go broke slower".
Dig a bit deeper and you will see, for example, that in 2005 net Revenues were $1.93 Billion and net Earnings $831 million (all in $C). Then, by 2012 net Revenues had jumped 91% to $3.7 Billion - thanks to much higher oil prices. So one would logically expect a commensurate increase in net Earnings, however, they came in at an underwhelming 15% increase to $957 million, a significant underperformance. With flat production, we would expect higher oil prices to mean higher profits. Reasonable?
What happened is that costs exploded. Yes, COS does benefit as they own a big-ticket "Upgrader" which adds value over the competition, and Syncrude does get near WTI pricing, which runs at about a $25 premium to bitumen. Yet overall, production costs are still very high.
The only per barrel cost hinted at in the COS presentation is a slide showing EBIT - at $105 oil - with costs running close to $70 per bbl. With COS stating they are seeking to go to $1.5 Billion in long-term debt by 2015, expect further increases in total per barrel cost. Our question is: if costs are going to drop after the big Capex program is completed, why wouldn't they highlight this in the presentation? It's not there.
3. WTI prices are going lower. We don't pretend to be oil price forecasters, but one reliable 'tell' of long-term price trends, over the years, has been the oil futures curve. Presently, while February WTI trades at $92, WTI 2 years out sells for $82, 3 years out at $78 and 5 years out it is at $75. There seems to be a trend here, one that does not favor folks expecting a continuation of COS's 7% dividend yield.
The shift in the WTI futures price curve began this past summer, and we believe it is a quantum, generational, shift brought on by the 'shale revolution'. Normally, WTI trades at a significant premium in the future - since someone wishing to purchase oil today, at a fixed price, but take delivery 5 years later, should reasonably expect to pay somebody to store all that oil. It varies, but we will say the premium usually runs around $15.
The significance being that 5 years from now, if the futures today are selling for $75, then the market is expecting spot WTI in 2018 to sell for $60.
If so, that's going to be a bit of a problem for COS and other high-cost producers. Nobody can say for sure, but "price is truth" and anyone considering an investment in COS had better look at the long-term fundamentals and pricing trends.
4. Old technology. While most newer shale producers have a chance to reduce costs via improved technology, COS is going to remain a mostly old-style open pit mine, mined by men with shovels and trucks, big ones indeed, but still capital and labor intensive, with few opportunities for major cost improvement. Since COS talks up their refining capacities, we think investors may be better off looking at them as a more-volatile refiner than a steady, long-life producer.
5. COS management has consistency over-promised but under-delivered. One of the nice things about getting older is you get a chance to look back over many years and see how a company's guidance works out. We have with COS and have spoken directly to management in the past. We have found them "disappointing".
This is, naturally, our subjective opinion, and perhaps this time it will be different, but then we are always reminded of the classic "Peanuts" gag where Lucy promises, but then pulls away the football from Charlie Brown. He never seems to learn. We try to.
Hey, I though oil was still near $100?
Final note. I predicted, back in 2003, that Warren Buffett would, one day, invest in the Oil Sands, reasoning such because of the 40-year plus reserve-life index. He finally did buy in 2013... but that was before the dramatic change in the oil futures curve. I would wait to see if he keeps buying.