The global financial and economic meltdown caused new development of the Canadian oil sands to a virtual standstill. By late October 2008 the per-barrel price of crude oil had fallen to the mid-60s from the mid-140s. Black gold peaked in July 2008, a couple months before Lehman Brothers imploded and nearly sucked the global financial system into the abyss, then hit a cycle low below USD34 in early December 2008.
Much of the selling in the futures market was based on panic, exactly like that which gripped investors ran from equities and any other instrument that connoted any sort of risk whatsoever. Nevertheless, despite the long-term structural argument in favor of higher prices, crude cratered; operators in the sands cut back spending plans for 2009 and adjusted project schedules to account for new methods of financing.
Many projects were cancelled outright, while others were simply delayed. No wonder: Producing oil from the sands is expensive in terms of operating costs--about USD35 per barrel. Obviously, oil has to stay above a certain level consistently and predictably for sands production to be economic.
But here in early 2010 several factors suggest we’ve entered a “new normal” for oil prices, a neighborhood above USD60 per barrel. One of the clear outcomes of the Great Recession is that the global demand profile has changed; emerging economies, led by China and India, will burn more and more fossil fuels as their consumers, too, feed the desires that come with rising incomes.
On the supply side, easy-to-access, easy-to-produce--and therefore cheap--reserves are depleting rapidly. Failure to prepare leaves the oil-intensive US economy, in particular, vulnerable to future supply and price shocks that create short-term profits for producers but long-term turmoil for the broader economy. Unconventional sources are of greater and greater strategic importance, and the vast Canadian oil sands--at 172 billion barrels second only to Saudi Arabia in terms of estimated reserves--are located right next door to the world’s biggest oil consumer.
In addition, although still high compared to conventional production, oil sands operating costs have come down from 2006 levels. And costs of credit have also come down significantly from late 2008, early 2009 levels. Companies are planning now to meet anticipated demand as the global economic recovery takes hold.
Producers are only slowly acknowledging plans to boost spending in oil sands assets. But if oil stays above USD60 through 2010--and this is as close to lead-pipe certainty as you’ll get in the market these days assuming we’re not headed for the increasingly unlikely (and historically anomalous) double-dip recession--look for Suncor Energy (TSX: SU, NYSE: SU) to kick-start the ambitious Fort Hills project it owns by virtue of its August 2009 acquisition of Petro-Canada.
Our favorite way to play the Canadian oil sands is through Pembina Pipeline Income Fund (TSX: PIF-U, OTC: PMBIF), the pipeline operator with an exclusive contract to service the 360,000-barrels per day Syncrude project.
Exhortation and Harmonization
The oil sands are fixed in the North American energy supply equation. It’s the source of 1.2 million barrels of crude per day, most of which is exported to the US. Extracting and processing bitumen from the sands is an energy-intensive process that requires both electricity and steam, which are usually generated by burning fossil fuels.
This energy intensity and related emissions--as well as the massive and ugly footprint oil sands operations leave on the natural landscape--have raised concerns about the management of the resource at the activist level, of course, but also now at the official level.
The Conservative government in Ottawa rightly understands the oil sands as a vitally important economic and strategic resource; no other country among the G-7 has a comparable asset.
In fact, Environment Minister Jim Prentice used almost those exact words in recent talk in Alberta: “The oil sands is an important strategic resource,” noted Canadian Environment Minister Jim Prentice to a group of reporters following his appearance at the University of Calgary’s School of Public Policy. “No other industrial democracy in the world has an asset that is similar to that and there certainly is no asset similar to that in the United States.”
That hasn’t stopped officials from essentially telling oil sands producers to clean up their act. “For those of you who doubt that the government of Canada lacks either the willingness or the authority to protect our national interests as a ‘clean energy superpower,’ think again,” said Prentice to a meeting of business leaders in Calgary. “We do and we will. And in our efforts we will expect and we will secure the co-operation of those private interests which are developing the oil sands. Consider it a responsibility that accompanies the right to develop these valuable Canadian resources.
“How we manage environmental issues post-Copenhagen will define Canada’s future and our reputation on the international stage.”
And as he exhorted the private sector to basically tell a better story Prentice provided real help by saying Canada wouldn’t adopt its own climate change legislation until the US passes a bill. This suggests any government approach to oil sands and emissions reductions will involve incentives for research and development as opposed to punitive levies.
In recent public remarks Prentice has repeatedly used the word “harmonization” to describe the Conservative government’s approach to the global warming issue. In fact, Canada submitted its carbon-emission-reduction goal on time and as politely requested by the Copenhagen Accord. With its commitment, our neighbors up north also announced their approach to climate change: “Canada’s emissions reduction target for 2020 will be aligned with the emissions target and base year of the United States.”
What this means functionally is still probably at least many months off, so Conservatives have extended the game; what it means symbolically is that Canada has committed to reducing carbon emissions 17 percent below 2005 levels by 2020, a downgrade--at least in the eyes of environmentalists--from the 20 percent from 2006 levels by 2020.
A US climate bill in 2010 will be a tough slog, one, most observers predict, Congressional Democrats will shy from rather than arm their Republican opponents with more “big government” ammo--on top of the health care stockpile--ahead of November’s midterm elections. In the budget presented Monday by President Obama, USD646 billion in revenue from a cap-and-trade system has been dropped, an indication of lack of confidence in Congress’ ability to pass a bill with such a system.
The wildcard here is the Environmental Protection Agency, which is on course to unilaterally impose CO2 limits if Congress doesn’t act. This has prompted some swing Democrats in the Senate to re-think positions on cap-and-trade, and Republicans as well are thinking about striking deals. The choice here isn’t “doing nothing” and “doing something.” It’s “doing something” or having the EPA do it for them.
However the US politics shake out, the current Canadian government has sent a strong signal that oil sands production will be front-and-center in any consideration of federal and continent-wide energy policy.
Curious about the Canadian oil sands story? Join Roger Conrad in sunny San Diego, California, April 23-24 for the 2010 Wealth Society Member Summit. You’ll have a chance to sit down with Roger one-on-one to talk about where to find the best ideas to generate total returns as Canadian income trusts convert to high-yielding corporations and how to position your portfolio for the year ahead.
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Roger Conrad is Editor of Candadian Edge, Utility Forecaster, Chief Strategist of Portfolio2020, and Co-Editor of MLP Profits.
Disclosure: "No Positions"