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(photo credit: Bloomberg)
Oil sands - alternative crude oil extraction is increasing. Big oil companies are in search of new oil reserves around the globe. Easily accessible reserves have already been discovered and extracted in many places.
After Saudi Arabia, Canada has the world's largest oil reserves but, instead of being in liquid form, these are in the form of oil sands - a mixture of quartz sand, clay, silt, water and bitumen. A ton of such oil sands yields 79.5 liters or a half barrel of clean oil, on average.
Alberta, Canada, has the world's second-largest oil reserves, extraction of which has only recently become economically viable. This means that Canada has larger oil reserves than Russia and Iraq together.
With extraction and refining costs of $18-$25 per barrel (159 liters), oil sands promised little in the way of profit until 2004/05. However, with the international price for crude oil now established well above the $25 mark, extraction of Canada's oil reserves has become viable.
Why invest in oil sands? With conventional oil reserves becoming scarcer and the sharp rise in oil prices, unconventional means of extracting fossil fuels are increasingly the focus of attention. Oil sands may, therefore, represent an extremely worthwhile investment. Numerous factors point to long-term positive performance in the oil sands sector.
Technological progress. With production costs currently at less than $20 a barrel and an international oil price of well over $40, the extraction of oil from oil sands is now highly profitable. Further advances in extraction technology could reduce operational costs to $10 a barrel in some cases. 1
Safe geopolitical situation. There are oil sand deposits all over the world. By far the largest are in Canada and Venezuela. However, large oil companies are likely to be very hesitant about investing in Venezuela as a result of political instability. Canada, on the other hand, offers political and economic stability. Furthermore, in Canada, all oil-producing companies in the oil sands sector are open to foreign investment compared to Russian or Arabian energy groups.
High levels of investment. The sharp rise in the oil price has led to an enormous level of activity in oil sands processing in Canada. The investment bank Lehman Brothers estimates that the Canadian industry will invest approximately C$85-C$90 billion in oil sands projects over the coming years. Shell Canada, for instance, has so far invested around US$4b. in the Athabasca Oil Sands Project. 2
One might ask why oil sands did not attract the attention of the international financial markets sooner. The answer is clear and simple: the average long-term oil price did not rise beyond $30 a barrel until the summer of 2005. If the oil price remains well above $40, a sharp increase in extraction from oil sands can be expected. This explains why such extraction has only recently become attractive.
Rising profits. Oil sands are not just a prospect for the future. The Canadian oil sands industry is largely well-established and already makes substantial profits.
What kind of companies should be considered for investment portfolios? Companies that are expected to generate a significant proportion of their earnings from products and services in connection with oil sands. This ensures that company policy is focused on oil sands. It means that large energy conglomerates that currently make their profits almost exclusively from conventional oil and gas extraction are excluded from consideration. Companies must have a market capitalization of C$500 million in order to avoid smaller companies, which usually have a higher share price volatility. Companies that are expected to extract at least 25,000 barrels a day until 2015. This will help to ensures the inclusion of companies that will be genuine blue chips of the oil sands industry in the medium term.
This article is not intended to be an investment recommendation. Before investing, speak with a professional adviser to determine whether investing in oil sands-related equities is appropriate for your investment portfolio.
1 Canadian Oil Sands: Development and future outlook, Eddy Isaacs, Ph.D. managing director Alberta Energy Research Institute.
2 FAZ.net 29.05.2006
The author is Global Investment Strategist at Tandem Capital.