Supply squeeze favours oil sands investments

(August 10, 2005) Despite some optimistic predictions to the contrary, the world is entering a long-term period of high oil prices, as world demand surges and production increases only gradually, according to one senior strategist.

“Over the last six years big oil has failed to replace their production,” says Donald Coxe, global portfolio strategist for BMO Financial Group and its Chicago-based affiliate, Harris Bank. “Despite this, last year oil companies made $100 billion, an unbelievable amount of money for this industry, the best year in history.”

In a recent conference call on energy, Coxe said 85% of the world’s major oil reservoirs are experiencing declining output. Despite official denials, many reports say Saudi Arabia’s oil fields are declining and North Sea production is expected to drop in two years time. Meanwhile, the world’s largest oil companies have until only recently failed to invest in exploration.

Coxe says those who dismiss the notion of peaking oil production are “wrong, wrong, wrong,” pointing out that any efforts to rejuvenate aging wells have proven to be stop-gap measures, many of which actually damage the well and decrease its life-time production.

As reliance on Middle Eastern oil has become ever more politically unpopular, the U.S. has sought to secure new sources of oil. Russia and Venezuela had been viewed as likely providers, but recent developments have not favoured U.S. access.

In Russia, the Kremlin has tightened its control over the industry, causing most U.S. firms to walk away. Venezuelan president Hugo Chavez has expressed a preference toward exporting to China, rather than the U.S.

With these sources all but shut off, the U.S. and its major oil companies seem to be realizing the Alberta oil sands may be their last option.

“Our theory has been that you invest on the basis of reserves in the ground in secure areas of the world,” said Coxe. “You don’t worry too much about current earnings or the price earnings ratio. You buy barrels of oil or millions of cubic feet of gas in the ground in secure areas of the world.

“The oil sands represent the largest commodity resource of any kind in the world that fits those criteria. You get more barrels of oil per share if you buy a Canadian oil sands trust than if you buy any oil company that’s headquartered in the United States or Europe or Australia.”

He says the estimates for the oil sands reserves range from 179 billion to 800 billion barrels, which can be developed with today’s economics. Some estimates even put the reserve as high as 1.6 trillion barrels.

“We believe there’s a good chance the International Monetary Fund is going to come out and announce that Alberta has two to three times as much oil as Saudi Arabia,” he says.

With interest growing in the oil sands, Coxe says the companies already operating in the area represent a ready-made investment opportunity. With no “cheap” oil in the foreseeable future — futures contracts as far out as 2009 predict $59 oil — these companies should be able to count on a steady revenue stream.

Another factor favouring oil sands investments are Canada’s demographics. With an aging population finding little real income from their bond portfolios, the highly profitable oil sands companies are in demand.

“If you own a stock such as Suncor or Canadian Oil Sands trust or one of these other oil sands companies then what’s going to happen is your income is going to rise faster than inflation,” he says, pointing out that even real return bonds are offering little in terms of income yield.

Given the massive potential reserves of the oil sands, these companies could operate well through the lifetime of anyone investing in them.

“If you live 50 or 90 years don’t worry about it; it’s going to keep on growing,” Coxe said. “If you take the leading US exploration and production companies, their reserve life indices are at the most 17 to 19 years. There’s just no comparison if you’re talking about reserves.”

Control of the oil sands will likely be hotly contested, Coxe said, pointing out that U.S. Treasury Secretary John Snow recently visited the area.

“I’m not aware that the writ of the Treasury Secretary expands to analyzing oil sands,” Coxe said. “My guess is that they’re going to really not let the Chinese come in if they’ve got an easy way around it.”

Filed by Steven Lamb, Advisor.ca, steven.lamb@advisor.rogers.com

(08/10/05)

Steven Lamb