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The Canadian Oil Sands: Unconventional Energy Attracts Asian Investment

By David Dittman on October 4, 2011

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Someday the world won’t be dependent on carbon-based energy. Nobody knows what this future will look like, though it’s pretty clear that it’s a long way off. One study, which evaluated the ability of markets to predict innovation and subsequent product development, pegged the time when renewables will power the globe at or around 2141.

The US Energy Information Administration’s (EIA) International Energy Outlook (IEO) for 2011 provided a slightly more concrete forecast: The world will still depend for about 79 percent of its energy demands on good old fossil fuels in 2035. And despite generally rising oil prices, global petroleum use is expected to be stronger over the next two decades than forecast in the 2010 version of the IEO. Oil demand will grow to 112.2 million barrels per day in 2035, 1.4 percent higher than the EIA thought a year ago. World energy use will increase by 53 percent by 2035, led by China, India and other developing nations.

Global petroleum consumption could rise by 26.9 million barrels per day by 2035, with conventional oil production meeting less than half of this growth, at 11.5 million barrels per day. Here’s a key point that at least one Wall Street brokerage and one Chinese state-owned oil company executive have certainly zeroed in on: Production of “unconventional sources of liquid fuels” is forecast to increase to 13.1 million barrels per day in 2035 from 3.9 million in 2008.

“Unconventional sources of liquid fuels” includes the Canadian oil sands.

The Canadian Oil Sands: China Sees Value

Five companies in the Canadian Edge How They Rate coverage universe have been named by Hong Kong-based Sanford C. Bernstein analysts as potential acquisition targets for growth-focused, Asia-based oil companies. The basic angle of the research report: Long-term money is hunting for solid energy producers that are cheaper than the market realizes right now.

Rule No. 1 when staking out any positions based on takeover appeal: Never buy stock in a company you wouldn’t own if there’s no deal at all. If you focus on quality and value–within the context of a diversified overall portfolio–you won’t get burned in the long run.

That being said, a number of Canada-based companies with exposure to the oil sands figure prominently in the report; included in Bernstein’s list of potential targets of Asian capital are Athabasca Oil Sands Corp (TSX: ATH, OTC: ATHOF), Canadian Oil Sands Ltd (TSX: COS, OTC: COSWF), Cenovus Energy Inc (TSX: CVE, NYSE: CVE), MEG Energy Corp (TSX: MEG, OTC: MEGEF) and Nexen Inc (TSX: NXY, NYSE: NXY).

According to Bernstein’s research Canadian oil sands companies and Canada-based E&P firms have relatively low exploration premiums, and they’re cheaper on a reserves-per-barrel-of-oil-equivalent basis. Canada is also a relatively easy place for Asian oil companies to do business. The political climate in the US, where the Senate is currently debating an antagonistic Chinese currency bill, prohibits Middle Kingdom investment in shale deposits made recoverable by new drilling technologies. Australia, despite thorny regulations when it comes to foreign purchases of energy assets, could become a focal point based on recent offshore and onshore natural gas discoveries.

Bernstein posits that Asia-based companies will look for “farm-in” deals on particular assets, a balance that recognizes the complexity and long-term costs of some of these potential projects as well as the political realities that may confront an attempt at a larger-scale, wholesale takeover. On this basis Athabasca Oil Sands, which owns leases and permits on 1,570,000 acres in the region that gives the company its name, makes an attractive candidate. It already has a state-controlled, China-based joint venture (JV) partner, PetroChina Company Ltd (NYSE: PTR) and it’s trading at just 1.33 times book value. The biggest initial public offering (IPO) in Canada since 1999 when it debuted on the Toronto Stock Exchange (TSX) in 2010, Athabasca’s 33 percent first-month slide made it the worst-performing new issue since 2007.

But the company controls an estimated 114 million barrels of probable reserves and about 8.6 billion barrels of potentially recoverable oil. Athabasca sold 60 percent of two major assets to PetroChina in 2009, a deal that included mutual put/call options that were designed to protect the smaller Canadian player against any attempts to push it around by the enormous state-controlled company and to provide China’s biggest government-run oil outfit a way out if it got cold feet in its first oil sands venture.

The structure of the Athabasca/PetroChina joint venture allows Athabasca to sell its remaining 40 percent interest to PetroChina in each of the two subject projects, MacKay and Dover, for CAD1 per barrel of contingent resource. PetroChina can buy the interests for the same amount. The options are exercisable within 30 days of regulatory approval on the projects; MacKay is on course for regulatory approval sometime in November, meaning the JV partners will have decisions to make. Dover will come due in 2012.

If both options are exercised by either party, PetroChina will take over the remaining 40 percent of the two projects for an estimated CAD2 billion. PetroChina will control one of the most potentially prolific SAGD operations in Canada.

Industry Canada approved the mutual put/call arrangement as part of its original ratification of the Athabasca/PetroChina JV in 2009. Relatively friendly relations between the two companies suggest their partnership will continue. The important implication is that this could be groundwork for deals involving other names on Bernstein’s list, including those under How They Rate coverage.

Allowing foreign buyers to increase positions over time without further regulatory scrutiny will make Canada even more attractive to Chinese buyers than it already is.

The Canadian Oil Sands: Takeover Targets

Canadian Oil Sands owns 39.7 percent of the Syncrude joint venture, which includes Exxon Mobil (NYSE: XOM) through Imperial Oil (TSX: IMO, AMEX: IMO), Suncor Energy Inc (TSX: SU, NYSE: SU) and the aforementioned Nexen, which owns 7 percent of the project. Also involved, with a 9 percent stake, is China Petroleum & Chemical Corp Ltd (NYSE: SNP), better known as Sinopec and a subsidiary of state-owned Sinopec Group.

Production at Syncrude, which is always jagged, declined by 28 percent in September to 240,100 barrels per day from 331,500 in August. The stock has slumped from a high above CAD33 in mid-April to below CAD19 as of this writing, as much if not more because of falling crude oil prices. At 2.21 times book it’s more expensive than Athabasca Oil Sands. Canadian Oil Sands does, however, pay a dividend and currently yields more than 6 percent.   

Cenovus was split off from Encana Corp (TSX: ECA, NYSE: ECA) in 2009 to hold oil assets that belonged to PanCanadian Energy Corp and Alberta Energy Company, the two companies that merged to form the original Encana in 2002. Its operations include SAGD oil sands projects at Foster Creek and Christina Lake. Struggling to fund ambitious expansion plans at those projects, Cenovus would welcome participation in a JV.

MEG has only a little more than 12 months as a publicly traded company but years of efficient and innovative production history behind it. It also has the backing of CNOOC Ltd (NYSE: CEO), China’s third-largest oil and natural gas company. CNOOC bought 17 percent of MEG for CAD150 million in April 2005.

MEG is producing slightly above design capacity with a steam-to-oil ratio (SOR) slightly lower than the design forecast. MEG is among the most efficient SAGD producers around. Though it doesn’t pay a dividend and so doesn’t meet one key wealth-building criterion, MEG’s track record and ability to control costs in a game notorious for the opposite is noteworthy. So is the fact that it’s trading for just 1.69 times book value.

Nexen is the majority owner and operator of the Long Lake oil sands project, which has been plagued by technical problems and has yet to reach even 50 percent of production targets. Former Nexen partner OPTICanada, now going through bankruptcy proceedings, recently sold its 35 percent interest in the project to CNOOC for USD2.1 billion. The cheapest of the five How They Rate stocks mentioned in the Bernstein report, Nexen is selling for less than book value as of Tuesday’s close.

Asia-based natural resource companies–excluding Australia and Japan–spent USD30 billion on overseas mergers and acquisitions in 2010. They’ve already spent USD33 billion in 2011.

Deputy Chairman and CEO Mr. Yang Hua, speaking not only for his company but also perhaps on behalf of his country reiterated stated during CNOOC’s first-half 2011 conference call in August that “unconventional resources are strategically significant to our long-term growth plan.”

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