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Markets: Super Sands
New York: May 15, 2006
By John R. Stephenson

The oil story continues to be front-page investment news with the world seemingly leaping from one potential crisis to the next. First Iran, then Venezuela. It seems as if there is no end to the potential nightmare scenarios that could unfold and send crude prices spiraling upward. Yet investment banks and the International Energy Agency seem oblivious to most of these concerns. For the most part, investment banks are calling for falling crude oil prices in the year ahead as demand softens and supply continues to grow. So is it time to lighten up on your oil names?

Not for our money. While energy investing has been an elixir for many an investment portfolio, it should continue to be the go-to sector in the months ahead. The reason? Demand continues to grow, while supply continues to struggle. Few regions in the world offer as much potential for investors as Canada's oil sands, an unconventional resource base of huge abundance, located in the province of Alberta. With some 175 billion barrels of reserves in the ground (second only after Saudi Arabia) Canada's oil sands hold the key to our increasing dependence on crude oil.

Now, more than ever, investors are looking at safety of supply, as well as, the longevity of that supply. Canada's oil sands with their massive reserves fills the bill on both accounts and will likely play a crucial role in plugging a growing supply gap in the years to come.

Figure 1: Deep Sea, Oil Sands Drive New Crude Oil Supply Growth

Source: CIBC WM


Certainly, oil in Canada is nothing new, but lately, the focus has been on the province of Alberta and the vast energy reserves that are mixed with sand. Despite Canada's relatively small conventional oil and gas resource base, it managed to clock in as the fourth largest global oil and gas producer in 2003 (behind Russia, the United States and Saudi Arabia). As well, Canada accounted for some 17% of total U.S. petroleum imports (the largest single supplier) last year versus a combined total for all of the Middle Eastern countries of 21%.

Today, more than ever, oil from Canada's oil sands is looking like the winning solution. Unlike conventional oilfields, Canada's oil sands are not experiencing the steep declines (approximately 8.3% a year) that traditional oilfields are experiencing. Not only that, but Canada is a politically stable country.

Figure 2: Depletion Eats Up 60-70% of Conventional Projected Capacity Growth

Source: CIBC WM


That stability was underscored earlier this week when the oil industry's reigning punch line, Hugo Chavez, remarked that he was incensed that big oil was recording Venezuelan reserves on their balance sheets. While the never-ending rhetoric out of Venezuela is in itself worrisome, it underscores a broader point. Increasingly, big oil is reliant on countries such as Venezuela, Nigeria, Russia and Iran to meet their future production forecasts; while at the same time many oil producing regions of the world are becoming more aggressive and antagonistic towards the west.

Figure 3: Alberta Tops Next Decade's New Production

Source: CIBC WM

While the musings from Chavez and Iran's Ahmadinejad may be dismissed as crazy talk, they do present a serious problem for big oil. For many of the largest oil companies in the world their reserve life indices (proven reserves divided by current production) have been in decline for some time. The risks of a reserve-write down grow increasingly loud as Hugo Chavez exclaims that this is "our oil" and should not appear on the balance sheets of foreign oil companies. If reserve accountants start taking a hard line on oil reserves booked in countries with rising nationalism, investors should look for the reserve life indices of major oil companies to tumble in the years to come. While this is bad news for big oil companies (e.g. Exxon, Conoco-Phillips), it is good news for the players in Canada's oil sands projects.

Already, the stock market is starting to differentiate by awarding higher price/earnings multiples to companies that have long reserve life indices and production from politically stable regions of the world.

While the ride ahead is likely to remain volatile for energy investors, one thing seems certain — a strong or growing reserve life index and stable secure supply seems to be the order of the day. For our money, Canada's oil sands and companies such as Suncor, Western Oil Sands, Canadian Oil Sands Royalty Trust and Petro-Canada that are levered to this resource base should be investment superstars in the months ahead.

StephensonFiles is a division of Stephenson & Company Inc. an investment research and asset management firm which publishes research reports and commentary from time to time on securities and trends in the marketplace. The opinions and information contained herein are based upon sources which we believe to be reliable, but Stephenson & Company makes no representation as to their timeliness, accuracy or completeness. Mr. Stephenson writes a regular commentary on the markets and individual securities and the opinions expressed in this commentary are his own. This report is not an offer to sell or a solicitation of an offer to buy any security. Nothing in this article constitutes individual investment, legal or tax advice. Investments involve risk and an investor may incur profits and losses. We, our affiliates, and any officer, director or stockholder or any member of their families may have a position in and may from time to time purchase or sell any securities discussed in our articles. At the time of writing this article, Mr. Stephenson may or may not have had an investment position in the securities mentioned in this article
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