Talking Tar Sands

02/17/2006 12:00 am EST

Focus:

Jon Markman

Editor, Trader's Advantage

“Canada's oil sands could rival Saudi Arabia's vast reserves,” says Jon Markman, who jests, “We could annex Canada and put the Great White North under the Red, White, and Blue, or we could always just invest in the top tar-sands companies. “ Here, he looks at four favorites.

”President Bush, in his State of the Union address, said that the US must slash its dependence on oil from ‘unstable nations.’  Federal energy officials figure US oil imports from Canada will almost double over the next 20 years, to 2.7 million barrels a day from 1.6 million. That would go a long way toward cutting our imports of Mideast oil to three million barrels a day from six million. But it’s only a start.

“It’s a little hard to believe, but the tar sands in Alberta hold 175 billion barrels of recoverable oil. That rivals Saudi Arabia’s reserves, and would help get us well in a hurry. Tar sands may represent up to two-thirds of the world’s entire stockpile of oil. But the fact that every Canadian does not live like a sheikh is testament to the plain reality that it’s really hard to turn the stuff into useful energy.

"First you need to strip-mine it from deep in frozen ground, then blast it with steam to separate the oil from the sand and clay, an operation that demands a vast amount of water and pricey natural gas. Overall, the projects break even when the world crude-oil benchmark is at $20 per barrel, or one-third the current price.

“Meanwhile, the top Canadian oil sands pure plays rose more than 200% on average in 2005, and there’s probably still a long ways to go. Companies with a lot of exposure to oil sands will generate tremendous free cash flow for at least 20 years, judging from the current estimates of reserves and rates of production, even if they have to invest another $10 billion or more to get the job done. One of the top names up there is Suncor Energy (SU NYSE).

"Suncor did $8 billion in sales and earned $782 million over the past 12 months, which was good for a $35 billion stock-market capitalization. But a lot of investments the company has made in tar sands are just coming on line, so the turnaround in earnings power has been fantastic. It earned $1.75 a share in 2004 and $1.98 in 2005, but it expected to earn as much as $4.85 in 2006 and $5.40 in 2007. Put a price-to-earnings multiple of 20 on the latter number, and you could be looking at a $100 stock in 18 months.

"Philip R. Skolnick, an excellent analyst at Genuity Capital Markets, likes Canadian large-caps Nexen (NXY NYSE), Encana (ECA NYSE), and Canadian Natural Resources (CNQ NYSE) even more. He figures that they have 27% to 60% of their future values locked up in oil sands. I’ll skip over his earnings estimates for each, and just note that they imply price targets of $78, $57, and $74, which are 20% to 40% above current levels. This is going to be a long, long secular story: something like investing in Saudi Arabia in the 1940s."

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