By Alexander Green, Chairman, Investment U
Friday, May 23, 2008: Issue #799
Earlier this month, I questioned whether the recent spike in crude oil was a potential bubble. The price of crude has more than doubled in a year and there are some reasonable doubts whether oil can maintain these levels.
No one can say for certain, of course.
But whether prices continue to rise or not, there are plenty of opportunities out there for investors looking to capitalize on the world’s long-term needs for oil. Some believe the meteoric rise in crude oil we’ve seen over the last three years is a temporary phenomenon. T. Boone Pickens isn’t one of them.
The long-time oilman, and current chairman of BP Capital Management, was recently asked in a 60 Minutes interview when he thought we’d see $1.50 a gallon at the pump again. “We won’t ever see $1.50 a gallon again,” said Pickens. “No, that’s gone.”
It’s tough to disagree. On the demand side, citizens of the wealthy West aren’t using any less oil, nor are the up-and-coming Tigers of the East.
On the supply side, just look at many of the world’s biggest exporters: Iran, Nigeria, Venezuela, Saudi Arabia and Russia. It’s a virtual rogues’ gallery, filled with nations that represent tyranny, corruption or instability.
Fortunately, the world’s single-largest oil deposit sits right here in North America. Time magazine calls it “Canada’s biggest buried treasure.” It’s an area with up to 2.5 trillion barrels of crude oil, locked in Alberta sand. That’s eight times the total reserves of Saudi Arabia, enough to satisfy the world’s demand for petroleum for the next century.
This is easily the world’s most exciting energy story.
And one publicly traded company is supremely positioned to earn billions from this region in the months ahead…
The Competition For Crude Oil Is Heating Up
In May, the International Energy Agency (IEA) revised upwards its estimate of world oil demand, squashing hopes that a significant decline in the price of oil is imminent.
Demand growth this year is running at its fastest level in 24 years. Last year, world oil use was estimated at 82.6 million barrels a day. The United States burns a quarter of that. But competition for oil is heating up.
Emerging markets – and particularly giants like China and India – are rapidly industrializing. According to the U.S. Energy Information Agency, world demand for oil is expected to increase 54% over the next 25 years.
Unfortunately, American oil production has been on the downswing since 1970. And many of the world’s major oil suppliers are either indifferent or downright hostile to U.S. interests. Where can Americans look for a steady, reliable source of black gold?
How about 900 miles north of Montana, in Alberta, Canada?
The Largest Crude Oil Reserve On Earth
Alberta’s oil sands are the largest known reserve of crude oil on earth, containing between 1.7 and 2.5 trillion barrels. (Saudi Arabia, by comparison, has only 262 billion barrels of proven reserves. In fact, all OPEC nations combined have less than 900 billion barrels.)
For decades, these sands weren’t even considered part of the world’s oil reserves because the oil there wasn’t economically extractible at prevailing prices using then-current technology.
But times have changed… And the new gold rush is on…
- In Canada’s oil sands, energy companies don’t drill for oil. They dig it up.
- After excavation, giant trucks three stories high – carrying up to 400 tons of oil sands – carry it off to a processing plant.
- There, the sands are heated in a cell where the crude oil comes to the top of the water and the sand drops to the bottom.
- This oil froth is then sent to an upgrader and eventually to a refiner.
Is this oil really as good as the stuff coming from Saudi Arabia?
Actually, it’s better.
According to Clive Matter, Chief of Shell Canada, this crude oil is “absolutely as good as it gets. In fact, it even trades at a premium because it’s high-quality crude oil.”
And here’s the kicker: Exploration of Alberta’s oil sands is virtually risk-free. You can’t drill a dry hole here. There’s no drilling at all. It’s a mining operation – and the reserves are thoroughly outlined. So what you really need is a company with plenty of machinery, money and manpower to dig it up and process it as quickly as possible.
There are dozens of small companies flocking to Alberta for a piece of the action. But in this capital-intensive business, why gamble on the small fry?
The Blue Chip Crude Oil Play: Suncor Energy
We suggest you opt for the undisputed blue chip crude oil play: Suncor Energy (NYSE: SU).
Based in Calgary, Suncor is an integrated energy company. It extracts and upgrades crude oil through its oil sands operations near Fort McMurray, Alberta. Its operations throughout Western Canada produce natural gas.
It operates a refining and marketing business in Ontario, with retail distribution under the Sunoco brand. And it has operations in the United States and retails its products under the Phillips 66 brand. It also manufactures the gasoline additive ethanol.
However, the most exciting aspect of Suncor’s business is in Alberta’s oil sands, where it operates the single largest extraction operation. CEO Rick George says the mine will be in operation for at least 25 years.
That doesn’t mean they are out of options for new locations, they have plenty to choose from. Based off the current production levels, the oil reserves of Canada should last for 150 years. Yesterday the S&A Oil Report’s Matt Badiali said, “[Tar sands] production will climb from 1.1 million barrels per day in 2006 to 3.8 million barrels per day in 2020. That’s 250% growth in just 14 years,” he stated. “This is one of the greatest growth stories on the planet right now.”
Making our neighbor to the north an integral trading partner in our energy future.
And that’s a good thing. Numerous international pressures have impacted oil prices: escalating violence in the Middle East, ongoing concerns about Iran’s nuclear program, OPEC’s continued apathy towards the U.S. interests, saber-rattling in Venezuela, the threat of civil war in Iraq and Saudi Arabia’s recent unwillingness to raise outputs.
A Steady Rise in Crude Oil Prices
The steady rise in crude oil prices over the past three years, and the fear of potential supply disruptions, have created an environment where oil over $110 a barrel is the norm and $150 oil is hardly unimaginable.
Fortunately, Suncor is moving full speed ahead to bring its reserves to market. Production at its oil sands facility in April averaged 241,000 barrels per day (bpd). And this summer, Suncor announced it has started production at its new $108 million St. Clair ethanol plant, which will turn corn into the gasoline additive.
Earnings are already blasting higher. First-quarter profit rose 25%, from $818 million last year to $1.02 billion this year. Management gives most of the credit to higher oil sands production. But there are other factors, too.
“The refining and marketing side just left the Street in the dust,” said oil analyst Martin Molyneaux at FirstEnergy Capital in Alberta. “It was outstanding results.”
But the company is just gathering momentum. Suncor has already spent $3.3 billion to boost daily output from the oil sands to about 350,000 barrels by the end of 2008. And its board just approved $17.3 billion more to increase output to 550,000 bpd.
Increased production output is lowering per-barrel operating costs, from $31.55 to $27.00 a barrel.
Oil sands excavation is not the only thing the company is doing to meet rising energy demands. Suncor has been blending ethanol into its Sunoco-brand gasoline for 10 years now. Its Ontario plant will produce 53 million gallons of ethanol a year, making the plant the largest ethanol producer in Canada.
The Alberta oil sands are the best short-term solution we have to avoid a looming oil crisis. And Suncor is the premier play, with 87% revenue growth since last year and 20%-plus operating margins.
Given that political uncertainty in the Middle East is unlikely to change – and viable alternative energy sources are still years away – oil reserves outside troubled regions are likely to fetch a premium.
And, of course, so are shares of Suncor.
Today’s Investment U Crib Sheet – The Rise of Crude Oil
- Oil has been on a tare recently… and shows no sign of stopping. Take a look:
- Since October the price has never closed below $85 a barrel.It’s difficult to single out one point in the supply chain causing expensive oil. From explorers, governments, producers, transporters, refiners, regulators and finally the merchants who sell oil, they have all profited along the way.
- There are a few more investable oil ideas in Investment U Issue #753, Investing In Oil Companies: Here Are Five Oil Stocks Set to Surge in 2008.