Canadian Oil Sands Industry in a Sticky Mess

On Jan. 18, Suncor Energy (NYSE: SU) finalized a $4.6 billion takeover deal for Canadian Oil Sands Ltd. (OTC: COSWF).
Suncor is the largest operator in Canada’s oil sands regions. Its latest move makes it the biggest stakeholder (49%) in Syncrude. This company is a bitumen mining and upgrading joint venture in the Athabasca oil sands region. Other partners in Syncrude include: Imperial Oil (NYSE: IMO) with 25%; Sinopec (NYSE: SNP) with 9%; CNOOC (NYSE: CEO) with 7%; Murphy Oil (NYSE: MUR) with 5%; and JX Holdings (OTC: JXHLY) with 5%.
At the moment, this deal makes Suncor a very brave and very lonely company. That’s because investment into Canada’s energy is falling off a cliff.

Canadian Energy Feeling the Heat

The Canadian Association of Petroleum Producers forecast that only $29.5 billion would be invested by the industry in 2016. That is 13% less than last year, and a whopping 48% lower than in 2014. Overall, there has been over 4 million barrels of oil equivalent reserves deferred so far.
Specifically for oil sands, investment in the 2014-2016 period is forecast to drop by 38%.

The problem for the bitumen companies is price. Many producers are literally losing money on every barrel of oil they sell from existing operations.
Forget the worries about West Texas Intermediate crude oil selling for below $30 a barrel. Canada’s benchmark Western Canada Select oil contracts are at a steep discount to WTI, in the $13-$14 a barrel range. Producers in the oil sands think even that price would be nirvana.
The price for a barrel of bitumen is trading at just a bit above $8 a barrel. That’s about a tenth of the $80 a barrel price consultancy Rystad Energy says is needed for new projects to be viable. Needless to say, new projects in the oil sands region have put on indefinite hold or outright canceled. Arc Financial says at least 17 oil sands developments were delayed or canceled in 2015.
One prime example was a $2 billion write-off taken by Royal Dutch Shell (NYSE: RDS-A) last October after it canceled its Carmon Creek oil sands project in western Canada.
The huge hit to Canada’s oil industry tells me that, in addition to U.S. shale drillers, the Canadian oil sands industry has been a prime target of Saudi Arabia’s oil share war. Oil sands accounted for 61% of Canada’s oil output in 2014. Canada’s reserves, mostly bitumen, are the world’s third largest.

Other Headaches for Oil Sands

Even when oil prices do rise, Suncor and other oil sands companies face other headaches.
Primary among those is the fact that oil production in western Canada is at or very near the limits of pipeline capacity. Environmentalists in Canada have been successful in blocking the construction of new pipelines.
The pipeline problem was a key reason cited by Shell for ending the Carmon Creek project. It said, “(The decision) reflects current uncertainties, including the lack of infrastructure to move Canadian crude oil to global commodity markets.”
Another headache is the imposition by Alberta’s new left-of-center government of a cap on carbon emissions by the oil sands industry. That is in addition to higher corporate taxes and a review of the royalty rates paid to the government. That makes it tough for all companies in the sector – including Suncor, which is the best of breed.
Yes, Suncor acquired more production capacity through the Canadian Oil Sands deal much cheaper than the cost of starting a new bitumen mine. But the way things are unfolding, it may not really matter.
The deal is a bet that, over the long term, oil prices will recover. That’s not in the cards for the foreseeable future. My outlook is for still lower oil prices to come. That means Suncor and its peers should be avoided.

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