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5 Reasons There's More Investment Upside In Bitumen Than Shale Oil

Posted By Dick Sterling
April 10, 2014

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While shale oil has been getting Wall Street's attention, Alberta's oil sands and bitumen carbonates have been largely ignored, providing a spectacular opportunity for long-term thinkers who are willing to take a contrarian position, sit back and wait. There are several reasons (all of which are transitory) why bitumen has temporarily fallen out of favor relative to the shale oil plays:

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First, shale oil is more exciting than bitumen because it's a domestic phenomenon (as opposed to an Alberta phenomenon) and has legitimately received a ton of good press. Good press has led to strong retail buying in the high profile E&P companies which have exploited the Bakken, Eagle Ford, etc. Meanwhile, bad press has plagued the bitumen players --- from exaggerated environmental problems to temporary pipeline delays and distribution bottlenecks. Bad press is a contrarian's opportunity.

Second, even though multi-stage horizontal frack plays require big capital outlays, it's trivial compared to an open-pit or in-situ bitumen recovery operation. True, a shale oil well might cost $10 million (often less, sometimes more). But an open-pit or in-situ bitumen producer will spend many, many times that (the range is from tens-of-millions for a robust SAGD operation to billions if it's a surface mine). But I would argue that the risk is far, far less for the bitumen producer --- he usually knows what he's got before he builds, whereas the shale operators frequently won't know if the well is successful until after they've fracked. The relatively high initial cost for the bitumen producer is mitigated by the reduced risks.

Third, shale oil flows, bitumen doesn't. Thermal treatment is a hassle and can be expensive. Never mind the reality that many bitumen producers have a much lower cost per barrel than the average shale oil play, the perception is that thermal treatment is always expensive. It's true that it's expensive in the beginning, but it gets easier from there. Once the infrastructure is deployed, it becomes similar to a leaching operation --- you can relax a bit and let the process work.

Fourth, shale oil production has usurped the pipeline capacity. This means Alberta bitumen has been partially shut-out of the distribution network. As a result, the price differential between what Alberta's producers are getting versus what they could be getting if they could readily transport their product to the US refineries, is substantial. But this problem is temporary and is being addressed, with more pipeline capacity already being planned or built. No one in the industry believes the bottleneck is going to last. In fact, it was recently revealed that Enbridge is doubling the capacity of one of its pipelines into the US, which will be partially used to transport heavy oil. No political approval is required because the pipeline already exists.

Fifth, very few retail or institutional investors are willing to think longer term, and instead become obsessed with the very near term. They want NOW production (shale oil) versus LATER production (bitumen). They want quick, not slow. Admittedly no one knows how long strong oil prices will last, so longer-term projects carry a greater commodity-price risk. But beyond that, there is a deficit of patience which leads many investors and fund managers to disregard longer-term ideas even if excellent. To be reasonable, this tendency is exacerbated by the inconsistent judicial and political processes, which make long-term planning more difficult.

This list is not exhaustive, but I've made my point. Without reading Warren Buffett's mind, I think it's positive that he loaded up on Suncor (SU) this past summer. So did T. Boone Pickens and Steve Cohen. And now it's been revealed that George Soros has been buying into the oil sands too. So should you?

It's been reported that Alberta's oil sands producers are producing oil more cheaply than their American counterparts in the prolific Bakken and Eagle Ford shale oil formations. And yet, according to another report, Alberta oil and gas companies are only trading at around 1.5 times compared to their US counterparts at about 2.5 times. It seems that Wall Street hasn't mustered the courage to exploit this differential yet, meaning you have a window of opportunity.

The report which I just cited went on to describe how some of the high-profile Bakken wells declined by 70% in their first year of production, with some analysts projecting a massive drop-off in shale oil production throughout several key US formations within the next five years. Compared to Alberta's oil sands operations which often have reserves of more than 40 years, shale oil deposits can run-out fairly quickly. This is another reason for investors to favor Alberta bitumen producers over their shale oil cousins.

And while I highly recommend many of Alberta's oil sands producers (such as Baytex Energy which is cold-producing much of its bitumen), I would actually argue that the bitumen-carbonates represent even more upside (yet more risk) than the open-pit or in-situ bitumen-sands plays. It's why Rick George (former head of Suncor and considered one of the leading oil-sands veterans) recently joined the board of one of the top carbonate players (OSUM, which is private). It's why Glenn Schmidt (who sold his oil-sands company to Total SA for more than a billion dollars) started up Laricina Energy --- the leading carbonates player (also private).

Are there any publicly-traded companies with exposure to bitumen-carbonates? Athabasca Oil (a mixed bag of sands and carbonates, ATHOF or ATH:TSX --- shares around $6) and Strata Oil (pure-play on carbonates, SOIGF at 20 cents) are just two although there are others --- Shell and Husky are major players in Alberta's bitumen carbonates and have already invested billions. Institutional investors in the carbonates include Warburg Pincus, Blackstone Capital, and Goldman Sachs.

In short, I believe that carbonate-hosted bitumen developers are going after a prize which could be "the next oil sands" --- representing many, many billions of barrels of production and, ultimately, trillions in revenue. As in most investments, the biggest gains will go to those who have the courage and foresight to position themselves early.

Posted by: Dick Sterling, Editor   contact here


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