Investment with Income:
CANADIAN OIL SANDS LIMITED (COS.TO) and (COSWF.PK)
Per share values in USD 1-19-2012
Market value $ 20.64 Canadian
Market value $ 20.40 US
Indicated Dividend rate ~6.75 %
Durig Capital seeks out quality high yielding global investments that offer both a high yield and a good probability of appreciation, while providing a unique hedge against inflation and/or a continued devaluation of the US dollar. As a result of our diversification research efforts, we have identified and selected Canadian Oil Sands (COS.TO), Canada’s largest oil producer operated by the Syncrude consortium. Syncrude began operation in 1978 and is the biggest mine of any type in the world.
US Dollar Concerns
Most investors seeking income with growth for their investment portfolios are aware of the US 15 plus trillion in debt, but few understand that the M1 money supply “printing of money” is up 18.3% in the last twelve months alone. When you consider the fast growing economies known as the BRICs (countries Brazil, Russia, India, China, and South Africa) and the fact they are looking at replacing the US dollar as the reserve currency, any one of the above factors alone could over time cause havoc to the dollar and/or increased inflation. Having all three major forces occurring simultaneously while the US Government is lacking a real fiscal compass make it even more imperative for the wealth preservation of our clients.
Syncrude Canada Ltd. is one of the world’s largest producers of a single high quality light sweet synthetic crude oil (SCO) know as Syncrude (SSP) from oil sands and is the largest single source producer in Canada. It is located just outside Fort McMurray in the Athabasca Oil Sands. The U.S. imports about 19 percent of its total foreign oil supply from Canada, more than from any other nation, and around half of that now comes from the oil sands.
In 2003, when the Oil & Gas Journal added the Alberta oil sands to its list of proven reserves, it immediately propelled Canada to second place, behind Saudi Arabia, among oil-producing nations. The proven reserves in the oil sands are eight times those of the entire U.S., and we believe that number will go up.
Syncrude is not traded directly, but rather through the individual owners. The company is a joint venture between seven partners (by percentage): Canadian Oil Sands Limited (COS.TO)(COS WF.PK) (36.74%), Imperial Oil Limited (IMO) (25%), Suncor Energy Inc (SU) (12%), Sinopec Shanghai Petrochemical (SHI) (9.03%), Nexen Inc (NXY) (7.23%), Mocal Energy a subsidiary of Nippon Oil (5%), and Murphy Oil (MUR) (5%). Exxon Mobil (XOM) currently owns 69.6% of Imperial Oil. In 2010 Conoco Phillips (COP) sold its 9.03% interest in Syncrude to the Chinese company Sinopec for $4.65 billion. Using today’s valuation Synopec paid about a 60% premium over the value of the current share price of Canadian Oil Sands. Athabasca Oil Sands (ATH.TSE), a similar but smaller Canadian Oil Sand play with no consistent dividend, currently has lower value metrics. We value Canadian Oil Sands more on an international cash flow basis, as it has superior free cash generation, a healthy dividend, and a long life hard asset base.
The ownership board must approve all annual operating budgets, proposed capital spending projects, and are required to provide the funding for said activities based on their ownership share.
Syncrude has stated it has 20 years of proven reserves and about 40 years of probable reserves. Probable reserve means it has the same probability of having 41 years as it does 39 years of reserves. We have seen in our research indications that probable reserves have a much greater tendency to grow, often significantly, over time. Syncrude has been permitted to produce 173 million barrels of SCO which expires in Dec 2035.
Canadian Oil Sands
Canadian Oil sands is the largest shareholder with 36.74 percent of the company. Considering its long life assets, its internal cash flow is one of the highest we could identify in the Canadian Community market, including bonds. Canadian Oil Sands currently yields about a 6.75% dividend, which is above most Canadian corporate bonds that we have reviewed and significantly above the 1.945% yield for the Canadian 10 year government bond. Considering that it just raised its dividend from 30 cents to 35 cents and expects major cost to significantly decline starting in 2014, an environment is set that could afford a even higher dividend payout ratio. When you factor in probable reserves of around 40 years, it makes for a very high yielding, long term, hard asset based investment much like the Southern Copper Corporation (SCCO) that we recently recommended. The real return will vary due to the international prices of oil, but with that said, it looks as though any real or material alternative for guaranteed power is not on the short term horizon.
The dividend has been just increase by the company to 35 cents even though they publicly stated that investors should expect a 30 cent quarterly dividend targeted for 2012.
While we now want to identify what we believe to be the four largest risks to our investors, please do not assume that this list is intended to be complete or comprehensive.
- Oil Prices.
1. Oil Prices. We believe that unless supply and demand characteristics change significantly, the price of oil is likely to gradually increase. Possibilities for change would be a change in the present US administration’s policies from a restrictive oil platform to a pro energy platform, which could potentially lower oil prices.
2. Possibly the largest risk, but one that’s hard for us to quantify, is the environmental risk. We do not see this primarily as a catastrophic risk, but the risk of possibly new and/or additional building or mining regulations intended to improve or protect the environment. The oil sands process is not a very clean or easy way to extract oil and is generally considered to be more environmentally damaging than more conventional methods. Therefore it has detractors that frequently harangue politicians for operations to be closed. However, the location of its operations is in a place where it’s so cold that it tends to avoid public scrutiny. The European Union plans to adopt the fuel quality directive, which calculates a fuel’s entire life cycle of emissions, which will make fuels from oil sands less competitive in the EU market and has caused friction between the EU and Canada.
3. Production risks. The Oil Sands appears to have resulted from centuries of oil flow. Out of a higher point of earth’s crust the oil flowed along in a river until it began to solidify at a low point or valley, which makes it uniquely different from most oil deposits still in the ground. Being a newer form of energy and mixed in with the sands, Canadian Oil Sands and the industry is still achieving significant gains in production despite the associated pitfalls of not being far along on the learning curve. That said, Canadian Oil sands could possibly run at higher cost than forecasted for a while.
4. We’ve seen many articles indicating that the lack of transportation pipelines for the Alberta and beyond region is causing a bottleneck in supply lines, and that the Keystone Pipeline (among others) would greatly expand alternative modes of transportation to market. Looking at the price history and knowing that Syncrude has been both above and below the WTI prices, it’s hard to project its impact. The current reason stated for 20 dollar lower per barrel prices in the Alberta area is the frequent recurrence and increased development of several choke points in distribution, which is common in new regions with rapid improvements in production. Our best estimate is that if Keystone and/or other pipelines are approved, it would greatly reduce the volatility of prices and make the income and earnings more correlated to other oil market prices, thus making the operation more desirable.
Summary and Conclusion
Canadian Oil Sands integrates well into our strategic plan of finding strong balance sheet companies that own highly desirable assets and/or are monopolistic businesses, and are significantly undervalued as a result of depressed markets and/or currencies, such as our recently selected Administradora de Fondos de Pen (PVD), which holds a dominant position similar to Canadian Oil Sands, when neither copper nor the Chilean peso were having much success in finding a bottom.
Therefore, we think Canadian Oil Sands allows our clients to attain the strategic goals of an income stream and long term capital growth, offers diversification away from the US economy and the US dollar, which is why we have added it to our Investment Growth & Income Portfolio. For Canadians we recommend using Bank Offshore to attain foreign denominated bonds and income.
Disclosure: Durig Capital and some clients currently have positions in COS.TO.