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Beneath Canadian Oil Sands’ troubles, value lurks Add to ...

This is not the way that investing in Canadian Oil Sands Trust was supposed to work. Costs were supposed to come down. Oil prices were supposed to go up. The rich and widening spread between those price points was supposed to accrue to shareholders.

There was – there is – no other reason to invest in the wretched and risky business of bitumen mining.

Instead, only half this thesis is coming to pass. Oil prices are, in fits and starts, going up. But the costs of mining oil, broadly defined, are going up even faster. The spread between the two isn’t widening, it’s narrowing and investors are suddenly and sharply repricing the stock.

That’s arguably warranted. But this remains, in my view, a promising long-term investment.

The accompanying chart shows Canadian Oil Sands’ current plight. The trust’s units used to track the price of crude pretty faithfully. That relationship seems to be falling apart, especially after last week, when the trust stunned investors – of which I’m one – with its budget for next year.

According to the budget, spending is going way up and as a result the distribution is being cut by 60 per cent. Investors are bolting for the exit and the units are about 15 per cent cheaper today than they were before the announcement.

Is the selloff overdone? Retail investors love their distributions and often act rashly when they’re cut. If so, this could be a good time to buy.

Before doing so, though, you should peer into the details.

The Finer Points

Canadian Oil Sands’ only asset is a 37-per-cent stake in the Syncrude joint venture. The big question: Will Syncrude ever produce oil at its designed capacity without spending billions in maintenance costs to get there? Or should investors throw in the towel and assume that producing at 85 per cent capacity, where Syncrude sits now, is as good as it gets?

I put the question to Marcel Coutu, CEO of the trust and chairman of the Syncrude joint venture. His answer: “We haven’t given up yet so my advice is that I wouldn’t discount [our prospects] until we do.”

Syncrude says its best investment opportunities in the near term is to improve the reliability of its plants. But it’s been saying this for years and no amount of money seems to help.

The almost billion dollars earmarked for spending next year isn’t for growth (although Syncrude has long-term plans to expand production). The spending isn’t even for improving efficiency in the very near term. It’s either for routine maintenance, like moving equipment around as certain areas of the mines get depleted, or for meeting environmental obligations, which seem to be rising.

Mr. Coutu says “it’s really a poor coincidence” that a lot of this extra spending happened all at one time. But that doesn’t help investors wondering whether operating at 85 per cent of capacity is as good as it gets.

Mr. Coutu lists several obstacles that have prevented Syncrude from attaining its projected output. Among the challenges: ore that’s got lots of clay in it, which is harder to process; equipment maintenance schedules that are difficult to co-ordinate; harsh weather; brutal wear and tear on steel equipment.

Good reasons all, but none of them are new. If Syncrude hasn’t solved these problems yet, will it ever?

Prized Asset

Investors have already spoken: They’re not counting on huge upside any more. Canadian Oil Sands is a “show me” story now.

But having said all that, I also suspect that this is still a prized asset selling for a pretty good price. Sinopec, the Chinese oil company, paid $4.65-billion for a 9-per-cent stake in Syncrude. Canadian Oil Sands, with its 37-per-cent stake in Syncrude, is quoted at $12-billion. Meanwhile, MEG Energy and Athabasca Oil Sands, which are either not producing or barely producing, both have Chinese backers and multi-billion-dollar market values.

This space has touted Canadian Oil Sands as a good long-term investment for years, and it’s been a pretty good one. Despite the challenges and understandable revaluation, it remains one, in my view. I don’t think it will be around in 10 years though – it will be picked off before then by a buyer who can spot the asset value lurking beneath the current problems.

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