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The Surmont oil sands project uses steam-assisted gravity drainage.

Nathan VanderKlippe/The Globe and Mail

Canada has staked its future on the oil sands. In November, Report on Business magazine together with Thomson Reuters examine what that means both at home and abroad. Read more from the issue at tgam.ca/oil.

It was early 2012, and investment bankers at BMO Nesbitt Burns and other major Canadian dealers were racking up the frequent-flyer miles. Many of them were making monthly — sometimes even biweekly — trips across the Pacific to visit state-owned oil companies anxious to buy into Canada's oil sands.

As the deal tally among Chinese state-owned enterprises began to pile up, back in the mid-2000s, BMO opened an office in Beijing. Players from Japan, South Korea and even Thailand were in on the action, too, fuelled by their governments' need to secure enough energy to support booming economies. And the prices they were willing to pay — well, they were well above what domestic players would consider laying down. With oil hovering around $100 a barrel, and few political impediments to picking up chunks of a region with oil reserves trailing only those of Saudi Arabia and Venezuela, it seemed like the deal-making would never end.

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"There was a map on everyone's desktop that had who was interested in what," says Shane Fildes, BMO's managing director of investment and corporate banking and head of its global energy group. "Every significant energy company in those jurisdictions was studying it...and that was only one part of the world."

Then everything changed. By 2013, bids for oil sands property had gone from a gusher to a trickle. And they have yet to recover — even as deals in other parts of the oil patch have picked up in a big way. Transactions with oil sands content added up to only $770 million in 2013; so far this year, they've totalled $1.8 billion, according to FirstEnergy Capital. Compare that to the boom years: In 2007, as oil began its steady march to an eventual high of $147, buyers spent $18.9 billion on oil sands assets (big deals included Marathon Oil's $6.5-billion acquisition of Western Oil Sands, and Statoil's $2.2-billion purchase of North American Oil Sands Corp.). In 2010, companies poured $16.6 billion into oil sands acquisitions — with the largest being the takeout of ConocoPhillips's 9% interest in Syncrude Canada by state-controlled China Petroleum & Chemical Corp. (Sinopec). That deal alone was worth $4.7 billion.

So what's different? Crude prices have declined, but inflation in labour and material costs is nowhere near the feverish levels that led to massive overruns in oil sands projects before the financial crisis in late 2008 forced the industry to take a year-long spending breather.

One new wrinkle: political risk. Fildes's team at BMO was the Canadian adviser for China National Offshore Oil Corp. (CNOOC) when it bought Calgary-based Nexen Inc. for $15.1 billion (U.S.) in early 2013. Prime Minister Stephen Harper grudgingly approved the takeover, but imposed new rules that effectively barred any more state-owned enterprises from buying control of oil sands projects.

Yet, domestic companies have also moved to the sidelines, as have privately owned foreign ones. The main reason? Quite simply, buyers have discovered just how difficult it is to operate in the oil sands. Costs are still high compared with conventional energy. For multinationals, the oil sands have to compete for capital with projects around the world that may not have gargantuan reserves, but offer quicker payouts.

Troubles among smaller, single-project companies like Sunshine Oilsands Ltd. and Southern Pacific Resource Corp. have also given potential buyers pause. Costs spinning out of control, engineering problems — the oil sands have proven to be a quagmire for developers that lack the deep pockets to withstand unforeseen snags. And there are quite a few of those smaller players in Northern Alberta, many of whom did deals in the latter part of the last decade, fuelled by easy financing many thought would never end.

Then there's the transportation bottleneck, which casts a shadow over the entire industry. Producers have struggled for years to move bitumen to refineries on the U.S. Gulf Coast and to Asian markets, which pay more for the stuff than traditional markets in the U.S. Midwest and Southern Ontario. Rail has helped ease the downward pressure on Canadian crude prices, but producers need a more permanent antidote to the congestion — and fast. (For more on the oil sands' transportation woes, see "All pumped up with no place to go," page 48.)

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Despite the challenges, there has been a bit of action on the deal-making front, including the $751-million acquisition of undeveloped leases from ConocoPhillips by Exxon Mobil and Imperial Oil, and Osum Oil Sands Corp.'s $325-million purchase of Royal Dutch Shell's Orion project (though it's worth noting that both assets sat on the block for more than a year). This summer, Athabasca Oil sold its 40% interest in the Dover oil sands project to PetroChina — though the option deal had been arranged years earlier.

The drop in mergers and acquisitions does not mean developers have turned their backs on the oil sands. Far from it: Imperial Oil, Suncor, Canadian Natural Resources, Cenovus, Husky Energy and others are moving forward with multibillion-dollar projects, employing both mining and steam-driven extraction technology. And the Canadian Association of Petroleum Producers (CAPP), the International Energy Agency and the U.S. Energy Information Administration have all predicted that production will double over the next decade.

The big draw remains decades' worth of reserves, especially compared with shale oil, which requires constant drilling to maintain production levels. The trick now is extracting the bitumen profitably as inflation creeps back into the sector. Meanwhile, better access to new markets through pipelines could fuel an uptick in M&A activity — though the buyers of the future are bound to be large, established developers only, as they consolidate land positions.

As for BMO's Fildes, he says his bankers still maintain regular contact with Asian companies (though many — including CNOOC — are still struggling to develop what they've already bought). The maps in Fildes's office now feature targets much closer to home, since the bulk of deal-making has shifted to shale plays producing light oil and liquids-rich gas in Alberta and Saskatchewan, as well as recapitalizations of companies that have stumbled. "No question," he says, "the focus is more North American than in the past."

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