Investing in Canada's Oil Sands
Joshua is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
The Canadian oil sands are a controversial topic given the desire for North American Energy security and the need for environmentally friendly methods to meet such goals. Recent industry publications predict flat or lower oil sands capex in 2013 given resource and pipeline constraints. As The Economist recently noted there are serious financial and capital constraints in the oil sands.
Canada is a highly developed nation, but its small population around 35 million and GDP around $1.4 trillion on a 2011 PPP basis does not have anywhere near the amount of resources of the U.S. At the same time foreign direct investment outside of the U.S. is treated with much caution by the Canadian government. There are still profitable investments in the Canadian oil sands, but flat capex and a lack of infrastructure development could limit future intra-industry synergies.
In the recent third quarter presentation of Suncor Energy (NYSE: SU) they lay out how they cut $850 million from their 2012 capex and instituted a $2.5 billion share buyback plan. In a sense their actions are discouraging as it seems to suggest that SU is unable to find more profitable investments for their capital.
Regardless, their share buybacks and increased dividend show that the firm prefers to return capital to investors rather than waste funds on less profitable investments. SU has been able to maintain a healthy return on equity of 11.9% and a total debt to equity ratio of .26. With a $50 billion market and a plethora of assets in a highly specialized area of the energy industry, SU is a respectable company that is learning to deal with a maturing market.
Canadian Natural Resources (NYSE: CNQ) is another larger player in the oil sands. Currently 40% of their production comes from heavy oil, 30% is light oil/SCO, and 30% is natural gas. In addition to their oil sands interests they are involved in the North Sea, the western coast of Africa, and in South Africa. In their defined growth plan, CNQ projects an additional 40,000 bbl/d in thermal insitu production per year until 2027, but given the volatility of the energy markets these projections should be taken with a grain of salt.
In the first decade of 2000 many capex projects were canceled as high crude prices overheated Alberta's economy and greatly elevated input costs while the subsequent crash in oil prices greatly reduced firms' profitability. CNQ's return on equity of 9.7% is not spectacular but their total debt to equity ratio of .35 is reasonable. CNQ has a large reserve base before royalties around 7500 mmboe and if North America's pipeline infrastructure is improved then CNQ should see a major boost in earnings.
Imperial Oil Limited (USA) (NYSEMKT: IMO) is a major Canadian energy firm that is expected to double its liquids production by 2020. As their conventional production continues to decline, their oil sands assets will continue to provide growth. Resource constraints do put a limit on investment but IMO will still be able to continue growing their production. XOM owns close to 70% of Imperial and both companies work very closely together in the oil sands. IMO boasts a return on equity of 23.5% and a return on invested capital of 19.7%. They have a very low total debt to equity ratio of .09 and trade at a PE ratio of 9.9, which makes IMO very attractive.
Nexen (NYSE: NXY) has a pending takeover deal by CNOOC and a number of assets in Canada's oil sands, BC's shale gas, North Sea, the Gulf of Mexico, and off the coast of Nigeria. Although the takeover deal has won shareholder approval, it continues to be very politically sensitive. The recent agreement that half of the board seats will be Canadian and a stock price inching toward the $27.50 takeover price suggests that the deal has a high chance of being approved. With the Canadian Prime Minister's recent push for greater involvement with Asia, there is a strong desire by some of Canada's political leaders to get the deal approved. With a total debt to equity ratio of .51 and a return on equity of 6.2%, NXY is not a leader in the oil sands. The difficulties in accepting the foreign takeover of NXY only exaggerates the capital constraints in the oil sands.
SU Operating Margin Quarterly data by YCharts
SU Return on Invested Capital data by YCharts
Conclusion
Suncor's actions demonstrate some of the fundamental forces affecting the Canadian oil sands industry. They are an important part of North America's energy infrastructure, but resource constraints limit North America investment while politics limits foreign investment. Those firms that return unusable capital to investors with dividends or share buybacks should remain strong investments. In the past decades the oil sands were viewed as an area of innovative growth, but now the oil sands are behaving more like a mature cash flow producing company, weary of foreigners.
MrCanadian1 has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!
