Report Reveals the Future of the Oil Sands

Robert is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Editor's Note: This article has been modified in regards to Connacher's current financial position.

Earlier this month the Canadian Association of Petroleum Producers predicted output from the Albertan oil sands will increase nearly three-fold by 2030. The chief driver of all this growth comes down to one technology - Steam Assisted Gravity Drainage, or SAGD. 

Steam what?

SAGD is the most common form of in-situ (Latin for “in place”) production where oil is recovered through a well, much like conventional drilling, rather than extracted through open pit mining. But unlike conventional methods, Alberta bitumen is too thick to flow freely on its own. Steam must be pumped underground, heating and diluting the bitumen, so it can be pumped to the surface. 

In-situ methods have already further eclipsed traditional mining techniques. In 2012, 800,000 b/d were mined, and nearly 1 million b/d were extracted through in-situ techniques.

By 2030, in-situ production is expected to increase over three fold accounting for 70% of oil sands production. 

Of oil sand developments planned between 2012 and 2015, 12 are SAGD projects while only four are mining projects. 

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In-situ is attractive for several reasons. 

First - access. Approximately 80% of Albert's bitumen is too deep for mining extraction. Through in-situ techniques, like SAGD, producers have the opportunity to open up vast quantities of exploitable resources. 

Second - economics. SAGD is about 10% to 20% cheaper than mining extraction. Small projects can be profitable and easily be scaled up over time. Wells also have shorter lead times that mean companies can respond quickly to changes in market prices. 

Third - environment. In-situ disturbs only 15% of the surface land in development areas whereas mining completely removes all top soil and over burden. 

Homework

But before investors plop down their investment dollars in fast growing SAGD producers, they have to do their homework. To measure project quality, there're four factors investors need to evaluate: 

Reservoir quality: Reservoirs with saturated and thick bitumen will cost more to develop and have lower production rates. Time taken to get a project to capacity is critical to profitability. A project failing to hit 80% of design capacity won't be profitable at current prices. 

Efficiency: The steam-oil ratio, or SOR, is typical measure of efficiency. A low SOR implies lower energy usage, lower operating costs, and lower emissions.

Output: Output is measured by daily production versus design capacity, otherwise known as the utilization rate. The current median utilization level for in-situ projects is below 70% of design capacity. To be economical, operators have to sustain rates above 80% at current prices. 

Management: SAGD is a new technology with a steep learning curve. Does management have the skills needed to actually execute on its growth plan? 

Connacher Oil and Gas is a lesson in how a SAGD project can go wrong. In 2012, the company's Great Divide project was operating at only 60% of design capacity.

Who are the leaders?

Fortunately, there're several SAGD producers earning great returns for investors. 

Cenovus (NYSE: CVE) is by far the SAGD leader in the business. In 2012, the company's premier Foster Creek project had the lowest steam-oil ratio in the industry. In addition, the development clocked a 90%+ utilization rate with production nearing 120,000 b/d. 

As an early pioneer in SAGD technology, Cenovus has the most expertise of any producer. That should give investors’ confidence that management will be able to execute on growth plans. Cenovus has several upcoming SAGD projects including its Christina Lake expansion and Narrows Lake. 

After struggling initially, Suncor (NYSE: SU) is rapidly ramping up SAGD production.

Phase three of its Firebag project is expected to grow production to 60,000 b/d in 2013 from 10,000 b/d in 2011. The company has recently completely stage four of the project 10% under budget and ahead of schedule. Once completed, phase four is expected to produce 30,000 b/d this year.

Suncor's MacKay River project is another low-steam leader. The project produced 27,000 b/d last year and this is expected to increase to 32,000 b/d in 2013. 

As Suncor gains more experience in SAGD, operating efficiency should improve. 

Finally, Devon Energy (NYSE: DVN) is also betting heavily on SAGD technology. In 2010, the company sold several assets to fund its oil sands expansion. 

The firm is ramping up production at its Jackfish 2 facility increasing production from 12,000 b/d in 2011 to 35,000 b/d in 2013. Those results are impressive. By operating near design capacity, Devon ensures maximum profit for investors.

The company began construction on Jackfish 3 last year and is expected to begin production in late 2014 at 35,000 b/d. 

Risks

However, the biggest risk for investors may not be in execution but in the price producers receive for their product. High production is slamming right into a wall of low prices thanks to clogs in the energy supply chain. Growth may be capped if new pipelines are not constructed.

Rising costs are also a major threat. In 2012, in-situ projects costs increased by 6.3% year-over-year due to chronic labor shortages. 

Foolish bottom line

SAGD represents the future of the Canadian oil sands. But in this high-stakes game, investors have to be careful when choosing between producers. 

If you're on the lookout for some currently intriguing energy plays, check out The Motley Fool's "3 Stocks for $100 Oil." For FREE access to this special report, simply click here now.


Robert Baillieul has no position in any stocks mentioned. The Motley Fool owns shares of Devon Energy. 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!

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