Canadian Oil Sands Trust COS_U
February 25, 2004 - 10:19pm EST by
issambres839
2004 2005
Price: 37.29 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 3,252 P/FCF
Net Debt (in $M): 0 EBIT 0 0
TEV ($): 0 TEV/EBIT

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Description

Canadian Oil Sands Trust (COS) is not just for income investors and offers tremendous upside beyond its 4% dividend. By 2007, production of oil should increase by nearly 40% and double in ten years, enabling significant dividend appreciation. By 2007, COS should pay $5.82 a share dividend. Discounting back 30% and assuming COS’ yield in 2007 is 7%, COS should be trading at $58 a share, 57% higher than current prices.

Note: (All figures are in U.S., unless otherwise stated. Also COS trades on the pink sheets as COSWF.pk, but I recommend buying the stock in Toronto where it trades as COS_U and trades on average 184,000 shares a day.)

Second Largest Reserve of Oil in the World

The oil sands in Alberta, Canada represent the second largest reserve of oil in the world. The established proven reserves are 175 billion barrels of oil. However, there is another 315 billion in oil potentially recoverable and another 1.7 trillion barrels of the resource in place (though it may not be economical to get that amount out). By comparison, Saudi Arabia has 260 billion barrels of oil in proven reserves.

The problem with oil sands is that it is expensive to get out of the ground. You need a Syncrude production plant (cost in the billions) to process the sands. Historically the cost has been higher than C$25 a barrel making production not very profitable. Only in the last 5 to 10 years has real progress been made to lower production costs. Last year cash costs were down to C$21 a barrel. And oil prices have been increasing in the last five years, making it a better proposition to invest in this high cost oil.

The most fascinating part of the oil sands reserve is its long life. COS currently estimates the life of its reserves at 35 years, but this is really an estimate on its plant, not its reserves. What is truly amazing is that you can own reserves that last almost indefinitely as the stats above show. I believe confusion and misunderstanding of these reserves are one of the reasons the price of COS is so low.

One last thought is the strategic geographic value of these reserves. The world’s oil reserves are now dominated by areas of the world inherently unstable and not necessarily friendly with the U.S. With any kind of disruption in Russia or the Middle East, the Canadian oil sands could represent a valuable and very important strategic source of oil for America.

With Partners like This

COS owns a 35.5% interest in the syncrude plant in Alberta. Its other owners are a who’s who of energy and refining companies: ExxonMobil (NYSE: XOM), ConnocoPhillips (NYSE: COP), PetroCanada (NYSE: PCZ), and Murphy Oil (NYSE: MUR). The expertise, experience and help from such partners are invaluable and reduce the risk of operational problems (though problems do occur as a coker failed last year temporarily reducing production).

Six Year Oil Futures Saudi Arabia Troubles & Chinese Demand

The six year futures price for oil is at $28.70. The implications of this for a high cost producer of crude cannot be understated. COS can now lock in a price 82% higher than its cash cost for the next six years.

It is important to figure out why the long term price of oil is so high. There are a number of reasons. I think it started with disappointing Iraqi oil production and the true state of Iraqi oil fields after the war was over. The hope of Iraq pumping oil to pre-1991 levels is misguided and will never happen. This is why after the war ended oil did not plummet as many expected.

Second, demand from Asia and primarily China is soaring. In the next ten years, demand from China is expected to double. The oil market is already tight and inventory of oil in North America is at record lows. The pressure on price of oil will only increase as China’s economy grows.

Third, Dan Simmons of Simmons & Company (analyst in 1990s predicted a peak and eventual decline in North American production of natural gas) said in December that based on his data and estimates Saudi Arabian production is at or near its peak. This may be another reason why oil continues to move higher. Check his presentation out:
http://www.iaee.org/documents/p03simmons.pdf

and this NY Times article:
http://www.nytimes.com/2004/02/24/business/24OIL.html

Also OPEC related countries, are content to see higher oil prices due to the decline in the dollar. I see oil as another way to hedge the decline in the U.S. Dollar.

Finally, a longer term look at the real (inflation adjusted) price of oil shows that oil is at the low end of its forty year trend. It may surprise people that $50 oil is not an unlikely event in the next couple of years if trends stay in effect.

Capacity Increase and Implications on Cash flow

The Syncrude plant is currently undergoing an expansion likely to be completed in mid 2005. Production should grow from 264 mpd (thousand barrels per day) to 350 mpd. I estimate full production won’t hit until 2006.

The Alberta Chamber of Resources outlined an “aggressive expansiond of the oil sands development that could result in a twofold increase in production from the oil sands to 5 million b/d, which could help meet about 16% of North American crude oil demand by 2030. With the local government so behind the development of the oil sands, the future is bright for further capacity increases.

Summary

At $27 a barrel for oil, in 2007, COS should produce C$675 million in free cash flow that should be paid out in dividends. That is C$7.75 a share in dividends. But as already shown the six year futures price for crude oil is nearly $2 a barrel higher than my estimate. A simple present value gives us a price north of $50 (using a 9% discount rate and the six year future of oil with a 2.3% increase in oil thereafter). In short, the stock is cheap just on the basis of its anticipated production increase. And considering current oil prices, it’s even cheaper. The real potential is what happens if oil continues its march higher. COS should easily double or triple in the next three to five years.

Catalyst

1) Increased U.S. ownership of this trust
2) Growing realization of problems with Saudi oil
3) Growing realization of massive dividends to flow in two years
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