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Why Are Some Of The World's Most Astute Investors Turning To Oil Sands Stocks?

While Wall Street's focus has been predominantly on shale oil plays, Alberta's bitumen carbonates and oil sands have been, on the whole, relatively ignored. This has furnished forward thinkers with an excellent opportunity, provided they are willing to take a contrarian viewpoint and remain patient. As I point out later in this article, some of the world's top investors have been turning to oil sands stocks in recent months, and with good reason.

A handful of transitory reasons illuminate why bitumen producers have temporarily lost mainstream investor favor relative to shale oil E&P companies:

Number one, shale oil plays have received a rush of positive media-exposure, largely because they are a domestic sensation as opposed to an Alberta sensation. This has legitimately garnered a fair share of the press's ink. Enthusiastic coverage has spurred strong retail buying in those E&P companies with substantial stakes in the Eagle Ford and Bakken formations. By the same token, negative press has bedeviled the bitumen players, whether from overblown environmental issues to bottlenecks in distribution to short-lived delays in pipelines. But negative press is an opportunity for contrarians.

Number two, even though the multi-stage, horizontal frack plays in shale oil formations demand large financial investments, these are minor in comparison to in-situ or open-pit bitumen recovery operations. A shale oil well may require five or even ten million, but an in-situ or open-pit bitumen producer must spend that amount many times over for an in-situ thermal operation. I would argue, however, that the risk is much smaller for a bitumen producer; he generally knows what he's got before committing, whereas a shale operator oftentimes has no idea whether the well is economic until after fracking. The comparatively large start-up investment for the bitumen producer is offset by the reduced risk.

Number three, bitumen doesn't flow, while shale oil does. Thermal treatment is a hassle. Despite the fact that a large portion of bitumen producers enjoy substantially lower costs per barrel than typical shale oil plays, the perception lingers that thermal treatment must always be pricey on a per unit basis. But after the initial infrastructure is established, it's comparable to a leaching operation -- you're able to relax somewhat and allow the process to work.

Number four, pipeline capacity has been usurped by shale oil production. What this means is that Alberta bitumen has been partly cut off from the most important leg of the continental oil distribution network. Due to this, there is a substantial price disparity between what Alberta's producers are currently receiving versus what they might be receiving if they were able to move their product to US refineries. This has negatively impacted the market capitalizations of all oil sands stocks. But the problem is easing thanks to additional capacity currently in the planning and building stage. In the industry, no one thinks the bottleneck is permanent. It was, in fact, revealed recently that Enbridge is doubling the volume of one of its pipelines into the States, which will be partly used to move heavy oil. Political approval is unnecessary since the pipeline already exists.

Number five, a minority of institutional and retail investors think long term, instead becoming fixated on the very short term. Their desire is NOW (shale oil) production versus LATER (bitumen) production. Granted, no one can see exactly how long strong oil prices will endure, which means longer-term projects carry a larger commodity-price risk. Beyond that, however, there is a lack of forbearance that causes many fund managers and investors to ignore longer-term prospects even when superb. This inclination is aggravated by political and judicial hiccups, which make long-term planning more risky.

While this isn't an exhaustive list, the point has hopefully been made. Astute investors should recognize the value in Alberta's bitumen developers, particularly relative to their shale oil counterparts. Warren Buffett is now reported to own 1% of Suncor (SU). Steve Cohen and T. Boone Pickens have also taken positions. And now we've learned that George Soros has been getting into the oil sands as well. Should you?

According to a report, Alberta's oil sands producers are producing oil at a lower cost than their peers in the Eagle Ford and Bakken shale formations. Yet Alberta producers are trading at only about 1.5 times compared to US operators which are trading at about 2.5 times. Wall Street hasn't taken advantage of the disparity yet, which means investors have a window of opportunity.

Plus, it should be noted that a large portion of Bakken wells drop-off relatively rapidly, some declining by nearly 70 percent in their first year. Some analysts are predicting an enormous reduction in production across several US shale oil formations inside the next five years. In comparison to Alberta's oil sands operations which frequently have reserves in excess of 40 years, shale oil deposits can run dry relatively quickly. This is one more reason why investors should consider Alberta's bitumen companies.

And while I highly recommend several oil sands stocks (including Baytex Energy (BTE) for example, which cold-produces a large portion of its bitumen) I would also point out that bitumen-from-carbonates offers even greater upside (and greater risk) than the in-situ or open-pit bitumen-from-sands project. This is why Rick George (former head of Suncor's and regarded as one of the chief oil-sands veterans) joined the board of a top carbonate player (OSUM, which is private). It's also why Glenn Schmidt (who sold his oil-sands company to Total SA for more than a billion dollars) established Laricina Energy -- the dominant carbonates player (private as well). Investors include Goldman Sachs, Blackstone Capital and Warburg Pincus.

As for publicly-traded companies with strong bitumen-carbonates positions, there are at least two: Athabasca Oil (ATH:TSX) and Strata Oil (SOIGF). Beyond that, Husky Energy (HSE:TSX) and Royal Dutch Shell are massive players in Alberta's carbonate-hosted bitumen plays as well.

I believe that carbonate-hosted bitumen players are developing a prize which could be "the next oil sands" -- constituting many billions of barrels of production and, in the end, revenue in the trillions. As with the majority of investments, the largest gains will go to those with the foresight and risk-tolerance to position themselves early. I provide more detailed guidance on oil sands stocks in my free Sterling Intelligence email letter.


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