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A Major New Tailwind for the Canadian Oil Sands

By Frank Curzio, editor, Small Stock Specialist
Friday, June 11, 2010

The U.S. government is set to kill offshore drilling... and hand a gift to a niche group of energy producers.
For more than a month, people all over the world have watched the Deepwater Horizon debacle develop into one of the worst environmental disasters of all time.
BP, the oil giant operating the rig, has tried several methods to plug the hole. Thus far, none have worked. Its next step is to drill two "relief wells" on the sides of the existing well to intercept the oil. Once the oil is intercepted, the leak will be plugged.
There's a high probability the relief wells will work. By August, the leak should be contained.
However, looking ahead, I see terrible times for the offshore industry. That's great news for Canada's oil sands. Let me explain...
On May 27, the government suspended offshore exploratory drilling for at least six months. After that ban is lifted, costs will surge as new mandatory safety measures are implemented. Oil producers may have to drill relief wells next to existing wells, also resulting in increased costs.
Offshore drillers will see huge tax hikes. Insurance for rigs will skyrocket. It may not be worth it (based on costs and politics) for Big Oil to allocate tens of millions of dollars into offshore drilling. It'll be too risky to put money to work in this space.
And for this to happen in the U.S., it's especially problematic... According to the Energy Information Administration (EIA), the U.S. consumes 20% of the world's oil. It only has 2% of the world's reserves, including deposits in the Gulf of Mexico.
The U.S. is the largest consumer of oil in the world, using about 6.8 billion barrels annually. Earlier this year, the EIA predicted expanded areas for U.S. offshore drilling will yield up to 63 billion barrels of oil. With the new moratorium in place, we know that drilling won't happen for a long time. That means more than nine years of U.S. oil production could be in jeopardy (63 billion barrels/6.8 billion barrels a year = 9.2 years) due to an increase in offshore regulation.
To feed our appetite for oil, we must tap another source. Sure, we could import more oil from the Middle East. We can also try to increase imports from Mexico and Venezuela. However, the easiest solution is to tap reserves in Canada's oil sands.
Most Americans don't know it, but Canada is already our largest supplier of foreign oil. They have monstrous deposits trapped in layers of silt and sand. Canada's oil sands region holds over 173 billion barrels of oil reserves... second in the world behind Saudi Arabia.
That oil is right on our doorstep, in a country much more politically stable than our other oil suppliers (Mexico, Venezuela, Nigeria, the Middle East). We already have pipelines in place to transport oil into the U.S. And it's cheaper to get oil from the oil sands than to get it from deepwater oil areas.
But like most of the world's large oil patches, anyone interested here will have to compete with China...
On May 13, a subsidiary of China Investment Corporation (CIC) gave Penn West Energy Partners $1.8 billion to develop its oil sands assets in Alberta.
This followed two other major deals over the past 12 months. Sinopec and PetroChina, two of the largest oil producers in China, invested a total of $6.5 billion in Canadian companies Athabasca Oil Sands and Syncrude.
So we've got a huge headwind for offshore oil... and a tailwind from China for the oil sands.
Both these trends will benefit Canada's large-cap oil producers like Suncor (SU) and Petro-Canada (PCZ). But as someone who analyzes smaller, more volatile, under-$10 stocks, I'm more interested in infrastructure providers.
The big players need these companies to build roads, remove and process waste, and provide labor. Infrastructure firms that have been in the oil sands region for awhile and have good ties with the government are your best bets.
Good investing,

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Market Notes

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Market Watch
Symbol Price
S&P 500 1091.60 +0.4% +15.5%
Oil 34.23 -1.6% -13.7%
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Biotech 17.93 +1.0% +31.6%
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