News Analysis date published New: 
Friday, October 21, 2011 - 11:00
New Date created: 
Tuesday, November 1, 2011 - 10:42
New Date last updated: 
Friday, October 21, 2011 - 11:00

2 Stocks for a Region with 175 BILLION Barrels of Oil

Friday, October 21, 2011 11:00 AM

If you've read the headlines lately, then you probably know that the future for "green" energy isn't looking too bright these days.

The Solyndra scandal, in which the U.S. government loaned $500 million of stimulus money to the solar-panel firm -- which later went belly-up -- has budget hawks crying foul. European countries, Germany in particular, have long been supporters of wind and solar through generous subsidies. That situation is tenuous now, thanks to a new era of austerity sweeping the continent. The Chinese are flooding the market with cheap solar panels, which is hindering the competitiveness of U.S. firms. And biodiesel isn't looking too good either, as an increasing number of experts have begun to question the fuel's viability.

What does this mean for investors? It means, given the headwinds, now's probably not the time to invest in alternative energy. And while it would be nice for one (or more) of these alternatives to pan out, it's just too risky for most investors at this point.

In the meantime, it looks like we're stuck with fossil fuels.

According experts, worldwide demand for oil is forecast to grow 20% to 104 million barrels a day. An industrialized China and India will be major contributors to this increased demand.

But with rising demand, oil supplies are dwindling. Output from leading oil producers, such as Saudi Arabia and Kuwait, is declining. Supply-demand imbalances are especially acute for the United States, which produces roughly 10 million barrels of oil a day but consumes nearly 19 million barrels daily.

The good news is there has been a major new oil discovery. Estimated reserves are sufficient to supply the world's energy needs for the next 100 years. Haven't heard about it? I'll give you a hint: it's closer to home than you think. This new discovery is not in the Middle East or even in Africa. It lies north of the U.S. border, in the Canadian province of Alberta.

Alberta oil fields are estimated to hold more than 175 billion barrels of recoverable oil, which ranks Canada second only to Saudi Arabia in proven reserves. But there's a catch. Canada's resource isn't conventional oil. Canada's reserves are "oil sands," which contain bitumen or, simply put, oil in its solid state.

So why don't we hear more about the "next great oil bonanza" to the north? There are a few reasons. First, much of the oil sands are recovered from open pit mining, which involves clearing many square miles of land and removing the top layers of earth to expose the oil sands. This method is considered to be fairly harmful to the environment. Second, the other for recovering oil sands involves injecting steam beneath the earth's surface in order to separate the bitumen from the sand and bring it to the surface. This method is much costlier, but experts estimate somewhere around 70% of the oil sands are too deep, and can only be recovered in this way.

Either way, both methods are costly (more on that later). And when the price of oil falls like it has recently, the chatter about oil sands fades into the background. But unless and until either a) alternative energy becomes economically viable or b) the world stops running out of "cheap" oil, it looks like oil sands will become more and more of a necessity in the future.

The third reason why you're not hearing about oil sands much, simply put, is because production is still in its early phases. Together, all of Alberta's oil sands are already producing more than 1 million barrels of oil a day. But the good news for investors is that's about to change. This number should continue to rise as new extraction technologies come into play. Most experts say production could reach 4 million barrels a day within a decade. This would make Canada the world's largest oil producer.

Given this promising scenario, investors looking for a long-term energy investment could take a stake in Canada's vast untapped oil wealth by owning shares of companies that are extracting oil from the sands. Here are two companies that own significant oil-sand assets and generate the strong cash flow needed to explore these resources.

Suncor Energy (NYSE: SU)
Suncor is the largest energy company in Canada. The bulk of the company's revenue comes from oil sands operations, which produce about 520,000 barrels of oil a day. Suncor is an integrated energy company, so it also owns natural-gas wells and refineries.

Rising oil prices are helping Suncor produce record cash flow this year. In the first six months of 2011 alone, cash flow improved to $4.4 billion a 58% increase compared with the first half of 2010. Operating earnings more than doubled to $2.5 billion in the same period.

According to CEO Rick George, it costs Suncor between $18 and $40 a barrel to process oil sands. The company is profitable when oil is at $70 a barrel, and when crude oil prices exceed $100 like they did in this year's June quarter, Suncor's earnings soar.

In addition, production is picking up, following the completion of several planned maintenance projects. These projects will help the company boost production to more than 1 million barrels of oil a day by 2020. Suncor expects oil sands production to grow by 10%, and companywide production to grow by 8%, in each of the next 10 years.

Suncor has delivered 23% annualized returns to shareholders since 1992. The stock pays a 1.5% dividend that is likely to grow in line with rising cash flow. Shares trade at a forward price-to-earnings (P/E) multiple of 8.

Canadian Natural Resources (NYSE: CNQ)

Canadian Natural Resources owns the Horizon oil sands project in Alberta, which is thought to contain 2.9 billion barrels of oil. In 2010, Horizon's output totaled 91,000 barrels of oil a day, but a fire in January damaged operations and halted production for several months. The company resumed production in August at 75,000 barrels a day, which rose to 110,000 barrels a day in September. Plans are to gradually increase production to 500,000 barrels a day in the next several years.

The production slowdown caused Canadian Natural's cash flow in the first half of the year to decline to $2.6 billion, a 16% decline compared with the $3.1 billion generated in the same period last year. However, production is back on track now and the company plans to extend its impressive record of output growth. In the past 10 years, Canadian Natural has expanded production 6% a year to 600,000 barrels per day (this includes production of oil sands and crude), improved cash flow 11% a year to $5 a share, and hiked dividends 22% a year to a current $0.36.

Analysts look for Canadian Natural to generate 15% a year in earnings-per-share (EPS) growth in the next five years. Shares are down 16% this year, currently trading at roughly $32, and carry a multiple of about 9 times earnings.

Risks to Consider: Both of these companies may get hurt by energy price swings. Environmental issues are also a factor. Oil sands stocks declined after the European Commission said it considered oil sands a dirtier fuel source than conventional crude. At present, the United States and Asia are the only buyers of oil sands fuel.

Action to take --> Conservative investors may prefer Suncor, since this company has large, already-established oil sands operations and plenty of cash flow to support any downside that may occur. Canadian Natural is still early in the process of rebuilding production, but may offer more growth potential for more aggressive investors. In either case, the two companies are great plays in this unconventional energy segment.

Lisa Springer does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.