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Mathew Ingram

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Staying power

Mathew Ingram

TORONTO (GlobeinvestorGOLD)—Canada's decision to ratify the Kyoto climate agreement has thrown a king-sized wrench into the multibillion-dollar development of Alberta's oil sands, and just as they were starting to get some recognition after decades of being dismissed as a high-cost venture with little promise. Some new entrants, such as Canadian Natural Resources, have scaled back their plans, while others have said they will likely put them on hold.

In the end, however, the oil sands will be developed and expanded, even if the Kyoto protocol delays the process, for the simple reason that the world needs that oil. In particular, the United States needs it and there are few places that can supply it. If tensions in the Middle East continue to increase, the attractiveness of the oil sands will only rise.

SU-T 1-year chartFor investors, there are a number of ways to play this resource. One of the most obvious is to buy shares of a company that has some exposure to the sands, and the one at the top of that list is Suncor Energy Inc., the company that first showed it was possible to make money in the oil sands after decades of billion-dollar losses. Suncor doubled in size last year by adding a new mine, making it the second-largest producer, just behind Syncrude, a joint venture partnership that includes Petro-Canada, Imperial Oil, Nexen and others.

One of the attractions with oil sands companies is that they don't have to worry about a major risk factor that afflicts the traditional oil business: finding and development costs, something that can easily sink a small or even medium-sized producer. Oil sands producers don't have any F&D costs, because the oil is right there; all they have to do is process it. Unfortunately, there are already more than enough costs associated with that.

Calculating the costs

In fact, cost overruns have hit both Suncor and Syncrude fairly hard in the past year, as both companies expanded. In part, the cost increase is a result of a lack of manpower, which has driven up the price of labour and will likely keep costs high well into next year. Oil prices have remained relatively high as well, but not enough to compensate. Suncor said that its operating costs for the year will likely be about $13 (U.S.) per barrel, much higher than its target of $10 per barrel.

COS.UN-T 1-year chartHigh costs have also had an impact on the other favoured way of playing the oil sands: the Canadian Oil Sands Trust, which was formed from the merger of Canadian Oil Sands Trust and Athabasca Oil Sands last year and is the second-largest stakeholder in Syncrude, after Imperial Oil. Although the trust format has some benefits for shareholders that direct share ownership doesn't, there are some drawbacks too. For more, read Rob Carrick's column on Canadian oil and gas trusts.

One of the benefits of the trust is that it is totally focused on the oil sands, so you get 100 per cent leverage. While Suncor isn't as broadly-based as some of the other "integrated" producers, it does have a retail arm that operates Sunoco gasoline stations and makes it less of a pure oil sands play. Trusts are also treated differently by Revenue Canada than common shares because of the payouts that unitholders receive. They are considered, in part, a return of capital rather than a dividend and this can be attractive to some investors.

At the same time, however, the payout from Canadian Oil Sands Trust has also decreased recently as a result of Syncrude's higher costs. According to the trust, operating costs are expected to be $16.50 a barrel, substantially higher than Suncor's. Despite higher production, the trust only paid out $1.50 per unit in the first nine months of last year, compared with $2.25 in the same period a year earlier, a drop of over 30 per cent. And the trust has said that higher costs could extend through most of next year as Syncrude's expansion continues.

In the end, it boils down to which is the lesser of two evils: Suncor is not as pure a play on the oil sands, and it doesn't offer tax advantages. Its stock is also not cheap, trading at more than 20 times earnings, which is at the high end of the industry range. However, the trust has higher costs and will likely have them for longer, since it is in the middle of an expansion while Suncor is finished, and that will affect its distributions.

All things considered, Suncor looks like the better bet.

Mathew Ingram joined The Globe and Mail's online news team in June of 2000, after spending four years as the Western business columnist, based in Calgary.

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