Canada is one of the best places in the world for oil and gas investment, but that doesn't mean the country doesn't have its fair share of energy production challenges. Oil investors in particular should pay close attention to three factors that will affect the country's production in both the long and short terms: the rising cost of production, growing opposition to the oil sands, and the potential inability to secure capital.
1. Rising costs, falling price of oil
Over the past 10 years, operating costs in Alberta's oil sands have climbed 250%. Ironically, part of the reason costs are rising is the success of production there. Shortages of material and skilled employees drive up costs, and the competition for those resources has never been higher as shale oil plays in North America are booming simultaneously.
According to energy consultancy Woods Mackenzie, the breakeven point of oil sands production varies from project to project. Depending on the extraction method, producers need the price of oil to range from $60 to $100 to break even.
Much to the dismay of oil sands producers, there are no guarantees: The price of oil is as volatile as ever. At the time of this writing, the WTI benchmark price for oil is down 13% from mid-September, sitting at around $85. Not to mention that much of this crude sells at a discount to the WTI index because of oversupply caused by prolific production in the American shale plays.
2. Opposition to resources
A big part of the oversupply problem is due to a lack of pipeline infrastructure out of the oil sands. TransCanada's (NYSE:TRP) Keystone XL is probably the most famous of the stalled projects, but midstream heavyweights Kinder Morgan Energy Partners (NYSE: KMP) and Enbridge (NYSE:ENB) are also faced with project delays that could significantly affect future oil sands production.
The opposition facing these projects is quite serious, and disgruntled citizens are not the only factor. Canada's National Energy Board will also play a role in the decision-making process, and though many expect these projects to ultimately gain approval, there is no telling how long that might take. The mere uncertainty of pipeline capacity that comes with this "will it or won't it be approved" situation makes it impossible to rule out a short-term production scale-back on high cost oil sands projects.
3. Inability to secure capital
To put it simply, Canada just doesn't have the money to develop its resources. Canadian Natural Resources Minister Joe Oliver was in the news last month discussing China's CNOOC (NYSE:CEO) and its attempted buyout of Nexen (NYSE: NXY). Oliver basically laid out the reality that the potential for resource development in Canada is so great, there is no way the country can go it alone. Roughly $660 billion will be poured into more than 600 Canadian energy projects over the next 10 years, and Oliver expects that number to climb.
The real problem, however, is that while there are plenty of companies that want to pour capital into Canada, they are, like CNOOC, increasingly likely to be foreign state-owned enterprises. And Canada has begun to balk at the notion that foreign governments should have access to, and ownership of, Canadian resources.
The Canadian government recently struck down a deal between Petronas, Malaysia's state-owned oil company, and Progress Energy. Petronas has extended its deadline for the bid in an effort to revise its proposal and ultimately win approval. That deal is worth $5.2 billion. The CNOOC/Nexen deal is worth considerably more, about $15 billion, and the Canadian government is expected to issue its decision on Nov. 11.
At the same time, Stephen Harper's government will issue an update to the Investment Canada Act, presumably clarifying the rules for foreign investment in the country. The importance of these guidelines will only grow over time, as Canada continues to need money and foreign governments continue to need resources .
Canada is still a very strong market, with plenty of potential. However, these are real risks that should be monitored, and investors must be careful banking on an industry that isn't as straightforward as perhaps it has been in the past.