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Where to Invest to Play the Keystone XL

By Arjun Sreekumar - Mar 11, 2013 at 11:33AM

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Could Keystone XL be the solution to tap Canada’s vast reserves of recoverable oil sands?

America's vast reserves of unconventional oil and gas are well documented. But less attention has been paid to Canada's energy reserves, which are nothing to scoff at, either. These reserves are mainly in the form of oil sands -- a dirty, viscous mixture from which heavy crude oil can be extracted.

While deriving crude from oil sands is a complicated and expensive procedure, Canada's huge reserves of recoverable oil sands have the potential to contribute strongly to Canadian and U.S. energy security for decades to come, as well as help the world meet our global energy challenge.

A primer on Canada's oil sands
Oil sands, often referred to as tar sands, are viscous mixtures of sand or clay, water, and a heavy substance known as bitumen. Bitumen is so heavy that it doesn't flow unless it's heated or diluted. At room temperature, some describe its appearance and physical characteristics as resembling cold molasses.

Crude extracted from Canada's oil sands is characterized by an extremely low API gravity -- a measure of its relative density -- of just 8 degrees. That means it is so heavy it actually sinks in water, unlike most other crude oils, which have API gravities greater than 10 degrees and float in water.

While the stuff is much more difficult to extract and requires more sophisticated equipment to refine, it's still oil. And Canada has tons of it.

Alberta's (black) gold mine
In fact, Alberta lays claim to the world's third largest reserves of recoverable oil sands. The three major areas in the Canadian province contain an estimated 1.84 trillion barrels of crude bitumen in place. A little under a tenth of this volume -- approximately 170 billion barrels -- is expected to be recoverable using currently available technologies.

There are two primary methods by which this sticky, heavy oil is recovered. It can be mined and transported via trucks to facilities that separate the bitumen from the sand, or it can be extracted via in-situ methods, which involve using steam to separate the bitumen from sand underground, allowing it to then be pumped to the surface. The former method is more commonly used for oil sands near the surface, while the latter is employed mainly for oil sands deep beneath the surface.

Going forward, Canadian oil sands production is expected to rise steadily over the coming decades. According to an annual report published in June of last year by the Canadian Association of Petroleum Producers (CAPP), production from Canada's oil sands will nearly double by the end of this decade, going from 1.6 million barrels per day in 2011 to a projected 3.1 million barrels per day by 2020. By 2030, CAPP reckons oil sands production will hit a staggering 5 million barrels per day.

Economic and other benefits to the US
As oil sands production grows, it is expected to confer major benefits not only to oil and gas producers, railroad companies, and midstream operators, but also to the broader U.S. economy and its energy security.

After all, Canada is currently the biggest single exporter of crude oil to the U.S.; the vast majority of Canadian crude oil production is destined for American markets. With high expectations for future production growth, Canada's oil sands have the massive potential to contribute to America's future energy security by providing greater reliability of fuel supply. 

In addition to improved energy security, the economic potential may be extraordinary, as well. According to a study by the Canadian Energy Research Institute (CERI), Canadian oil sands production could lead to nearly 350,000 new jobs in the U.S. between 2011 and 2015. In addition, as production from and investment in Canada's oil sands increases, it boosts demand for American goods and services, leading to a projected $34 billion rise in U.S. GDP in 2015 and $42 billion in 2025, according to the CERI study. 

Hurdles remain
But despite these optimistic projections, transportation remains a major issue for Alberta's oil sands producers. Due largely to limited outbound pipeline capacity, oil sands crude trades at a massive discount to other North American crudes, with Western Canada Select (WCS) having reached a record $42.50 a barrel discount to the primary American crude oil benchmark, West Texas Intermediate (WTI), at the end of 2012.

This has taken a toll on many oil sands producers' profits. For instance, Suncor Energy (SU -6.58%), the biggest Canadian oil sands producer by output, reported fourth-quarter operating earnings that were nearly a third less than the company's earnings in the year-earlier quarter due largely to lower average price realizations for oil sands crude. While the price of WCS has risen sharply in recent weeks, oil sands producers are still forecasting a bleaker year ahead.

For instance, Cenovus Energy (CVE -6.91%) lowered its guidance for cash flow this year from CA$3.7 billion to CA$3.1 billion due to  depressed WCS prices. To mitigate the impact of depressed WCS pricing, many oil sands producers are aggressively cutting costs.

Talisman Energy (NYSE: TAL), Canada's sixth largest independent oil producer, slashed its capital budget forecast for the year by 25%, from an expected $4 billion last year to $3 billion. And Canadian Natural Resources (CNQ -6.28%) has said it expects to cut spending on thermal-sands production, a process that uses heat to separate bitumen from sand underground.

Is Keystone XL the solution?
Going forward, one of the best ways to bring oil sands crude prices closer in line with prices for other North American grades of crude oil would be to improve outbound pipeline capacity from the region. Constructing the northern portion of the Keystone XL pipeline seems the most obvious solution.

The proposed pipeline, operated by TransCanada (TRP -2.49%), would deliver as much as 830,000 barrels of crude oil a day from Hardisty, Alberta, to Steele City, Nebraska. Though its proposed construction has faced significant opposition from environmental groups, a recent state department study validated its potential economic benefits and downplayed its environmental risks.

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Stocks Mentioned

Canadian Natural Resources Limited Stock Quote
Canadian Natural Resources Limited
$51.33 (-6.28%) $-3.44
TC Energy Corporation Stock Quote
TC Energy Corporation
$51.30 (-2.49%) $-1.31
Suncor Energy Inc. Stock Quote
Suncor Energy Inc.
$33.23 (-6.58%) $-2.34
Cenovus Energy Inc. Stock Quote
Cenovus Energy Inc.
$17.64 (-6.91%) $-1.31

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