The volume of crude oil production from sand has exploded during the past decade, but for the most part, investors have disregarded the sector as too speculative despite the presence of ExxonMobil (NYSE:XOM) and Imperial Oil (NYSEMKT:IMO). However, when Warren Buffett's Berkshire Hathaway waded into the sector, buying a small stake in Suncor Energy (NYSE:SU) last year, investors started to take note. Should you follow suit?
Mining oil sands is a relatively high-cost method of producing oil. For example, industry leader Suncor stated that the cost of oil sands production was around $35 per barrel for the third quarter. In comparison, based on figures from 2008, ExxonMobil and Chevron were able to produce their oil for an average cost of $10.50 and $8.70 per barrel, respectively .
However, technological developments have driven the cost of oil sands production lower during the past few decades, and this is set to continue.
Back in 1967, when Suncor became the world's first oil sands operation, the company's technology of choice for production was the drag-line and bucket wheel, which allowed to the company to produce 45,000 barrels of oil per day. By 1992, the drag-lines were replaced with trucks and hydraulic shovels, allowing the company to ramp up production to 100,000 barrels per day.
Now Suncor is introducing a new technology, the Autonomous Haulage System, which involves operating autonomous trucks in a continuous fashion. The greatest advantage for using this system is lower costs. Apparently the company won't save on manpower costs, however, as it seems the same number of operators are required in other roles.
Nonetheless, lower costs are expected to be realized from greater fuel efficiency, less wear and tear, and more volume hauled. If you've not seen the Autonomous Haulage System before, check out Rio Tinto's 40 truck fleet in Australia.
So, falling costs should continue to make Suncor's operations more profitable. It's not just Suncor that's benefiting.
Scale and progress
Imperial Oil, which is 70% owned by ExxonMobil, commenced production on its Kearl oil sands project last year and is planning another $7 billion oil sands facility just south of Kearl. As an example of how far things have come since Suncor first broke into the industry, it took Suncor from 1967 to 1992 to raise its production from 45,000 barrels per day to 100,000. Imperial's Kearl project is expected to produce 110,000 barrels of oil per day during its first year of operation. This is expected to rise to 345,000 barrels per day by 2020 -- that's 235,000 barrels of additional capacity in seven years.
Imperial's new $7 billion sands project just south of Kearl is also making use of new technologies. Imperial is planning to use a steam-assisted gravity drainage, or SAGD system to produce oil from its new site, a less invasive method of extraction compared to traditional mining. SAGD involves drilling two wells side by side and injecting steam to force heated bitumen out of the ground.
Meanwhile, Imperial and ExxonMobil are also buying up additional acreage from independent producers such as Conoco, which recently sold a 226,000-acre undeveloped property to the two international producers for $720 million. This reveals some interesting figures, most revealing of which is the fact that ExxonMobil and Imperial paid around $3,186 per acre for the land, about 25% more than the average price of similar deals based on data dating back to 2005.
Investors also need to consider the scale of these projects and the prospect that many oil sands projects could produce oil for longer than conventional fields. Suncor, for example, states that it has 6.7 billion barrels of oil reserves from sand. Meanwhile, Imperial's Kearl project has 4.6 billion barrels of recoverable resources.
In comparison, the world's fifth-largest offshore oilfield contains 6.5 billion barrels of recoverable resources. So, we can see what kind of scale these projects offer. Actually, both Suncor and Imperial have enough oil sands reserves to last for more than 30 years at current rates of production; these are very long-term assets.
Unfortunately, production of oil from oil sands is not a clean process, and this has attracted the attention of many environmental groups. There are also conflicts between native populations, in particular aboriginals, who according to the Canadian Press are preparing a long list of lawsuits to be brought against oil sands companies within the next year or so.
In addition, concerns about the long-term effects that mining has on the environment are increasing. The most recent study conducted by Environment Canada found that mercury levels around oil sand projects were up to 16 times higher than they should be. High levels of mercury, especially in drinking water can be extremely damaging to the health of humans and animals.
Overall, with the cost of producing oil from sand falling, the volume of production rising and a huge amount of reserves in place, Imperial and Suncor appear to be great plays on oil sands. That said, there are some concerning environmental issues associated with oil sands projects, so investors with a focus on ethics may want to choose a conventional play on the oil industry.