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Oil's $120/Barrel Beer Goggles

By Matthew McCall

Tickers in this Article: SU, IMO, XOM, COS-UN.TO, C.COS.U, OPC.TO, NXY

When the headlines read "Oil at $80", investors were amazed. We were stunned again when we read "Oil Cracks the Century Mark" and then astounded to see "Oil Closes Above $125 For First Time Ever".

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Well, with oil planted firmly above the $100 per-barrel mark for nearly three consecutive months, investors must now realize this is the new norm. We can all stop acting surprised that oil is in the triple-digits and adjust our portfolios accordingly. The question is how do we profit from $120 oil?

Welcome To Saudi Alberta
In 2007, Alberta's Energy and Utilities Board estimated there to be approximately 173 billion barrels of crude bitumen in the three Alberta oil sands areas. Considering the price of oil is now above $120, the amount of recoverable crude rises because it will cover the cost of removing it from the ground. The 173 billion barrel number puts Canada behind only Saudi Arabia in terms of reserves per country.

The Canadian oil sands become more attractive every time the price of crude moves higher or tensions rise in the Middle East. From the viewpoint of the U.S., not only is the proximity a benefit, but so is the stable government of Canada. The problem for the U.S. is that it's not the only country interested in tapping into the oil sands. A pipeline, called the Gateway Project, will transport crude from the oil sands to the west coast of British Columbia, which will then be shipped across the Pacific to Asian markets such as China. (Before jumping into energy stocks, take a look at Oil And Gas Industry Primer.)

Winners of the Oil Sands Boom
Suncor Energy (NYSE:SU)
The first company in the oil sands was the Canada-based Suncor Energy in 1967. Since that time, the company has been a leader in the area and the stock price has reflected its successes. Over the last 14 years the stock has risen more than 4,500% and hit a new all-time high in May 2008 at $128.50. In April 2008, Suncor reported production of approximately 223,000 barrels per day in its oil sands facility. The target for 2008 is 275,000-285,000, and the long-term plan is for Suncor to produce 500,000 barrels per day. The company is clearly one of the leaders in the oil sands and could be considered a core holding for an investor looking to build an oil sands portfolio.

Imperial Oil (AMEX:IMO)
Canada's largest petroleum company in Imperial Oil. It is controlled by Exxon Mobil (NYSE:XOM) through ownership of nearly 70% of the stock. Imperial Oil gets exposure to the oil sands through a joint venture called the Syncrude Project (operated by Syncrude Canada Ltd), which is 25% owned by Imperial Oil. The most recent earnings report (May 2008) was disappointing and hurt the stock for a few days. Revenue was up 25% to US$7.3 billion but net income was down to 76 cents per share from 82 cents one year earlier. It's exposure to the refining side of the energy business has hurt profits and kept the stock price from breaking out to new highs. That said, the exposure through Syncrude and more multi-billion dollar oil sands deals in the future make Imperial Oil an attractive play.

Investors that would like to play the Syncrude joint venture could also buy the Canadian Oil Sands Trust (TSX:C.COS.U). The trust is publicly traded on the Toronto Stock Exchange and holds the largest interest in Syncrude at 36.7%.

OPTI Canada (TSX:OPC.TO)
For a more unique play on the oil sands there is OPTI Canada. The company uses a less costly way of processing sweet crude called OrCrude technology, which eliminates the need for natural gas. The company is currently in a 50-50 joint venture with Nexen (NYSE:NXY), another oil sands play, in developing the Long Lake Project in Northern Alberta. The stock has been on a tear in 2008, rallying over 30% in the first four months. OPTI is a much smaller company and more aggressive play for investors.

Bottom Line
The danger for oil sands investments is that if the price of crude falls, the attractiveness of the area diminishes. While oil remains above $100 per barrel it makes sense for investors to pour money into the oil sands because it is cost effective. Though unlikely, if oil fell to $50 per barrel it would obviously hurt all related stocks. In the end, the cost of getting the oil out of the sand and the environmental concerns are the two issues I have with the oil sands. But with oil at $125 both of my concerns are quickly forgotten.

To learn other ways to make money off the high price of oil, see Peak Oil: What To Do When The Wells Run Dry.

By Matthew McCall

Matthew McCall is the president of Penn Financial Group, LLC, a registered investment advisor. He also publishes two newsletters, The ETF Bulletin and The PFG Letter as well as other educational material. As a registered investment advisor, he manages clients' investments based on their specific goals and objectives.

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