Does Canada’s Oil Sands Industry Make Economic Sense?

Lower-than-expected development costs for oil sands projects don’t tell the full story regarding the industry’s vulnerability to price shocks and price differentials.

| More on:
The Motley Fool

You’re reading a free article with opinions that may differ from The Motley Fool’s premium investing services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

Recently, French integrated global energy major Total SA (NYSE: TOT) suspended its $11 billion Joslyn oil sands project because of rising costs, transportation bottlenecks, and an uncertain outlook for crude prices.

How expensive are oil sands projects to develop?

In contrast, a report from Bank  of Nova Scotia (TSX: BNS)(NYSE:BNS) earlier this year indicated that the development costs for the oil sands are among some of the lowest for crude in North America. The report found the lowest breakeven costs were in the Bakken in South Dakota at $44.30 per barrel, while the highest were in the Permian shale in Texas at $81 per barrel.

In fact, the average breakeven cost for U.S. oil production is $72 per barrel; Canadian oil production averages between $63 and $65 per barrel, with the oil sands averaging $65 per barrel. This makes the oil sands’ average breakeven price lower than Canadian light crude production, which was $66 per barrel, and lower than a number of U.S. oil plays, including the Permian and Nioabrara.

This is in stark contrast to claims by oil sands operators that rising costs, volatile crude prices, and lack of pipeline capacity are making projects too expensive to develop. But these costs don’t tell the full story alone. A key issue for oil sands operators is that heavy crude produced from the oil sands trades at a considerable discount to West Texas Intermediate.

It was only six months ago that Canadian heavy crude was trading at a discount to WTI of around 40%, but this has narrowed over that period to 26%. There are fears among industry insiders and analysts that this price differential will widen as pipeline capacity constraints and growing U.S. crude production reduce demand for Canadian crude.

This discount to WTI sees players in the patch reporting some of the lowest operating netbacks per barrel of crude produced, and it is this figure that measures the profitability of a specific project and a company’s oil producing operations. The lower netbacks obtained from the oil sands become apparent when comparing the netbacks for various projects at Husky Energy (TSX: HSE). For the first quarter of 2014, Husky was able to generate an operating netback of $35.99 per barrel compared to $52.75 for its conventional medium oil and $41.86 for its conventional heavy oil.

This gave Husky a company-wide operating netback of $44.81 per barrel for that period, while one of the largest oil sands operators in the patch, Canadian Natural Resources (TSX: CNQ)(NYSE: CNQ), reported an operating netback for the same period of $34.61 per barrel. Another major player in the oil sands industry, Cenovus (TSX: CVE)(NYSE: CVE), reported an operating netback of $44.41 for the same period.

Light oil producers Crescent Point Energy (TSX: CPG)(NYSE; CPG) and Lightstream Resources (TSX: LTS), both reported significantly higher netbacks of $52.65 and $56.11 respectively.

This highlights the relatively thin margins oil sands operators are able to generate for each barrel of crude produced. As a result, both rising costs and the discount between Canadian heavy crude and WTI (which is expected to deepen) will significantly impact the profitability of oil sands projects.

How do investors manage this risk?

At first glance, the obvious solution for investors is to invest only in those companies with production predominantly weighted to Canadian light oil, but this is simplistic at best because there are a range of other factors at play. Key among these is growing downward pressure on the price of Canadian light crude as U.S. domestic light crude production grows and the demand for energy imports wanes. Already over the last year, Edmonton Par, or Canadian light crude, has seen its discount to WTI deepen by 16%.

A key strategy for managing this risk is to invest in integrated energy majors that have a geographically diverse range of assets and refining operations that allow them to better manage the price spread between different types of crude. These companies also have deep pockets, and when their possession of both downstream and upstream operations is taken into consideration, they are well positioned to remain profitable should there be any concerted downturn in crude prices.

Obviously, risk-averse investors can’t go past the majors including Suncor Energy (TSX: SU)(NYSE: SU), Canadian Natural Resources, and Husky, because of their solid operations, diversified asset bases, ongoing solid profitability, refining operations, and sustainable dividend payments. Due to higher realized oil prices and the narrowing discount between Canadian heavy crude and WTI, all three reported solid financial results in the first quarter of 2014, with Suncor posting record results for the quarter.

Should you invest $1,000 in Canadian Natural Resources right now?

Before you buy stock in Canadian Natural Resources, consider this:

The Motley Fool Stock Advisor Canada analyst team just identified what they believe are the Top Stocks for 2025 and Beyond for investors to buy now… and Canadian Natural Resources wasn’t one of them. The Top Stocks that made the cut could potentially produce monster returns in the coming years.

Consider MercadoLibre, which we first recommended on January 8, 2014 ... if you invested $1,000 in the “eBay of Latin America” at the time of our recommendation, you’d have $20,697.16!*

Stock Advisor Canada provides investors with an easy-to-follow blueprint for success, including guidance on building a portfolio, regular updates from analysts, and two new stock picks each month – one from Canada and one from the U.S. The Stock Advisor Canada service has outperformed the return of S&P/TSX Composite Index by 29 percentage points since 2013*.

See the Top Stocks * Returns as of 3/20/25

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool contributor Matt Smith does not own shares of any companies mentioned.

Confidently Navigate Market Volatility: Claim Your Free Report!

Feeling uneasy about the ups and downs of the stock market lately? You’re not alone. At The Motley Fool Canada, we get it — and we’re here to help. We’ve crafted an essential guide designed to help you through these uncertain times: "5-Step Checklist: How to Prepare Your Portfolio for Volatility."

Don't miss out on this opportunity for peace of mind. Just click below to learn how to receive your complimentary report today!

Get Our Free Report Today

More on Investing

A red umbrella stands higher than a crowd of black umbrellas.
Stocks for Beginners

2 All-Weather TSX Stocks You Can Buy Anytime

Are you putting your investments on the back burner due to market uncertainties? Consider investing in these all-weather stocks.

Read more »

Canadian dollars are printed
Dividend Stocks

How I’d Turn $12,000 in My TFSA Into a Money-Making Machine for Long-Term Growth

With $12,000 spread across high-quality dividend stocks like CNQ and goeasy, you could build a TFSA portfolio that does more…

Read more »

TFSA (Tax free savings account) acronym on wooden cubes on the background of stacks of coins
Investing

Where I’d Put $12,000 in Canadian Stocks for Permanent TFSA Holdings

Got $12,000 to invest in your TFSA? Here are four Canadian stocks to buy and hold for decades inside a…

Read more »

construction workers talk on the job site
Metals and Mining Stocks

2 Canadian Mining Stocks to Buy and Hold in Your TFSA for Long-Term Resource Exposure

Cameco (TSX:CCO) and another miner could boom again in 2025.

Read more »

tsx today
Stock Market

TSX Today: What to Watch for in Stocks on Thursday, April 17

The TSX is tracking toward another winning week, rising 2.2% week to date as markets head into the Good Friday…

Read more »

stocks climbing green bull market
Dividend Stocks

A 9% Dividend Stock Paying Cash Every Month, and Perfect in a Volatile Market

It's a volatile time, but this dividend stock can help you through it.

Read more »

Canada day banner background design of flag
Dividend Stocks

Top Canadian Stocks for a $7,000 Investment Today

These Canadian stocks are trading in the green year-to-date and have consistently outperformed the broader markets with their returns.

Read more »

Paper Canadian currency of various denominations
Bank Stocks

Here’s Exactly How Many Shares of BNS Stock You Need to Get $5,000 in Annual Dividends

BNS stock offers you a tasty dividend yield of more than 6%. But is the TSX bank stock a good…

Read more »