Why Canadian Oil Sands Ltd. Shareholders Are Best Left Alone

Suncor Energy Inc.’s (TSX:SU)(NYSE:SU) $4.3 billion hostile bid for Canadian Oil Sands Ltd. (TSX:COS) may look good on the surface, but patient Canadian Oil Sands shareholders have more to gain alone.

| More on:
The Motley Fool

With oil prices crashing to $30 per barrel—a 13-year low—Suncor Energy Inc.’s (TSX:SU)(NYSE:SU) deal to Canadian Oil Sands Ltd. (TSX:COS) shareholders may seem better and better.

Currently, Suncor is offering 0.25 Suncor shares for each Canadian Oil Sands share as part of a hostile takeover bid, meaning Canadian Oil Sands shareholders would get $7.85 or so per share. The result is that Canadian Oil Sands shareholders would lock in a 8.2% gain from current prices.

While Suncor may argue this is a good deal for Canadian Oil Sands shareholders, Canadian Oil Sands shares traded at $22 in September 2014 when oil was more reasonably priced. After enduring a 66% drop in price, those still holding on to Canadian Oil Sands shares would be a making a major error by choosing to tender their shares to Suncor at these levels.

The error? Canadian Oil Sands shareholders are effectively locking in their downside, while capping their upside. Suncor shares are far less correlated to the price of oil, and while those shares would certainly rise as prices rebound, the rebound would be far less than Canadian Oil Sands would experience. Currently, Canadian Oil Sands shares are 98% correlated to the price of oil.

Any investor still holding on to Canadian Oil Sands shares has the best hope of recovering their capital by continuing to hold on to their shares. It makes little sense to have endured a 66% drop in price—correlated to oil—and then give up that correlation when prices rise.

For Canadian Oil Sands to recover, however, two things need to occur. Firstly, oil prices need to recover, and secondly, Canadian Oil Sands needs to stay above water until they do. Here’s why these options are both likely.

Oil prices have more upside than downside

Nobody knows when oil prices will recover, or by how much. Simple economics, however, say that over a medium time frame (one to two years) there is much more room for oil prices to move up than down. This benefits Canadian Oil Sands.

The issue with oil prices is on the supply side. OPEC has refused to keep production targets and is flooding the market with supply, and Iran is set to ramp up more production as sanctions are lifted. This pushes down prices.

This strategy has effect of putting U.S. producers—who have higher costs—out of business. Currently, few producers are economical at current price levels, and the result is that a few things are happening. First, non-OPEC supply growth has fallen from 2.2 million barrels per day at the start of the year to 0.3 million barrels per day by year end. It is expected to contract by 0.6 million barrels per day in 2016 according to the IEA.

Secondly, capital expenses are falling dramatically, which means businesses are not investing actively in new supply. New supply is needed to keep pace with growing demand (which is growing at a quick pace), and current prices simply do not encourage it.

The end result is the IEA expects the gap between supply and demand to shrink in 2016, which should start to support prices.

Canadian Oil Sands can survive further pressure

Canadian Oil Sands expects to have free cash flow of $338 million in 2016. When you subtract the $97 million dividend, this means that Canadian Oil Sands will have $241 million left over at the end of the year.

These calculations assume oil will average $50 per barrel. Even if they average $40, however, Canadian Oil Sands should be fine. They would see negative free cash flow of around $10o million ($197 million including the dividend), which is affordable since they have $1.1 billion of undrawn room on their credit facilities, which they can rely on to fund the deficit.

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 Adam Mancini has no position in any stocks mentioned.

More on Energy Stocks

man touches brain to show a good idea
Energy Stocks

1 No-Brainer Energy Stock to Buy With $500 Right Now

Should you buy a cyclical energy stock at its decade-high? Probably not. But read this before you make a decision.

Read more »

A solar cell panel generates power in a country mountain landscape.
Energy Stocks

Top Canadian Renewable Energy Stocks to Buy Now

Here are two top renewable energy stocks long-term investors can put in their portfolios and forget about for a decade…

Read more »

oil and gas pipeline
Energy Stocks

Where Will Enbridge Stock Be in 3 Years?

After 29 straight years of increasing its dividend and a current yield of 6%, here's why Enbridge is one of…

Read more »

Pumpjack in Alberta Canada
Energy Stocks

Is Enbridge Stock a Buy, Sell, or Hold for 2025?

Enbridge stock just hit a multi-year high.

Read more »

oil pump jack under night sky
Energy Stocks

Where Will CNQ Stock Be in 3 Years?

Here’s why CNQ stock could continue to outperform the broader market by a huge margin over the next three years.

Read more »

engineer at wind farm
Energy Stocks

Invest $20,000 in This Dividend Stock for $100 in Monthly Passive Income

This dividend stock has it all – a strong outlook, monthly income, and even more to consider buying today.

Read more »

A worker overlooks an oil refinery plant.
Energy Stocks

Is Imperial Oil Stock a Buy, Sell, or Hold for 2025?

Valued at a market cap of $55 billion, Imperial Oil pays shareholders a growing dividend yield of 2.4%. Is the…

Read more »

Pumpjack in Alberta Canada
Energy Stocks

Where Will Imperial Oil Stock Be in 1 Year?

Imperial Oil is a TSX energy stock that has delivered market-thumping returns to shareholders over the last two decades.

Read more »