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Business Edge News (Canada): Is the great oilsands party over?

07/20/2006 – Vol. 6, No. 15 – Calgary/Red Deer Edition 

Energy sector’s jewel gets kick in the teeth

Western Oil Sands drops bombshell in laps of investors

That’s become the energy industry’s $897-billion question (this is a ballpark number so, in the spirit of the oilsands poker game, feel free to take a shot in the dark and fill in your own number).

Just as the Calgary Stampede’s bulls were busting out of the gate for the big bash in Cowtown, another storm cloud was rolling in over the oilpatch. With the ‘patch already reeling from collapsing natural gas prices, the champagne finally went flat in the long-running oilsands bull market when party pooper Western Oil Sands dropped a bombshell in the laps of investors.

Western Oil Sands sent shockwaves through the oil and gas industry when it reported that the company’s cost estimates for expansion of the Athabasca Oil Sands Project had skyrocketed a whopping 50 per cent in 10 months. Yes, that’s 50 per cent in 10 months!

Western Oil Sands (TSX:WTO), which has a 20-per-cent interest in the project operated by Shell Canada (TSX:SHC), said it expected costs to swell to $11 billion due to escalating demand for labour and raw materials. It also set its production target back by a full year. The $11-billion estimate is a far cry from last year’s estimate of $7.3 billion and a distant holler from the original estimate of $3.3 billion.

Shell Canada has a 60-per-cent stake in the Athabasca project and Chevron Canada has the remaining 20-per-cent stake.

Immediate reaction to Western’s revelations from the investment community was swift and decisive. It was a kick in the teeth to the jewel of the energy industry.

Even record-breaking oil prices couldn’t stem the tide. Shares in Western Oil Sands, one of a few pure oilsands plays, took an instant one-day hit of 12 per cent.

And industry experts believe there could be a domino effect of cost overruns and project delays in the sands, where there are $125 billion worth of projects planned or under construction and a projected 125 billion barrels of recoverable oil – the world’s second-largest resource next to Saudi Arabia.

Yet, from an investor’s perspective, things seem to have changed when it comes to oilsands plays. Until recently, it was a relatively simple game, primarily a play on the oil price. On days when the oil prices were up, companies with oilsands exposure, particularly the pure plays like UTS Energy (TSX:UTS), were virtually guaranteed to rally in lockstep.

Now, it’s not just about the oil price, it’s about dollar signs. It’s about the economics of the projects. It’s about whose projected numbers you can trust. And it’s about how badly the market gets spooked if another project warns that its cost estimate was a few billion dollars off the mark.

“It changes the whole economics of the oilsands,” David Cockfield of Toronto-based Leon Frazer & Associates told Bloomberg. “This (the $11-billion cost estimate) came as a shock to people in the market.”

When the news broke, oil was flirting with an all-time high in the $75 US per barrel range. Under those circumstances, the oilsands stocks would normally be kicking up their heels and in rally mode. But instead, there was a broad-based selloff of all companies exposed to the oilsands.

If you owned companies such as Shell Canada, which has a diversified portfolio of oil and gas projects, you got off easy. Shell’s stock dropped only 1.9 per cent on the day of the news.

However, high-volume go-to oilsands stocks were battered mercilessly. When UTS – a player in the Fort Hills Oil Sands Project operated by Petro-Canada (TSX:PCA) – sold off, that sent an alarming message that the game had in fact changed.

UTS was annihilated for a one-day drop of 10 per cent.

In a single day, it traded 10.3 million shares. Once the poster stock of the ‘sands, it was clearly getting the cold shoulder from a once-smitten market.

Three years ago, UTS was an obscure penny stock trading in the 30-cent range. But soaring oil prices, the global focus on the Canadian oilsands and the deal to partner with Petro-Canada sent the stock into the stratosphere. In a three-year span, UTS shares rose an astonishing 27-fold, peaking at $7.99 in April.

If oilsands stocks can take a hit of 10 per cent or more in a single day with the oil price hovering in record-breaking territory, one has to wonder how they would hold up if the oil price were to make a sudden U-turn and go into a downtrend.

With the oilsands stocks finally taking their lumps, the oilpatch wasn’t exactly the life of the party at the Calgary Stampede.

But if you think the oilsands stocks have had it bad, check out some of the charts in natural gas stocks.

With the price of natural gas down almost 50 per cent since December, the market has shown no mercy for companies weighted in natural gas.

Most of them are down anywhere from 20 per cent to 60 per cent year to date. And even the royalty trusts haven’t been spared the pain.

True Energy Trust (TSX:TUI.UN) is a prime example of a trust that has paid the price for its heavy weighting in natural gas (it’s about 70 per cent weighted in natural gas). True’s unit price plunged almost 35 per cent in the first six months of the year.

Remember that outcry last year over the federal government review of the income trust sector that precipitated a panic selloff in those investments, before then-finance minister Ralph Goodale’s announcement on Nov. 23 that there would be no change to the tax structure for income trusts?

Well, many of the royalty trusts are now back trading in the same range as their lows late last year, and grumpy unitholders don’t even have a convenient scapegoat in Ottawa to kick around.

And that’s enough to make an investor cry in his beer.

* TRUSTING CHAVEZ: When a caller to Report On Business TV’s Market Call recently asked the show’s guest expert Rob Cohen if one could trust wildly unpredictable Venezuelan leader Hugo Chavez, Cohen promptly replied: “Yes.”

That must have come as a shocking response to shareholders of Crystallex International Corp. (TSX:KRY), who have been sitting on pins and needles for years thanks to threatening remarks from Chavez about the status of foreign companies operating in Venezuela. Crystallex is developing the Las Cristinas gold mine in Venezuela and the stock has swung wildly, from $1.50 to $7 and recently back to the $3.50 range, largely on Chavez’s mood swings.

By the way, Cohen manages the Dynamic Precious Metals Fund, which recently listed Crystallex as its eighth-largest holding. Considering that, maybe his response was not so shocking.

* SAGE WORDS: “Go for a business that any idiot can run – because, sooner or later, probably any idiot is going to run it.”

– Legendary fund manager Peter Lynch.

(Gyle Konotopetz can be reached at [email protected])

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