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Attention, Energy Investors: Why $80 Oil Is Here to Stay

As the price of oil has melted down over the last six weeks or so, many investors have been eagerly sniffing out bargains in the energy patch. Many of the biggest oil producers in the country have sunk to levels not seen in a number of years. If the price of oil rebounds, this could be a terrific buying opportunity.

Perhaps the best example of this is Canadian Oil Sands Ltd. (TSX: COS), one of the largest producers in Northern Alberta’s infamous oil sands. Even though the company has all but finished a couple of capital projects which set it back more than $1 billion, it’s obvious the market is nervous that management is going to cut the dividend. The stock has slumped all the way down to below $18, which it last saw back in 2009 when oil was trading between $40 and $50 per barrel. It seems obvious that nervous investors have pushed the price down farther than what’s logical, creating a buying opportunity.

All across the energy sector, management teams are thinking the same thing. Oil selling for $80 a barrel is a little troubling, but the slumping Canadian Dollar doesn’t make things so bad. Business will continue as usual, and then profits will come back when oil trades back at $100 per barrel again.

Oh, if only it were that simple.

A changing market

Over the last decade, the North American energy market has changed extensively. Instead of importing 60% of its crude oil supply, the U.S. has dropped that to 30%, most of which comes from Canada. This is due to the boom in shale oil plays, increased prices which made previously uneconomic oil fields profitable again, and better fuel efficiency across the board, which has reduced demand. With each passing year, the U.S. is a little closer to becoming energy self-sufficient.

At $80 per barrel, a lot of this new shale oil production is marginally profitable at best. And yet, producers aren’t cutting back on production. If anything, it’s full speed ahead. The same phenomenon is happening in Canada as well. Many large oil sands expansions are still scheduled to come online in 2015 and beyond. So many billions have been invested in them that it seems silly to stop now, so companies are still moving forward.

And in the Middle East, it doesn’t seem like any members of OPEC are about to cut production either. Unofficial word out of Saudi Arabia is that the Kingdom is more than willing to play a high stakes game of chicken with American producers. The first one to cut production loses.

Put all those factors together, and we have a situation with a lot of supply, and not a whole lot of new demand. We all know how that ends.

Investor takeaways

There are a couple of ways that investors should position themselves.

First of all, don’t get too excited about picking up energy stocks at this point. If oil continues to bounce around the $80 per barrel mark, certain bits of bad news will push the price down to the $75 range. And as energy companies start coming in with lackluster earnings, opportunities will present themselves on an individual basis.

Additionally, investors should focus their attention on low-cost producers. One good choice could be Cenovus Energy Inc. (TSX: CVE)(NYSE: CVE), which has several new oil sands projects coming online over the next two to three years. Thanks to a new form of thermal mining, these new sources of production should have a cost of between $40 and $45 per barrel, making them comfortably profitable.

Cenovus is also sitting on more than $1 billion worth of cash, has a reasonable debt to equity ratio, and gives investors an attractive 3.9% dividend to wait out the storm. The company’s capital expenditures are high, but it will easily earn enough to keep the dividend intact, even at lower oil prices. It could end up being a solid pick.

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Fool contributor Nelson Smith has no position in any stocks mentioned.

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