With global oil prices plunging to a 47-month low, investors are rightfully concerned about the prospects for oil stocks. The International Energy Agency (IEA) recently reported that one quarter of new Canadian oil projects will be at risk if oil drops below US$80 a barrel, a level it is hovering dangerously close to.
To make matters worse, analysts estimate the cost of developing and profitably operating an oil sands mine is US$90 per barrel or higher.
What should investors do? Buy Cenovus Energy Inc. (TSX: CVE)(NYSE: CVE). With production costs significantly below average, huge growth, and a bargain valuation, investors should act now before the market catches on.
Cenovus has the lowest production costs in the industry
With oil prices projected to stay depressed for the short term at least, it is only logical that low-cost producers will do better. In this regard, Cenovus excels beyond almost all of its Canadian peers. Here’s why Cenovus has the low-cost advantage.
Cenovus uses a complex technique known as steam-assisted gravity drainage (SAGD) to drill for oil. This involves drilling horizontal wells in pairs, one on top of the other, and using steam to separate the oil from the sand. This allows two wells to be drilled from a single pad.
Between these two wells, an unrecovered wedge of bitumen forms over time, and Cenovus recently commercialized its Wedge Well technology to access this unrecovered area by drilling a third well between the original two. Since the wedge was surrounded by steam chambers from the first two-well pairs, far less steam is required to loosen the oil from the sand.
The result? Cenovus has the lowest steam-to-oil (SOR) in the industry on its Foster Creek, Christina Lake, Narrows Lake, and Telephone lake oil sands operations. SOR is the measure of efficiency for SAGD projects, and a low SOR means less steam is required per barrel of oil, and therefore lower capital costs, lower operating costs, and higher margins.
The numbers speak for themselves. According to a Goldman Sachs report, Cenovus’ oil sands SAGD projects have a supply cost break-even point as low as US$35 per barrel. Goldman estimates the global average supply cost is US$70 per barrel, with other analysts estimating even higher
Quite simply, this means crude prices of US$80 per barrel are no issue for Cenovus.
Great assets and growth
Cenovus’ very low production costs on its SAGD oil sands operations are partly due to the fact that its assets are very high quality. Foster Creek for example, which is Cenovus’ largest project, has been an industry leader, and recently became the largest SAGD project in Alberta to reach royalty payout status.
Foster creek production growth is occurring in several stages, and currently stages A-E are online and producing approximately 57,000 bbl/d net in Q3 2014, a 15% increase from Q3 2013. Phase F production has just began, and phases G and H are expected to begin producing in 2015 and 2015 respectively. Combined, all production at Foster Creek will reach 310,000 bbl/d gross within the next several years.
This growth is not only limited to Foster Creek, and Cenovus’ Christina Lake project also has a production capacity of 310,000 bbl/d gross over the next several years, and production on this project grew 77% from Q2 2013 to Q2 2014, currently averaging over 68,000 bbl/d net.
Very low valuation
Cenovus is currently trading at a discount thanks in part to the recent market correction. Analysts have a median price target of $36.00 per share on the stock, an almost $10 premium to the current price.
With a price-to-earnings ratio of 18.5 and price-to-cash flow ratio 5.9, Cenovus is trading far below its historical averages on both of these measures. Cenovus has a forward-price-to-earnings ratio of 13.7 for the end of 2014, and with valuations that low, investors should scoop up shares of Cenovus before it’s too late.
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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.