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Why Canada’s Oil Sands Could Be a Poor Long-Term Investment

The monumental slump in crude which has lasted far longer and been deeper than many pundits predicted is on the cusp of moving into its fourth year with no clear signs of a significant recovery in sight. Many well-known investors and political figures claim that Canada’s vast oil sands reserves are well on their way to becoming stranded assets.

One of the most prominent investors was hedge fund manager Jeremy Grantham, who in 2013 declared that Canada’s oil sands were stranded assets. There are signs that this prediction could very well become true as even greater pressures are being applied to Canada’s oil sands industry.

Essentially, a stranded asset is one that has prematurely lost its value because of economic, social, or technological change and innovation. The asset becomes worthless or, in some cases, a liability. Because of the growing pressures being applied to the energy patch, there are signs that the oil sands may become stranded assets faster than many pundits have anticipated.

Unsurprisingly, this has yet to be priced into the value of oil sands companies. When this finally occurs, it is highly likely that the value of those companies will diminish sharply once the costs associated with owning such assets are recognized by the market. 

Now what?

One of the major issues facing oil sands is growing environment pressures.

Concerns about global warming and the impact of carbon emissions have brought the spotlight firmly on to the high carbon costs associated with Canada’s oil sands.

It has been estimated that it takes three to four times more energy to extract and refine oil sands than it does conventional crude. This has been recognized by the U.S. Energy Information Administration, which has stated that producing oil from bitumen emits roughly three to four times as much greenhouse gases than conventional oil.

Now that the Paris Agreement on climate change has entered force, there are even greater pressures on the signatories, including Canada, to limit carbon emissions. The agreement essentially seeks to limit global warming to less than two degrees Celsius by reducing global greenhouse gas emissions. It seeks to do this be eventually removing fossil fuels from the global energy mix.

Analysts have estimated that up to $220 billion worth of Canada’s oil sands reserves are unrecoverable.

Even oil sands giant Suncor Energy Inc. (TSX:SU)(NYSE:SU) has recognized that in such an environment the extraction of some oil sands reserves is uneconomic. In August 2016, Suncor stated that it was working with Alberta’s government to strand those oil sands assets it believes are the least economic to extract.

Oil sands are recognized as being among the costliest sources of crude.

According to industry analysts, new oil sands projects have breakeven costs of US$75-100 per barrel, which is more than double the breakeven costs for U.S. conventional and shale oil production. This means that in an operating environment dominated by sharply weaker prices, where West Texas Intermediate is trading at about US$53, much of Canada’s vast oil sands reserves are uneconomic to extract. 

So what?

During the years of the oil boom, the energy patch was a popular destination for investors, but the sharp collapse in crude coupled with growing environmental pressures and high extraction costs have seen that popularity wane.

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

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