Over the last 5 years the oil sands were among the most exciting international investment opportunities. The optimism surrounding this unique geological formation is best summarized by the statements made by Time magazine when they declared, “[the oil sands] could satisfy the world’s demand for petroleum for the next century.” (Time 2005) Recently, the price of crude oil has plunged with the hopes of the oil sands potentially plunging with it. A 65% drop in the price of crude since June has resulted in oil sands projects being delayed by some of the largest exploration and production companies in the world. This has led many to step forward and question both the short-term and long-term economic potential of these projects. With significant attention being paid to both alternative energy and the low price of crude, do the oil sands still hold within them an unequivocally large return potential and the ability to grow the Canadian energy industry into an unrivaled global sector?

The excitement surrounding the Canadian oil sands has been motivated by the sheer size and potential of the industry. It was predicted by the Alberta government in 2007 that the capital expenditure for the 5 years starting in 2007 would be nearly $77 billion. This is an inspiring sum that offers unique returns for the many market participants including production companies, pipeline companies and energy service companies.

The rapid drop in the price of crude has sobered up this excitement and allowed companies to re-evaluate their projects. The overall concern expressed by investors has been centered on the shutdown of oil sands projects with it being presumed that these projects are no longer profitable. Peters & Co., a top investment bank in the Canadian energy sector, suggests that when assuming a 10% discount rate, crude must be priced at $55/bbl for mining projects to be profitable and a price of $60-$100/bbl is necessary for SAGD projects to be profitable. The economics of these projects in the short-term are clearly under water, however there is room for a number of adjustments that will create more profitable projects in the medium and long-term. For the last 5 years, operational challenges have pushed the return on investment lower motivated mainly by high wages, limited skilled trades, regulatory delays and carbon emissions concerns. In slowing the progress of these projects, production companies are able to allow both themselves and their service providers the ability to reorganize in order to lower costs, upgrade quality and raise the return on investment for the whole project.

With this in mind, what can we expect from the market in both the short-term and long-term? UBS expects that a short-term price floor of $30 may be established as many producing reservoirs require pricing of at least $30 to stay online. The EIA expects the market to exhibit continued weakness as the global recessionary effects will continue for the next 6-18 months keeping oil prices around $43/bbl in 2009 and $55/bbl in 2010. This will lead to continued retrenchment by production companies as they adjust their development schedules for oil sands projects. In the long-term, demand for crude oil is forecasted to expand by 1.7% per year mainly due to increasing requirements from emerging economies. In addition to the demand expansion, the low price of crude has forced many production companies to delay projects that would have come online 2-5 years down the road. This is expected to lead to a supply/ demand disequilibrium forcing prices aggressively higher in the medium and long-term. In considering all of the dynamics influencing the price of oil, it is still believed that over the long-term prices will trend higher. This, in turn, will generate higher returns for oil sands projects, offering evidence for the long-term development of these ventures.

In answering the broader question, the oil sands are not dead, they are simply resetting themselves. The broad economic fundamentals continue to be reliable in the long run and through this the potential returns of the oil sands and more broadly speaking, the Canadian energy sector remain robust.