When Falling Energy Prices are Bad News

In one of my PROFIT CONFIDENTIALS, I wrote about Canada’s greatest buried riches–Alberta’s oil sands. Our oil sands are second only to Saudi Arabia’s reserves and are considered as sufficient to meet the world demand for fossil fuel for the next hundred years.

Just to remind you, oil sands are a molasses kind of deposit called bitumen because viscous oil and sand are all mixed together. The only way to separate oil from the sand is to heat it up with steam or to dilute it with lighter hydrocarbons. Both of these extraction processes are quite costly, and economically justified only when market prices of crude oil are sufficiently high.

Alberta’s oil sands spread in three major areas in its north-east, covering about 140,200 square kilometers. To give you an idea of the size, oil sands region is larger than the state of Florida. It is also two times bigger than the province of New Brunswick and 26 times larger than Prince Edward Island. However, in spite of all the excitement around oil sands and bombastic labels assigned to the resource by both the media and analysts, only two percent of the entire resource has been produced to date.

Why? As already mentioned, extracting crude from the sand is a costly process justified from the commercial point of view only when crude market prices are high. And, as far as energy prices are concerned, for the past few months it has been a rollercoaster ride at best.

Currently, oil futures are lingering below $60.00 a barrel, and already major players in Alberta’s oil sands are feeling the pinch. The latest “victim” was the proposed deal between EnCana Corp and two Chinese oil giants, China National Petroleum Corp. and China National Offshore Oil Corp. Namely, the latter two have declined to join EnCana’s joint venture to explore and develop its oil sands properties, citing the current adverse conditions in energy markets. In other words, because worldwide oil prices have dropped from record highs, Chinese are questioning the commercial viability of the deal.

Granted, deals have fallen through before. But, it is significant, (not in a good way), that the first and third oil producer in China are withdrawing from the potentially biggest oil reserve left in the world, especially after a growing number of Chinese oil producers are looking for lucrative global investment projects to satisfy the demand generated by Chinese red hot economy.

This may be a good time to review the energy portion of your portfolio. I already wrote about the income trust situation, and I’m mentioning income trusts here because most energy plays in Canada have been converted into income trusts. Also, evaluate internal and external risks of your energy stocks. Mind you, I’m not telling you to bail the energy ship just because one deal fell through. I’m merely suggesting that when first warning signs appear, you heed them by evaluating and re-evaluating your current holdings, preferably with your broker in the room with you.