“They’re not making more land” is a classic real estate saying used for generations. The scarcity of land stands out, one of the main reasons to invest with a long-term vision. Prime real estate has been a great source of profitability since the location cannot be duplicated and creates cash flows that exceed or at least grow with inflation. Interestingly, these issues have many parallels in today’s oil and gas space. The best resource was already scarce, but now ESG dynamics, combined with inflation and labor shortages, make it almost impossible to duplicate important assets. “They’re not producing any more” may become the catchphrase in energy, and nowhere is this more true than in Canada’s tar sands.
It is becoming increasingly difficult to obtain permits for large projects worldwide. This is doubly true for energy projects, as there are additional regulatory bodies and ESG considerations are accelerating. The fact that multiple wind and solar projects have been delayed or completely blocked should give an idea of how difficult it is to continue carrying out large projects. These renewable projects are exactly what ESG stakeholders should want to see. Still, the movement has become broader than any specific goal, and projects of all kinds have become victims. Oil and gas projects don’t stand a chance if renewable energy projects don’t prosper.
For energy assets in certain regions, we may be looking at the last type of asset of that type ever built. This is great for traditional operators as they compete with less supply. “Existing oil sands assets, particularly in Alberta, are nearly irreplaceable in the current regulatory environment. Approving new projects has become increasingly difficult, although the recent repeal of Bill C-69 helps moderate this,” said Connor Waterous, chief financial officer of Strathcona Resources. Strathcona has bet heavily on this issue, acquiring undervalued energy assets, including tar sands, in recent years.
This bet may prove wise in the current inflationary environment, as oil sands assets are well positioned to control their inflation costs versus similar projects. This is because costs are concentrated at the beginning and then maintenance costs are reduced. With large costs behind and higher income, this becomes a beneficial environment for this type of asset. “Tar sands assets are uniquely positioned to perform well in an inflationary environment, relative to other asset classes and oil assets,” Connor said. “For a typical oil sands asset, the price differential against WTI is the highest cost in its P&L, which is not affected by inflation and should decrease in the near term as they come online. new outlets from the Trans Mountain pipeline…the tar sands should get the double benefit of increasing revenue and decreasing costs in the near term.”
Tar sands assets have a longer life than other assets and now, like good real estate, will potentially never be able to be duplicated. Oil sands names have outperformed other Canadian sectors, such as banks and utilities, in recent multi-year periods. It remains to be seen if this trend continues and who ends up being the winners, but it is worth taking a second look at the new dynamics in the sector.