News Quickie: September 20, 2007

Alberta, the New Venezuela. Not.

On Wednesday September 19th, a study commission released a report to the government of Alberta saying that oil and gas companies operating in the province should be taxed about 20% more than currently is the case. The reactions were interesting:

  — Dennis Gartman, a well-followed, commodity sensitive commentator and investor excoriated the announcement in extreme terms and said he was selling all Canadian equities, never to look back (unless, one presumes, the Province rejects the recommended tax increases).

  — Marathon Oil, which has proposed to buy Western Oil Sands for nearly $6 billion, said the deal will go through. They suggested that the new tax proposal was already in their numbers but also said it might impact their capital spending plans. Why would they want to buy a company in which they hesitate to make further investments for growth? Their capex caveat seems like a rather weak version of the “Shocked, shocked” reaction required of any company toward any new tax.

But I was also disappointed. The recommendation reminds one of the Venezuelan approach to resource development, which is producing such disastrous results. On the other hand, my disappointment is mitigated somewhat by the fact that the new taxes are partially designed to repair the environment upon completion of the projects, which is a worthy and altogether appropriate reason for a tax. Also, I still do not believe the government of Alberta has any interest in being confiscatory or in denying investors a reasonable — even an excellent — return, unlike the base attitude of Dr. Chavez.

I sold two oil sands holdings that still require major capital investments in order to reach positive cash flow. Financing for such investments could suffer. On the other hand, I am keeping my core position in Canadian Oil Sands, which has its investments in place, is growing its cash flow enormously based on higher, non-hedged oil prices, and which pays a 5% dividend, which grows with the depreciating dollar and promises to grow further with the company’s cash flow. In fact, I think this recent pullback is an opportunity to add to holdings of COSWF.

The bottom line of investments in the oil sands is that they really will pay off if the price of oil not only goes higher but goes much higher. That, in fact, is exactly what the price of oil will do the closer we get to peak oil. And since peak oil is only a matter of time, it seems like investments in the oil sands are as close to a sure thing as we are likely to find, if one has patience.

In terms of the actual impact of this proposed tax, let us note that taxes (to simplify the matter) are currently 25% of profits for COSWF. If they are increased 20%, they will become 30% of profits. Taxation calculations at COSWF are complex, but I would estimate that a 5% greater tax on profits could equate to something like a 3% reduction in cash flow. On the other hand the price of oil today is about 17% higher than it was just a few weeks ago ($82 vs. $70). That higher price goes directly to the bottom line. It equates to a roughly 40% increase in cash flow. So I find it hard to be too disappointed in the possible loss of 5% of profits when my investment’s cash flow has just been increased by 40%, or 37% net of a proposed but not yet enacted tax.

Bottom line: higher oil prices make for very happy times for Canadian Oil Sands Trust regardless of this tax proposal. The oil price won’t keep going straight up, but the long term trend is clear. There are days (months) when the rain will fall on oil, but a sunny future is virtually assured in terms of higher oil prices. (Incidentally, I plan to address the moral dimensions of rooting for a higher oil price at a future time. Short take: higher oil prices are the best thing that can happen for the long term health of our society and economy. It’s why we need a carbon tax.)