The oil spill in the Gulf of Mexico is a disaster with likely many culpable parties whose liability will be determined at some distant date in a court of law. For now the US government is strong-legging one, BP (NYSE: BP), into covering the immediate costs of capping the ruptured wellhead. The Obama administration will also lean on the UK-based Super Oil to cover economic damages to the fishing and tourism industries along the Gulf Coast that will run deep into the billions; yesterday the White House labeled BP “the responsible party.”  

The timing of this incident–just weeks after President Obama suggested expanding US offshore exploration–probably means the six days’ worth of supply off the coast of Virginia will stay right where it is. But we’ve been drilling under water since 1947, and we’re not going to stop now. Spills like this will continue to happen; it is a cost of doing business the way we do business at this stage of our development. Fortunately, existing mechanisms will likely extract a big chunk of the monetary damages from BP, a company with a less than stellar safety record.

As it happens, the exploitation of some of the most abundant reserves on the planet awaits only the right market and geopolitical conditions as well as a little technological innovation.

As much as a quarter of Earth’s undiscovered oil and gas is believed to be in areas above the Arctic Circle. Significant portions of the 3.1 million square miles of the Arctic have been explored; 400 oil and gas fields north of the Arctic Circle in Canada, Russia and Alaska have been discovered. These fields account for ap­proximately 240 billion barrels of oil and oil-equivalent natural gas–about 10 percent of the world’s known con­ventional petroleum resources.

But most of the Arctic–including more than 2.7 million square miles of continental shelves under less than 1,640 feet (500 meters) of water–is virgin territory. According to the US Geological Survey (USGS), these shelves may constitute “the geographically largest unexplored prospective area for petroleum remaining on Earth.”

The total mean undiscovered conventional resources are estimated by the USGS to be approximately 1,669 trillion cubic feet of natural gas, 90 billion barrels of oil and 44 billion barrels of natural gas liquids–about 30 percent of the world’s undiscovered gas and 13 percent of the world’s undiscovered oil–most of it in those shelves in relatively shallow water.

Not many offshore wells have been drilled in the Arctic, but this handful has been productive, locating numerous significant oil and gas fields, such as the Snovit field in the Norwegian Barents Sea and the supergiant Shtokman field in the Russian Barents Sea.

Undiscovered natural gas is three times more abundant than oil in the Arctic and is largely concentrated in Russia.

The way things are going, even the relatively insignificant oil reserves estimated to be present in the region will prove critical to keeping the per barrel price within range of even the new, elevated ranged established over the trailing decade. Population growth in and the rate of expansion of emerging economies have changed the supply-demand profile.

Data reported by the US Energy Information Administration (EIA) in its April 6 Short-Term Energy and Summer Fuels Outlook indicating that supply growth is barely keeping up with growing demand means hard-to-access as well as expensive-to-produce reserves are ever-more critical. We’re literally going to extremes to find the energy that will get us to a cleaner-burning future.

Perhaps no other company better illustrates the present economic value of undeveloped Arctic resources than Canadian Oil Sands Trust (TSX: COS-U, OTC: COSWF), which describes its Arctic natural gas as “another sizeable, strategic, and long-term energy asset,” though it’s not producing it right now and has no plans to do so “in the foreseeable future.”

Rather, the trust acquired the Drake and Hecla onshore fields and an offshore field near Melville Island to partially hedge its future natural gas requirements for Syncrude operations.

Producing synthetic crude from bitumen requires significant amounts of natural gas during extraction as well as in the upgrading process. According to Canada’s National Energy Board, it requires about 1,200 cubic feet (34 cubic meters) of natural gas to produce one barrel of bitumen from in situ projects and about 700 cubic feet (20 cubic meters) for integrated projects. (For comparison’s sake, a barrel of oil equivalent is about 6,000 cubic feet [170 cubic meters] of gas.)

At the same time, particularly in light of the likely moth-balling of any plans to expand drilling near populated or economically vital coastlines in the wake of BP’s latest accident, costly processes such as the extraction and conversion of bitumen to oil are likely to seem more economic. Canadian Oil Sands: totally unconventional.

Along with economic value of this scale inevitably trails geopolitical intrigue. The drama surrounding the North Pole ratcheted another level higher with China’s recent entry into the game. In March a Chinese rear admiral asserted that the Arctic belongs to all peoples.

“The Arctic belongs to all the people around the world as no nation has sovereignty over it,” said Yin Zhuo of the Chinese Navy, in a statement published by the official China News Service. This comment has been interpreted by many as a sort of “claim staking” by China.

China, anxious to maintain the near double-digit pace of growth necessary to keep an itinerant population employed and fed, is interested in the disposition of the oil and the natural gas; however the various continental shelves are defined, China will be able to participate in the exploitation of Arctic resources as an owner, operator, investor and consumer.

China is also the world’s busiest shipper and would love to find out how much faster and how much more it can move through the Northwest Passage once enough ice melts to clear the way. That may be its primary interest.

The Arctic Circle encompasses 8.2 million square miles, or about 6 percent of the Earth’s surface. Under international law, no country currently owns the North Pole or the section of the Arctic Ocean surrounding it. The five surrounding Arctic states, Russia, the US (Alaska), Canada, Norway and Denmark (Greenland), are limited to an exclusive economic zone of 200 nautical miles (230 miles) adjacent to their coasts.

The status of certain portions of the Arctic sea region is in dispute; Canada, Denmark, Norway, Russia and the US all regard parts of the Arctic seas as “national waters” (territorial waters out to 12 nautical miles) or “internal waters.” All countries officially regard all waters beyond the 12-mile territorial sea limit as international waters. But there are disputes about rights to passage along “international seaways” that might violate national boundaries. This is a key consideration as the fabled northern route melts into reality.

Russia has the longest Arctic coastline of any of the Arctic littoral states, claiming about 30 to 35 percent of the total, though it must prove the validity of its territorial claims to the UN Commission on the Limits of the Continental Shelf by 2011. In April 2007 the crew of a Russian deep-sea submarine planted a titanium flag beneath the North Pole. It was a symbolic gesture, a point Russian officials make every time another claimant of Arctic interests criticizes the move. But Moscow has also sent bombers close–but never into–Canadian Arctic airspace.

Responding to recent provocations, a spokeswoman for Canadian Foreign Minister Lawrence Cannon told the Canadian Press, “This government is dedicated to fulfilling the North’s true potential as a healthy, prosperous and secure region within a strong and sovereign Canada. We take our responsibility for the future of the region seriously.”

We’ll be burning fossil fuels for decades to come. This reality is dictated by the fact that there are no viable, scalable alternatives that can satisfy aggregate global energy demand. An economic storage technology that would allow wind, for example, to provide base-load electricity does not exist. And energy demand is getting back to normal after falling during the recession.

Sheer remoteness and difficulties associated with working under water in cold temperatures severely restrict offshore Arctic activity; most discoveries remain undeveloped, as will those areas assessed by the USGS in 2009. But this unfolding tale of Arctic commerce illustrates the extremes we have to contemplate in order to satisfy energy demand as well as the ridiculous mess in the Gulf of Mexico.

You Cruise, You Win

Roger Conrad and his KCI Investing colleagues have been combing the globe for their next luxury investment cruise: Any ports of call must be ripe with investment potential, of course, but they must provide a rich slice of the world’s treasures and unique insights into human luxury. And after the brutal year we just finished, who couldn’t use some luxuriant down time learning how to prepare their portfolios for what this next decade has in store.

Save the dates: Thursday, October 21, through Monday, November 1, 2010. Explore the wonders of Turkey and the Greek Isles while learning about the newest investment strategies from Roger, Elliott Gue, Yiannis Mostrous and GS Early.

While you enjoy unfettered access to the finest minds in investing today, Seabourn Cruises will upgrade the way you think about luxury cruising as you are feted aboard the brand new Seabourn Odyssey. From its all-included open bar of premium liquor, wine and beer to its almost better than 1-to1 staff-to-passenger ratio, to its maximum capacity of only 450 passengers, you will understand why it immediately jumped to the top of the luxury cruise line ratings charts when it hit the water in 2009.

For those of you lucky enough to have sailed with this keen crew in the past, you know you are in for a meticulously planned journey into the business, investment and cultural offerings of the region. KCI in partnership with Joseph H. Conlin Travel Management is offering this journey solely to KCI subscribers and their friends.

For more information and reservations, please click here.

The Roundup

The biggest development on the Portfolio front is last week’s announcement by AltaGas Income Trust (TSX: ALA-U, OTC: OTGFF) that it will pay an annual dividend of CAD1.32 per share after it converts to a corporation. If all goes to plan, unitholders will approve the proposal in June. As of August 15 AltaGas will pay CAD0.11 per month.

The details on the conversion and a review of AltaGas’ first-quarter numbers are available in yesterday’s Flash Alert.

We summarize results from two Conservative Holdings below. We’ll have details and analysis on those Portfolio recommendations that get their reports in on time for the May Canadian Edge, due this Friday afternoon.

Aggressive Holdings

• Ag Growth International (TSX: AFN, OTC: AGGZF)–May 7
• ARC Energy Trust (TSX: AET-U, OTC: AETUF)–May 5 (confirmed)
• Chemtrade Logistics Income Fund (TSX: CHE-U, OTC: CGIFF)–May 10 (confirmed)
• Daylight Resources Trust (TSX: DAY-U, OTC: DAYYF)–May 6
• Enerplus Resources Fund (TSX: ERF-U, NYSE: ERF)–May 7 (confirmed)
• Newalta Income Fund (TSX: NAL, OTC: NWLTF)–May 11
• Paramount Energy Trust (TSX: PMT-U, OTC: PMGYF)–May 7
• Penn West Energy Trust (TSX: PWT-U, NYSE: PWE)–May 5 (confirmed)
• Peyto Energy Trust (TSX: PEY-U, OTC: PEYUF)–May 13
• Provident Energy Trust (TSX: PVE-U, NYSE: PVX)–May 13 (confirmed)
• Trinidad Drilling (TSX: TDG, OTC: TDGCF)–May 6
• Vermilion Energy Trust (TSX: VET-U, OTC: VETMF)–May 7

Conservative Holdings

Colabor Group’s (TSX: GCL, OTC: COLFF) results reflect difficult operating conditions in the food service industry, but the company’s conversion transaction included the acquisition of significant tax pools that allowed it to post first-quarter earnings per share of CAD0.12. This figure bested last year’s CAD0.08 and was in line with analysts’ expectations.

The first quarter is the seasonally weakest part of the year for Colabor; payout ratio on a diluted cash flow basis was 96 percent on lower margins. Sales were down 12.3 percent from a year ago, largely because Colabor lost a significant customer in February. Management is still negotiating with the customer but is also working other angles that it thinks may provide greater long-term upside for the business. Setting aside the impact of this loss, comparable sales were off 3.4 percent, in line with expectations.

Colabor has about CAD80 million available on its revolving credit facility after issuing a new series of convertible debentures; this should allow it plenty of room to grow through acquisitions. Colabor Group–and its 9 percent–is a buy up to USD12.

RioCan REIT (TSX: REI-U, OTC: RIOCF) reported robust funds from operations (FFO) growth of 22 percent. First-quarter net operating income (NOI) increased 17 percent year over year and 11 percent compared to the fourth quarter of 2009.

NOI is beginning to reflect acquisitions completed in the fourth quarter of 2009 and in the first quarter of 2010. RioCan picked approximately CAD204 million worth of new properties at a weighted average capitalization rate of 8.1 percent in the first 12 weeks of 2010.

First quarter rental revenues increased CAD18 million over the same quarter in 2009 to $200.8 million. Same-property NOI was up 4.2 percent from a year ago and 1.8 percent quarter over quarter; same-store NOI increased 3.1 percent over first-quarter 2009 levels and 1.8 percent since December 31. These NOI gains were driven largely by fixed rental increases, new and renewal leasing, lower bad debt expenses and a reduction in the number of unanticipated vacancies.

RioCan reported an occupancy rate of 97 percent, down slightly from 97.4 percent at Dec. 31, 2009, and 97.5 percent on Mar. 31, 2009. The REIT has cash on hand of CAD106 million and a debt-to-gross book value ratio of 56.8 percent.

RioCan REIT–well positioned to grow and exempt from impending taxation of other Canada-based pass-through entities–is a buy up to USD20.

• Artis REIT (TSX: AX-U, OTC: ARESF)–May 12 (confirmed)
• Atlantic Power Corp (TSX: ATP, OTC: ATLIF)–May 14 (confirmed)
• Bell Aliant Regional Communications Income Fund (TSX: BA-U, OTC: BLIAF)–May 4 (confirmed)
• Bird Construction Income Fund (TSX: BDT-U, OTC: BIRDF)–May 13
• Brookfield Renewable Power Fund (TSX: BRC-U, OTC: BRPFF)–May 12 (confirmed)
• Canadian Apartment Properties REIT (TSX: CAR-U, OTC: CDPYF)–May 11 (confirmed)
• CML Healthcare Income Fund (TSX: CLC-U, OTC: CMHIF)–May 7
• Davis + Henderson Income Fund (TSX: DHF-U, OTC: DHIFF)–May 4 (confirmed)
• Innergex Renewable Energy (TSX: INE, OTC: INGXF)–May 13
• Just Energy Income Fund (TSX: JE-U, OTC: JUSTF)–May 14
• Keyera Facilities Income Fund (TSX: KEY-U, OTC: KEYUF)–May 12 (tentative)
• Macquarie Power & Infrastructure Income Fund (TSX: MPT-U, OTC: MCQPF)–May 11 (confirmed)
• Northern Property REIT (TSX: NPR-U, OTC: NPRUF)–May 12
• Pembina Pipeline Income Fund (TSX: PIF-U, OTC: PMBIF)–May 6 (confirmed)
• Yellow Pages Income Fund (TSX: YLO-U, OTC: YLWPF)–May 6 (confirmed)