The Canadian oil sands–actually a mixture of bitumen (a semi-solid form of crude oil), silica sand, clay minerals and water–lie beneath an aggregate 54,000 square miles in three main patches of Alberta. They contain an estimated 1.7 trillion barrels of bitumen in place, comparable to the world’s total proven reserves of conventional crude. About 170 billion barrels is recoverable, making the Canadian oil sands the world’s second-largest store of crude reserves behind Saudi Arabia.

As we’ve often noted, the oil sands, among other commodities soft and hard, set Canada apart from its develop-market peers and provides a solid foundation in this resource-driven economy of the early 21st century. And we’ve outlined ways to approach the Canadian oil sands from an investor’s perspective.

But, as the Royal Society of Canada concludes in a 438-page December 2010 report, the Canadian oil sands are an eyesore. Images of what goes on in north central Alberta are ugly. Tailings ponds–massive collections of filthy water discarded during the extraction process–blot the landscape. The high-profile deaths of hundreds of Canadian geese that alit in tailings ponds drew furious scrutiny. And now that the notorious BP Plc (NYSE: BP), fresh off its Macondo escapade in the Gulf of Mexico, is getting back into the production game by way of the Canadian oil sands the region is sure to draw a little more ire.

That same Royal Society of Canada report, “Environmental and Health Impacts of Canada’s Oil Sands Industry,” also concludes, however, that what’s happening around Fort McMurray do not constitute the most environmentally destructive projects on earth. “Based on our review of the publicly accessible evidence, a claim of such global magnitude is not accurate,” the RSC panel of seven academics from a variety of fields concluded. “This depiction is clearly aided by the photographs of ugly surface-mined landscapes, but the claims of global supremacy for oil sands environmental impacts do not accord with any credible quantitative evidence of environmental damage.”

The RSC set out of its own accord in October 2009 to address questions about the oil sands and how production of the resource would affect the country. Major findings of the RSC expert panel’s study include:

• There’s “no credible evidence of environmental contaminant exposures from oil sands reaching Fort Chipweyan at levels expected to cause elevated human cancer rates.” The report also notes, however, that more data is required to thoroughly address concerns raised by First Nation and local experience in the Fort Chipweyan area.
• Lands exploited for oil sands production can be reclaimed for “traditional land uses,” but current means of establishing funding for such reclamation leaves Alberta vulnerable once acreage is tapped for all its usable bitumen. A policy solution to this problem would certainly involve increased costs for producers.
• The panel also found social stresses caused by rapid expansion of towns located near oil sands projects–“boom town” health impacts, problems attendant to infrastructure deficits, etc.
• Significantly, the report found that “Current industrial water use demands do not threaten the viability of the Athabasca River system if the Water Management Framework developed to protect in-stream, ecosystem flow needs is fully implemented and enforced.”
• Nor does available evidence suggest oil sands activities threaten life in the lakes and streams in the region. As with other areas studied, however, there are significant research holes; for example, there have been no studies to date on the cumulative impact of oil sands development on regional groundwater.
• Although technological advances have improved the efficiency of tailings pond management, the pace of same hasn’t kept up with requirements–in the RSC’s words, there’s a growing inventory of tailings ponds.
• According to data available to the RSC expert panel, oil sands development has little impact on regional air quality, except for noxious odor emission problems over the trailing two years. Research does indicate that control of emissions and regional acidification potential are still valid concerns.
• The report acknowledges that the Canadian oil sands industry has made progress in its effort to reduce overall greenhouse gas (GHG) emissions per barrel of bitumen produced. However, overall GHG emissions will grow as total oil sands output increases over the coming decade. Canada’s international climate treaty commitments must take account of the impact rising oil sands output will have on the country’s GHG emissions.
• The report assigns blame to provincial and federal governments for failing to keep pace with the rapid development of the Canadian oil sands over the preceding decade. Processes to assess the efficacy of oil sands projects must be tightened up, and data collection practices must improve so judgments may be better informed.

Nobody contests the view that production of the Canadian oil sands is a filthy blot on the planet. But the truth is production takes place large in a sparsely populated area, basically 54,000 square miles of boreal forest and peat bogs. Ugly pictures have helped enforce emotional appeals, but, as the RSC report confirms, the reality of oil sands production is far less threatening than sometimes hysterical opponents would have you believe.

The question of whether full-scale exploitation of the Canadian oil sands will continue apace is moot. Output from the oil sands is an absolutely critical piece of the North American energy puzzle. Canada is the No. 1 source of oil for the US, and oil sands output makes up an increasing share of the total shipped across the border. Reducing dependence on hostile foreign regimes for secure supplies of what remains the critical element of the 21st century economy virtually requires development of the Canadian oil sands.

The question is one of costs. Somebody will bear the burden of increasing the scope of available data on the oil sands in a manner the RSC prescribes. Somebody will have to pay to make provincial and federal governments better able to monitor activity and collect information. The spark that will accelerate research and development on technologies that will enable more efficient extraction, processing and refining of oil sands bitumen is cash.

The trouble–as Canadian Oil Sands Trust (TSX: COS-U, OTC: COSWF) has discovered this month–is that investors, particularly those focused on dividends, are sensitive these days to burdens on cash flow. Canadian Oil Sands, which owns a 36.7 percent interest in the Syncrude oil sands project is experiencing unique pressures because of persistent problems at its main processors, which have unexpectedly driven up capital costs. Nevertheless, production costs average USD30 per barrel for oil sands operators, versus about a third to half that for traditional extraction methods.

Not only is it an ugly business. It’s an expensive one, too. When crude oil prices are high–like they are now, flirting with USD90 per barrel–times are good. The incremental impact on profits for an oil sands producer is greater, in fact, with the jump from USD70 than it is for conventional producers, who are already experiencing solid margins at those levels.

But every little bit counts, as Canadian Oil Sands’ troubles attest. The added weight of whatever costs may be associated with implementing suggestions made express in the RSC’s report or merely implied could be prohibitive in the hands of a clumsy government.

The study and its conclusions set the stage for provincial and federal governments to deal with the Canadian oil sands through rational regulation. Although the expert panel was unsparing in its criticisms, the Royal Society of Canada provides significant cover for policymakers to encourage technological solutions to GHG emissions problems, for example, while they stumble around for an agreement that puts a price on carbon.

At any rate, the realities of global supply, demand and geopolitics dictate that the Canadian oil sands play a critical role in the North American energy drama over the coming decade. Not only are the oil sands not the greatest present threat to the environment.

In fact the RSC panel found that oil sands production accounts for about 5 percent of Canada’s total emissions; electricity generation, meanwhile, is responsible for 17 percent, and transportation 27 percent. Ugly pictures will continue to draw extraordinary scrutiny to north central Alberta. But the Canadian oil sands are an increasingly important part of the crude oil supply picture for the US. The RSC’s sober assessment of the risks will ensure aggressive development of the Canadian oil sands, so long as the normal variables–specifically oil prices above USD60 per barrel–remain in the industry’s favor.

The Roundup

Happy Holidays from the Canadian Edge staff. Here are estimated (except where noted) fourth-quarter and full-year 2010 earnings announcement dates for the CE Portfolio.

Aggressive Holdings

• Ag Growth International (TSX: AFN, OTC: AGGZF)–Mar. 11, 2011
• ARC Energy Trust (TSX: AET-U, OTC: AETUF)–Feb. 9, 2011
• Canfor Pulp Income Fund (TSX: CFX-U, OTC: CFPUF)–Feb. 4, 2011
• Chemtrade Logistics Income Fund (TSX: CHE-U, OTC: CGIFF)–Feb. 24, 2011
• Consumers’ Waterheater Income Fund (TSX: CWI-U, OTC: CSUWF)–Mar. 1, 2011
• Daylight Energy Ltd (TSX: DAY, OTC: DAYYF)–Mar. 2, 2011
• Enerplus Resources Fund (TSX: ERF-U, NYSE: ERF)–Feb. 25, 2011
• Newalta Corp (TSX: NAL, OTC: NWLTF)–Mar. 2, 2011
• Parkland Income Fund (TSX: PKI-U, OTC: PKIUF)–Mar. 2, 2011
• Penn West Energy Trust (TSX: PWT-U, NYSE: PWE)–Feb. 18, 2011
• Perpetual Energy (TSX: PMT, OTC: PMGYF)–Mar. 9, 2011
• Peyto Energy Trust (TSX: PEY-U, OTC: PEYUF)–Mar. 10, 2011
• Phoenix Technology Income Fund (TSX: PHX-U, OTC: PHXHF)–Mar. 3, 2011
• Provident Energy Trust (TSX: PVE-U, NYSE: PVX)–Mar. 11, 2011
• Vermillion Energy (TSX: VET, OTC: VEMTF)–Mar. 3, 2011
• Yellow Media (TSX: YLO, OTC: YLWPF)–Feb. 11, 2011

Conservative Holdings

• AltaGas Ltd (TSX: ALA, OTC: ATGFF)–Feb. 23, 2011
• Artis REIT (TSX: AX-U, OTC: ARESF)–Mar. 16, 2011
• Atlantic Power Corp (TSX: ATP, NYSE: AT)–Mar. 29, 2011
• Bell Aliant Regional Communications Income Fund (TSX: BA-U, OTC: BLIAF)–Feb. 3, 2011
• Bird Construction Income Fund (TSX: BDT-U, OTC: BIRDF)–Mar. 11, 2011
• Brookfield Renewable Power Fund (TSX: BRC-U, OTC: BRPFF)–Feb. 9, 2011
• Canadian Apartment Properties REIT (TSX: CAR-U, OTC: CDPYF)–Feb. 24, 2011
• Cineplex Galaxy Income Fund (TSX: CGX-U, OTC: CPXGF)–Feb. 11, 2011
• CML Healthcare Income Fund (TSX: CLC-U, OTC: CMHIF)–Mar. 4, 2011
• Colabor Group (TSX: GCL, OTC: COLFF)–Feb. 24, 2011
• Davis + Henderson Income Fund (TSX: DHF-U, OTC: DHIFF)–Mar. 2, 2011
• IBI Income Fund (TSX: IBG-U, OTC: IBIBF)–Mar. 17, 2011
• Innergex Renewable Energy (TSX: INE, OTC: INGXF)–Mar. 22, 2011
• Just Energy Income Fund (TSX: JE-U, OTC: JUSTF)–Feb. 11, 2011
• Keyera Facilities Income Fund (TSX: KEY-U, OTC: KEYUF)–Feb. 18, 2011
• Macquarie Power & Infrastructure Income Fund (TSX: MPT-U, OTC: MCQPF)–Mar. 2, 2011
• Northern Property REIT (TSX: NPR-U, OTC: NPRUF)–Mar. 17, 2011
• Pembina Pipeline Corp (TSX: PPL, OTC: PBNPF)–Mar. 3, 2011
• RioCan REIT (TSX: REI-U, OTC: RIOCF)–Feb. 9, 2011
• TransForce (TSX: TFI, OTC: TFIFF)–Mar. 2, 2011 (confirmed)