Canada: The View From Up Here

By David Dittman • September 20, 2011 • Canadian Edge Weekly

VANCOUVER, British Columbia–The picture below captures the view I woke up to this morning, from the 18th floor of the Pan Pacific Hotel in Vancouver, British Columbia. Based on this image alone it’s easy to understand why Vancouver consistently ranks among the world’s “most livable” cities; in fact research by The Economist’s Intelligence Unit found that Vancouver is the first city to list among the top 10 most livable cities for five straight years.

Originally settled around a logging sawmill in 1867, the site was renamed “Vancouver” in 1886 when it was announced that the transcontinental railway built by what’s now Canadian Pacific Railway (TSX: CP, NYSE: CP) would be extended to take advantage of the region’s large natural seaport. By 1887 the railway had reached Vancouver, establishing important trade routes with Eastern Canada, of course, but also London. And even more than a century ago planners understood the importance of and the potential for Vancouver connecting Canada to “the Orient.”

Vancouver has hosted many international conferences and events, including the 1954 British Empire and Commonwealth Games, Expo 86 and the World Police and Fire Games in 1989 and 2009. The 2010 Winter Olympics and 2010 Winter Paralympics were held in Vancouver and nearby Whistler, a resort community 78 miles north of the city. Roger Conrad and I are here this week for The World MoneyShow Vancouver.

The photo above is a closer shot of the formation at middle-right in the “wake up” picture. It’s a Chevron (NYSE: CVX) filling station, right where Coal Harbour meets Vancouver Harbour near Burrard Inlet. It’s a reminder of the ubiquity of petroleum products in our lives and that such will continue to be an important part–perhaps the most important single variable–of global commerce for years to come.

Each of the thousands of molecules that make up crude oil has particular physical and chemical properties. Hundreds of products are made by separating and sorting these molecules, then re-combining or processing them further. The range of products varies according to the particular type of crude oil and the refinery design. Processes can be altered to produce more gasoline in summer or more heating oil in winter.

On average, processing light crude oil in a modern refinery yields a range of products; gasoline to fuel cars, motorcycles, light trucks, small planes, boats, off-road vehicles, snowmobiles, lawnmowers, chainsaws, leaf and snow blowers, emergency generators, camp stoves, etc., accounts for about 40 percent of the original crude oil volume. Of course there are many other products derived from crude oil–including diesel fuel, home-heating fuel, asphalt for road paving and roofing, lubricants such as motor oil and grease, waxes for candles and polishes, and the raw materials for petrochemicals such as polystyrene and synthetic rubber.

As ever-present as Chevron stations and the like are in the West and as dependent as we are on cheap fuel, the intensity of new demand for gasoline and other crude-derived products from Asia, most notably China, is a slap in the face to those who would turn their backs on any reasonably accessible crude oil reserves.

From 2005 to 2010 global oil production grew by 2.2 million barrels a day, about 2.6 percent of 2005 levels. Over the same time frame China increased its consumption by 2.5 million barrels a day. A lot of this new demand is tied to new vehicle purchases. The US fleet of automobiles is still about five times the size of the Chinese fleet. But over the last decade, the average growth rate of the Chinese fleet has been about 23 percent per year; the Chinese fleet is on course to equal the size of the US fleet sometime before 2020.

The strain on global oil supplies placed by new Chinese drivers is already apparent, and it’s likely to get more intense over the next decade.

There is no question that exploitation of the Canadian oil sands is a messy business and that synthetic crude derived therefrom has greater total life cycle greenhouse gas (GHG) emissions.

Transportation fuels produced solely from oil sands result in well-to-wheels life-cycle GHG emissions 5 to 15 percent higher than the average crude refined in the US. “Well-to-wheels emissions” include those produced during crude oil extraction, processing, distribution and combustion in an engine.

Many analyses of oil sands GHG emissions focus on emissions in the extraction through refining phases, also known as the well-to-retail pump portion of the life cycle. However, 70 to 80 percent of GHG emissions for all sources of crude oil, including Canada’s oil sands, occur at the combustion phase. Combustion emissions don’t vary for a given fuel among sources of crude oil. Oil suppliers influence only the well-to-retail pump emissions, which account for 20 to 30 percent of total life-cycle GHG emissions. And the average oil sands import to the US has well-to-wheels life-cycle GHG emissions about 6 percent higher than the average crude refined in the United States.

It’s important to note, however, that significant progress is being made to reduce the difference in overall impact between traditional oil production and bitumen production. Companies such as MEG Energy Corp (TSX: MEG, OTC: MEGEF) have significantly reduced the so-called steam-to-oil ratio (SOR), a gauge of the efficiency of steam-assisted gravity drainage (SAGD) operations. SOR measures the volume of steam required to produce one unit volume of oil; typical SOR values for SAGD range from 2 to 5. The lower the SOR, the more efficiently the steam is utilized and the lower the associated fuel costs.

SAGD, a process with a much smaller footprint, is the future of oil sands development, for reasons of cosmetics as well as efficiency. MEG has reported SORs of less than 2.5 for its flagship Christina Lake Project, which means it takes less than two and a half barrels of water (which is converted to steam) to produce one barrel of oil. Low SORs reduce capital and operating costs, boosting profitability of the operation. SAGD also has a higher recovery factor than open-pit operations; the process is capable of recovering more than 70 percent of the oil in place, compared to conventional extraction, which often recovers less than 30 percent. SAGD footprints are also much smaller than those of traditional methods; MEG’s SAGD facilities only occupy 10 to 15 percent of the land surface of a producing lease.

MEG’s wells are drilled horizontally into the oil sands reservoir, which is located approximately 1,300 feet beneath the earth. MEG drills two wells horizontally, with one approximately 16 feet above the other. The top well injects steam into the reservoir, which heats up the bitumen so it flows down into the lower well, which transports it to surface. Horizontal wells are able to reach up to 4,900 fee), which means that the vegetation and wildlife on much of the surface of the producing reservoir goes undisturbed.

What’s happening in China is also happening in India and the rest of the developing world: Emerging middle class consumers want to drive cars and demand for gasoline is going to skyrocket. Efforts to diversify US transportation away from oil dependence, including promoting electric vehicle technology, increasing energy efficiency for vehicles and next generation biofuels will and should continue. But the most rigorous study of the problem yet undertaken suggests it could be more than 100 years–until 2041–before that transition is complete. Until then we have no alternative but to improve on existing technologies so that the extraction of non-traditional resources such as the oil sands becomes more environmentally friendly.

In the eyes of this beholder, that Chevron station facilitates the enjoyment of Vancouver’s natural surroundings, by boat and by seaplane. Although it may seem like blight on Coal Harbour to some, the fact is it’s a reality that won’t soon go away.

The Roundup

Canadian Edge Portfolio Conservative Holding Bird Construction Inc’s (TSX: BDT, OTC: BIRDF) HJ O’Connell Ltd subsidiary has executed a CAD100 million contract to remove waste rock at ArcelorMittal Mines Canada Inc’s (NYSE: MT) Mount Wright mine near Fermont, Quebec. Work will begin this fall and will conclude by the spring of 2015. It’s a very promising sign for O’Connell and validation of Bird’s acquisition of surface mining contractor.

Bird’s second-quarter net income didn’t cover its distribution for the period, as revenue and margins both weakened because of reliance on lower-margin contracts. But this is another good sign for Bird’s still-solid order backlog, which as of Jun. 30 stood at a record CAD1.138 billion up from CAD853.2 million as of Jun. 30, 2010. Bird Construction is still a buy up to USD12 for those who don’t already own it.

Former CE Portfolio Holding Arctic Glacier Income Fund (TSX: AG-U, OTC: AGUNF) is nearing its end–or rather, the current leadership, including the board of directors, is on the verge of paying the piper for a series of decisions that have left the company, which still generates impressive cash flow, on the verge of bankruptcy. “Major unitholders,” who have pushed for a special meeting of shareholders that would take place before Sept. 30, reportedly have secured new financing of CAD300 million.

Arctic Glacier is currently in technical default with its existing lenders, though the proposed refinancing would repay them in full. The plan includes new secured credit facility, a secured term loan and new equity financing from a rights offering available to all unitholders and to be backstopped by the major unitholder group. The group includes Coliseum Capital Partners, Talamod Master Fund and an unidentified institution.

Earlier in September Winnipeg-based Arctic announced that it was officially in default to lenders. The ice maker’s second lien secured lenders, CPPIB Credit Investments Inc and West Face Capital Inc, had refused to extend their waivers of certain covenants under the fund’s credit facilities. Arctic Glacier was in breach of covenants governing maximum leverage ratio, interest coverage ratio, fixed-charge coverage ratio and minimum EBITDA levels under its credit facilities on June 30, but the secured lenders had waived compliance until early September.

Coliseum and Talamod, which together own more than 10 percent of Arctic Glacier stock, have said the current trustees and management hadn’t provided a satisfactory response to requests for a meaningful dialogue. Sell Arctic Glacier.
Here are links to analyses of second-quarter earnings for all Portfolio Holdings except Student Transportation Inc (TSX: STB, NSDQ: STB), which will report fiscal fourth-quarter and year-end 2011 results on or about Sept. 23, followed by reporting dates for the third quarter.

Conservative Holdings

Aggressive Holdings

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