Oil Sands In Focus: Q&A With Derek Gates

ETF Database

The exchange-traded product lineup is quickly and surely approaching the 1,500 mark, showcasing the rapid expansion of the industry as investors and money managers alike have embraced this investment vehicle in their portfolios. One of the more recent strides towards delivering more granular exposure to a quickly growing, although often times overlooked, corner of the equity market comes in the form of the Sustainable North American Oil Sands ETF (SNDS). Derek Gates, seasoned investment advisor and President of Sustainable Wealth Management Ltd.,  recently took time out of his schedule to discuss what makes oil sands attractive, the basics behind SNDS, as well discussing long-term trends in the global energy market.

ETF Database (ETFdb):  Give us an overview of what your idea was behind launching SNDS.

Derek Gates (DG):  SNDS goes back to when we started in the oil sands sector, we focused in on the producers initially in Canada.  It was a part of an index I created for managing money for private individuals, the index was published, and then in 2006, before there was a big boom in the oil sands sector, I started licensing it. At first we only licensed to hedge funds but then it went to Claymore, which launched the first Canadian-only oil sands index on the Toronto exchange in October 2006. That got the ball rolling so in 2007 Claymore U.S.A., which is now Guggenheim, took the idea and wanted to launch an index that was focused on the oil sands and royalty trusts, which they did for a certain number of years. But I also expected that somewhere along the line the Canadian companies might get merged out of existence. This index  focuses on the major players in the sector, the acquiring companies and the companies that are likely to be acquired. SNDS is meant to go after the whole sector, the hundreds of billions of dollars that are going to benefit the producers, the refiners, the pipeline and the service companies, that’s what we are targeting with this product.

ETFdb:  You guys have put out SNDS which focuses on the oil sands corner of the market, what is your response when people say they already have exposure to this market through the Energy Select Sector SPDR (XLE) or Exxon mobile stock?

DG:  What we have done is created a broadly diversified global energy ETF tracking an index that is equally weighted to provide less concentrated exposure to the largest companies and more meaningful exposure to companies with outstanding growth prospects. We find the equal weighting methodology can offer a higher dividend yield and better exposure to non-U.S. companies. The Sustainable North American Oil Sands Index had a forward yield of 3.12% after the June 29, 2012 rebalance. With SNDS we are also targeting the fastest growing region of the energy sector. There are about 30 ETFs that follow the energy sector, and most of them are focused on the United States. We think that Canada will be a much more investor friendly place in the future. It’s the companies that have the cash and are exposed to huge acquisitions that are going to do well. We have benefited from high exposure to the merger and acquisition activity, the high growth prospects, and high dividends coming out of this sector. The oil sands have also been very stable through the market swings; when crude oil prices were high most companies couldn’t keep up, but the oil sands companies did just fine, and I think it is likely that we will see this happen again.

ETFdb:  What is the appeal behind investing in oil sands?

DG:  The appeal is that it is the largest supply of oil outside of OPEC member nations. Based on the projects that are under construction now, Canadian oil sand production is going to grow substantially in the next decade. It varies based on what other projects get added or cancelled, but it’s expected to double in the next ten years, and that’s pretty rare in the energy sector. What we are finding is that most oil production is declining every year by about 6 to 7%, so when a country like Canada can increase production so quickly it’s generally because they are investing substantially in new production. Canada’s oil sands provide energy companies with a huge opportunity to replace their reserves, which has been the major problem with energy companies. It was one of the biggest things that Exxon Mobile focused on, getting the Standards Council of Canada (SCC) to recognize the oil sands as reserves because for years they have been having a hard time replacing their reserves with conventional sources. The oil sands are over 170 billion barrels of crude oil reserves and it’s likely to go up as technological advances allow for new methods of extraction. 

The other thing you get from the oil sands is that you’re less at risk of nationalization of your assets. One of the biggest competitors to the oil sands is Venezuela, which has a very heavy type of crude comparatively. Companies that have invested in that region found that their assets were nationalized once they reached a certain level of profitability. That’s one thing that’s less likely to happen in Canada, it doesn’t even have a national oil company to compete with. The other thing I noticed over the years is that oil sand companies tend to have huge leverage to the rising price of crude oil. For example, most of their costs tend to be relatively fixed, once you recover your investment. So the rise in crude oil is upside profit for them. Another thing that makes the oil sands interesting is that if there is instability in OPEC nations, it tends to highlight how safe Canada’s oil production really is.

ETFdb:  You mentioned some pretty impressive figures on the oil sands projected production; it seems almost too good to be true, can you explain on how this is possible?

DG:  This production growth is a product of both technological advances and government incentives. Canada has been trying to get the oil sands production going since the 1930s but back then the technology didn’t exist or it wasn’t scale-able. What happened was in 1967, Sunoco, which is now Sun Core, came up with a mining process which has been described as “brute force combined with ignorance.” What you would do is pick up a whole lot of dirt, and sift the oil out with hot water and detergent. This separates out to sand on the bottom, water in the middle, and oil on top, but this is a hard and expensive process, and it’s the one that you tend to see in environmental stories. That’s about 8 of the projects; there are about 130 projects that follow the new approach from 1983, which uses steam injection to produce the oil. It’s a lot less messy; they just use a lot of natural gas to produce the steam. The future is where you don’t have to use natural gas, but nano tech, catalysts, or other solvents that can get the oil sands out without water or natural gas.   These future advancements will reduce a lot of the environmental impact. As it stands right now, 170 billion barrels of reserves is based just on the mining and basic steam technology. Further down the road the total resources, between 1.7 trillion and 2.5 trillion, will be accessible, but it will take much higher oil prices and more innovative technologies to extract those.  

ETFdb:  What are some other long-term trends that you are seeing in the global energy market?

DG:  One thing that really gets to me is that most of the world’s oil, about 90 million barrels a day, only 35 million are up for international trade, and Canada is one of the 15 countries that can export more than half a million barrels a day. In the future, Canada can export about 4 million barrels, which will put it into the top tier, only behind Russia, Saudi Arabia and maybe Iran. A lot of countries that used to be major producers, like Indonesia, are no longer because their production level declined and their own needs have increased dramatically. That’s happening right now to Mexico and maybe eventually Venezuela, so in the future where are we going to get our oil? The countries that can export will have a huge advantage in the next 10 to 20 years. It’s also becoming harder to find the reserves. We are having a hard time finding liquid crude oil and no problems finding natural gas; but in terms of high quality, low sulfur, “sweet crude” oil, those reserves have leveled off since 2005. We are finding that when countries are discovering new oil it’s very heavy and sour, requiring high end refiners that you find in the Gulf of Mexico, China, and Saudi Arabia. The countries that have those refineries will be in good shape because of this.  

Bottom Line:  investing in oil sands is undoubtedly a lucrative opportunity for those who wish to tap into one of the fastest growing corners of the global energy market. As such, SNDS presents itself as a viable tool for those looking to round out exposure to this segment of the energy sector, while at the same time beefing up their portfolio’s current return and favorably positioning themselves as energy consumption continues to increase around the world. 

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Disclosure: No positions at time of writing.

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