RBC Dominion Securities Inc. Emerging Oil Sands Producers Mark Friesen (Analyst) (403) 299-2389 Initiating Coverage: The Oil Sands Manifesto [email protected] Sam Roach (Associate) Investment Summary & Thesis (403) 299-5045 We initiate coverage of six emerging oil sands focused companies. We are bullish with [email protected] respect to the oil sands sector and selectively within this peer group of new players. We see decades of growth in the oil sands sector, much of which is in the control of the emerging companies. Our target prices are based on Net Asset Value (NAV), which are based on a long-term flat oil price assumption of US$85.00/bbl WTI. The primary support for our December 13, 2010 valuations and our recommendations is our view of each management team’s ability to execute projects. This report is priced as of market close December 9, 2010 ET. We believe that emerging oil sands companies are an attractive investment opportunity in the near, medium and longer term, but investors must selectively choose the All values are in Canadian dollars companies with the best assets and greatest likelihood of project execution. unless otherwise noted. For Required Non-U.S. Analyst and Investment Highlights Conflicts Disclosures, please see • page 198. MEG Energy is our favourite stock, which we have rated as Outperform, Above Average Risk. We have also assigned an Outperform rating to Ivanhoe Energy (Speculative Risk). • We have rated Athabasca Oil Sands and Connacher Oil & Gas both as Sector Perform, (Above Average Risk). We have also assigned a Sector Perform rating to SilverBirch Energy (Speculative Risk). • We have rated OPTI Canada as Underperform, Speculative Risk. • Key Industry Themes – We believe that industry focus has shifted from a resource capture mentality to a project execution mentality. We believe that the oil sands sector is positioning for another boom in the 2012–2015 timeframe (see Exhibit 37). We expect In- Situ projects with a focus on the Athabasca region will continue to dominate the emerging landscape and we expect economics to favour upstream only projects (i.e., no upgrading). We expect ample shipping capacity on export pipelines for the next decade and plenty of downstream demand for Canadian heavy oil. We expect environmental issues to be of keen consideration but not a deterrent to development. • Key Challenges/Opportunities – Near term, we believe the greatest challenge facing most emerging oil sands companies will be to successfully navigate the regulatory, project financing and project execution process in a timely and disciplined manner. In the medium to longer term, we see industry participants developing new technologies to address the most relevant technical, environmental and financial challenges facing the sector. Developing new production methods and unlocking new play types such as the bitumen carbonates could create tremendous investment returns. • Key Conclusions - We expect emerging oil sands companies to continue to demand capital (we estimate ~$20 billion based on projects in the regulatory queue), some companies to become large and well established oil sands producers over the decade and for emerging oil sands companies to likely be the target of corporate acquisition activity based on the resource and production potential they have captured. Mkt Cap Implied Est. Date of Company Ticker Exch Rating Risk ($mm) Price Target Return First Production Athabasca Oil Sands ATH T SP AA $5,593 $14.06 $16.00 13.8% 2014 Connacher Oil & Gas CLL T SP AA $513 $1.16 $1.50 29.3% Producing Ivanhoe Energy IE T O Spec $868 $2.42 $3.00 24.0% 2015 MEG Energy MEG T O AA $7,390 $39.00 $48.00 23.1% Producing OPTI Canada OPC T U Spec $194 $0.69 $0.60 -13.0% Producing SilverBirch Energy SBE V SP Spec $360 $7.20 $8.00 11.1% 2020 Source: RBC Capital Markets The Oil Sands Manifesto December 13, 2010 Table of Contents Comparative Valuation Tables......................................................................................................3 Valuation Approach – NAV is our Preferred Method.................................................................5 Risks to Target Prices.....................................................................................................................6 WTI Oil Price Sensitivity & Upside Potential ..............................................................................8 Oil Sands – Current Activities & Issues........................................................................................9 Current Production and Players ........................................................................................................9 Proposed Projects & Players...........................................................................................................10 Oil Sands Recovery Methods – Mining compared to In-Situ .........................................................13 Blending – Economics Favour Dilbit..............................................................................................14 Upgrading – It’s Not What it Used to Be........................................................................................15 In the Pipeline: Awash with Excess Capacity for a Decade............................................................17 Downstream Refining Complex: How It’s Adapted.......................................................................20 The Oil Sands Stigma: Project Delays and Cost Escalation ...........................................................21 The Environment: It’s the LAW (Land, Air & Water) ...................................................................22 Emerging Plays: Bitumen Carbonates ............................................................................................25 Reserves and Resources: Lock, Stock and Barrel...........................................................................27 Reservoir Basics – Spotting the Good from the Bad ......................................................................29 Fundamental Comparative Analysis...........................................................................................32 Company Profiles Athabasca Oil Sands Corp. (TSX: ATH; $14.06)...........................................................................38 Connacher Oil & Gas Ltd. (TSX: CLL; $1.16)...............................................................................65 Ivanhoe Energy Inc. (TSX: IE; $2.42)............................................................................................84 MEG Energy Corp. (TSX: MEG; $39.00)....................................................................................106 OPTI Canada Inc. (TSX: OPC; $0.69)..........................................................................................126 SilverBirch Energy Corp. (TSX-V: SBE; $7.20)..........................................................................147 Appendix I: Private Companies Laricina Energy Ltd. (Private Company)......................................................................................164 Osum Oil Sands Corp. (Private Company)...................................................................................170 Sunshine Oilsands Ltd. (Private Company)..................................................................................176 JACOS – Japan Canada Oil Sands Ltd. (Private Company).........................................................181 Appendix II: Oil Sands Lease Map ...........................................................................................185 Appendix III: Project Well Configuration Maps.....................................................................186 Appendix IV: Oil Sands M&A Transaction History ...............................................................192 Appendix V: Historical Land Sales ...........................................................................................193 Appendix VI: Historical Capital Spending...............................................................................195 Appendix VII: Table of Formations..........................................................................................196 Appendix VIII: Pricing Assumptions........................................................................................197 Required Disclosures ..................................................................................................................198 2 Mark Friesen, CFA December 13, 2010 The Oil Sands Manifesto Comparative Valuation Tables Exhibit 1: Comparative Valuation: Financial Ratings and Targets1. Market Data Capitalization Market 12 100 Day Shares Market Net Enterprise Oil Sands Price Month Implied 52 Week 52 Week Avg Vol. O/S Cap Debt Value2. EV2. Company Ticker Exchange 9-Dec-10 Target Return Rating Risk High Low (mm) (mm) ($mm) ($mm) ($mm) ($mm) Athabasca Oil Sands ATH T $14.06 $16.00 14% SP AA $18.11 $9.89 1.0 $398 $5,593 ($1,450) $4,143 $4,143 Connacher Oil & Gas CLL T $1.16 $1.50 29% SP AA $1.88 $1.10 1.8 $443 $513 $806 $1,319 $1,134 Ivanhoe Energy IE T $2.42 $3.00 24% O Spec $3.94 $1.55 0.4 $359 $868 ($46) $822 $610 MEG Energy MEG T $39.00 $48.00 23% O AA $40.94 $30.30 0.2 $189 $7,390 ($397) $6,992 $6,992 OPTI Canada OPC T $0.69 $0.60 -13% U Spec $2.47 $0.63 2.0 $282 $194 $2,445 $2,639 $2,639 SilverBirch Energy SBE V $7.20 $8.00 11% SP Spec $8.45 $5.55 0.3 $50 $360 ($44) $316 $316 Average 15% 1. RBC CM Ratings: Top Pick (TP); Outperform (O); Sector Perform (SP); Underperform (U); Restricted (R); RBC CM Risk Ratings: Average Risk (Avg);