March 2007 Archives

I have written prior articles about Getty Images Inc. (GYI). Black Star Rising has an interesting article Getty Photographers Pessimistic About the Future. It is worthwhile reading for photographers interested in stock photography and investors interested in stock agencies.

Kathy Sierra wrote a disturbing account of receiving death threats left on her blog Passionate: Creating Passionate Users.

As I type this, I am supposed to be in San Diego, delivering a workshop at the ETech conference. But I'm not. I'm at home, with the doors locked, terrified. For the last four weeks, I've been getting death threat comments on this blog. But that's not what pushed me over the edge. What finally did it was some disturbing threats of violence and sex posted on two other blogs... blogs authored and/or owned by a group that includes prominent bloggers.

As I read Kathy's article, I felt sad for her, even though I have never met her. I do not like to see others bullied or harassed. I believe strongly in free speech. Though, I am not supportive of hateful speech, speech that makes others live their lives in fear.

From what Kathy has written on her blog, she appears to be targeted because she is a woman working in a male dominated technology sector. We here in Canada have witnessed a similar ugly act of aggression where a murderer gunned 14 innocent women studying engineering in Montreal. There is no humor in threats or acts of intimidation.

I am fully supportive of her right to blog and her right to work and participate in the technology sector. I wish Kathy and her family the best. And I hope she returns soon, stronger and more determined that ever before.

Please visit Kathy's blog and read her article.

I just finished watching The Apprentice Season 6: Los Angeles tenth episode.

The task was to sell the most tickets for Universal Studios using its new technological device that allows the attendant to scan credit cards on the spot. Both teams competed mano-o-mano in close proximity to each other for the very same customers.

Whew, I had thought Nicole might be the scapegoat and be fired. Although it was her idea to rollerskate and sell tickets, at least she put forward a suggestion. And she did tell the team exactly what to expect. Angela, as much as I wanted her to stay, was ultimately accountable for the loss. The reality is that Team Kinetic did not have fire in their belly, and as consequence, got beat by Team Arrow. I do not think it mattered who on Team Kinetic was the leader, the leader was going to take the hit for the loss of the entire team.

Angela was classy in her departure. She sounded positive and professional. I am sure she gained a tremendous learning experience from the show.

As far as Team Arrow was concerned, they wanted the win more badly than did their opponents. They out hustled their competition. They also benefited from having a large display booth where they had a formidable presence, as opposed to Team Kinetic that skated around trying to convince customers to buy. From what I saw, though, the largest factor was desire to win.

I am not sure what to make of the Tim and Nicole relationship. Of the two, I think Nicole is handling it better and able to show better judgment in keeping a more even temperament. That said, despite what Trump said in the boardroom, I support Tim's decision to refrain from interfering with James' decision to send Nicole to Team Kinetic. Had he interfered, he would have made life difficult for both himself and Nicole. And it certainly would have harmed Team Arrow's dynamics for the task.

As far as picking The Apprentice favorite, I still do not have a clear favorite. All members on Team Arrow are doing well. I am not sure if any stand out above the others. On Team Kinetic, I do not have any clear favorites. While I like Kristine, her attitude needs a slight adjustment. She reminds me slightly of Tana Goertz, a finalist contestant in a previous series, who was strong but as appreciative of her teammates as she should have been.

Although I do not like having the winning leader repeat as leader this season, I am enjoying Season 6. There are still seven candidates, each of whom still has an equal or close to equal opportunity to win. At this point in the process in prior seasons, there were a few clear candidates with the rest as fillers. As mentioned, all remaining players are still very much in the running. The game is still wide open.

On March 19th, the Canadian federal government provided its 2007 Budget (pdf), which changed the fiscal regime for oil sands. More specifically, it phases the elimination of the accelerated Capital Cost Allowance (CCA) 41.

When the National Oil Sands Task Force (NOSTF) originally proposed the accelerated CCA 41 in the mid 1990s, the industry and governments believed that oil would be stuck in the $20 – $30 real price band forever. Although oil is a depleting natural resource, most believed technology would allow oil companies to find and exploit smaller pools of oil economically. Oil sands projects are huge mega-projects which take several years of engineering and design work prior to construction. Construction typically takes four to six years. After at least five years of spending money, the developer finally begins to start earning money as production begins. And then production usually lasts about 40 – 50 years. Under a moderate or low price scenario, oil sands projects are not attractive and are very risky. If a project happened to come on stream during a four or five drought of low oil prices, it would likely never recover its cost of capital. Moreover, there was a fear that within 50 years, there stood a strong chance that some other energy source might be developed and the oil sands would become worthless. Thus, there was a desire to monetize the oil sands by encouraging production as soon as possible.

To help reduce the risk and to encourage oil sand developers, the Alberta and Canadian governments put in place a fiscal regime that is extremely attractive. On the royalty side, the Alberta government allows the developer to earn the long term bond rate before paying meaningful royalties (payout). Prior to payout, the company only pays 1% gross revenue royalty. The industry wanted 0% but the Alberta government thought that was unpalatable. On the taxation side, the federal government allowed the accelerated CCA 41. At the time, the accelerated CCA 41 was a huge bonus to the industry.

The accelerated CCA 41 provides is a mechanism where a developer can recover its capital back quickly and the governments' taxation benefits are deferred. Under the prior rules, the developer was able to write-off its development capital at 100%. Now, it will use a 25% deduction.

When the NOSTF used moderate prices and reasonable costs, the accelerated CCA 41 provided roughly one-quarter to one-third more value on a net present value basis. Today, I was curious about how the change in CCA 41 would affect oil sands developers. I created a hypothetical case and ran a complicated financial model. My hypothetical case was pulled out of thin air and does not represent any real project. I used the following major assumptions:

• Mining Project only;
• C$40 bitumen price;
• 300,000 barrels per day production;
• Capital: $4.8 billion (40% of a $12 billion integrated project);
• Sustaining capital of 4% of construction capital;
• Operating costs of $15 per barrel;
• 50 year life;
• Alberta tax rate of 10%
• Federal tax rate of 19% throughout the time period (it is a bit higher today);
• 2% inflation; and
• 12.5% discount rate.

Using these hypothetical assumptions and using the accelerated CCA 41, the project has a 27.5% IRR and an NPV of $6.5 billion. Using the same assumptions but without the accelerated CCA 41, the project has a 26.5% IRR and an NPV of $6.3 billion. So yes, the change has an impact, but that impact is nowhere as important today as it was before under much lower prices. Using the set of assumptions above, the change in value to the developer is only 3% on a net present value basis. A very slight change in bitumen price would easily overwhelm this change.

To recap, when prices were lower and oil sands projects were marginal, the accelerated 41 CCA was a huge value driver. It added significantly to a developer's net present value. When prices are higher and the developer already has very attractive returns, the value of the accelerated 41 CCA as a percentage if net present value is not significant.

And to emphasize again, these assumptions are just my wild guesses. I have not calibrated my assumptions against any existing or proposed projects. I began with a capital cost intensity of $40,000 per barrel per day for an integrated project. I then assumed that mining was about 40% of that amount. The rest of the numbers tumbled out from those initial assumptions. I chose a mining project as opposed to an integrated project—one that includes an upgrader—because of the royalty complexity and uncertainty for an upgrader.

As an aside, most of the existing, perhaps all of the existing, oil sands operators were given the option of whether to have the upgrader included in the royalty calculation. To cut to the chase, if a developer believes that light heavy differentials will remain wide, it will elect to have the royalty on bitumen to maximize value. If a developer believes that light heavy differentials will quickly return to historical norms, then it will elect to have the upgrader as part of the royalty to reduce risk. This topic is a whole article in itself and will not be dealt with in further detail in this article.

I found the results interesting. I had expected more of an impact because of the attractive nature of the immediate write-off of capital. But pragmatically, with a rich project, it is of little consequence.

On FleckensteinCapital.com's subscription based website, I followed a link to an interesting Reuter's article concerning Jim Rogers' outlook for property values and emerging markets. He is bearish on both. I have read all three of Jim Rogers' books and always enjoy reading his latest comments.