Insiders Nibble at Tiny Canadian Tar Sands Infrastructure Play

By Michael Brush
Exclusively for InvestorIdeas.com
September 28, 2006

Canadian tar sands stretching through three major deposits in northern Alberta hold enough oil to potentially satisfy North American demand for several generations.

But it’s only been in the past few years that the price of oil has gotten high enough to peak interest in rendering oil from tar sands in a big way.

To get the job done, energy companies will need more roads and housing in this barren region – not to mention the huge plants that process the tar-like bitumen into oil. And to make all this stuff, builders will need tons of crushed stone, concrete and limestone.

That’s what makes a small, Calgary-based building materials company where insiders have been buying lately – Birch Mountain (BMD) -- an interesting investment play.

The stock has declined considerably since May – to about $3.20 from above $8. But down here insiders have been nibbling, including chief executive Douglas Rowe and a vice president in charge of engineering named Russell Gerrish. In September, they purchased moderate amounts of stock in the $3.19 to $3.85 range (U.S. dollars).

Birch Mountain holds mineral rights on about one million acres in the Athabasca region north of Fort McMurray, Alberta, the heart of oil sands country.

It currently supplies small amounts of crushed rock, known as aggregate, from its Muskeg Valley Quarry – used in the construction of roads. Further on, a form of limestone that will likely be produced by Birch Mountain may be used to clean up the tar sands production process.

Here’s a closer look at the potential demand for its construction materials.

Sources of demand

Tar sands plants. It takes about eight million tons of aggregate and half a million tons of concrete to complete a plant. Over the 35-year life span of an oil sands plant, millions tons of aggregate are needed to keep the plant going. Currently about 30 energy companies have proposed over 80 oil sands projects in Alberta.

Infrastructure. Regional government’s are in the process of spending over $1 billion on infrastructure like highways, air strips, water plants, schools and health care facilities to support workers and their families in the region. Birch Mountain expects to sell 2.5 million tons of crushed rock to be used in infrastructure projects in 2006. That should bring in $20 million for the year, estimates Davenport & Company analyst Robert Norfleet. He thinks Birch Mountain will soon have eight million tons of annual capacity, for a potential $80 million in annual sales.

Quicklime. But the big payday for Birch Mountain may come further down the road once more tar sands producers have plants up and running. When they do, they’re likely to need a substance called “quicklime” to help “scrub” sulfur dioxide from the smoke stacks of tar sands plants. Birch Mountain has applied for permits to produce quicklime at its proposed Hammerstone project.

It won’t be up and running until late 2007 or early 2008, if it gets approved at all. But well before then, producers could announce plans to use tar sands processing techniques that call for quicklime, speculates Norfleet. If so, that would spark investor interest in Birch Mountain shares well before it is producing quicklime in quantity. Norfleet believes the company’s potential business here could be worth at least $8 to $9 a share.

The crushed rock business may be worth about $3.60 a share, suggests Jason Bouvier, who covers the stock for RBC Capital Markets.

If they’re both right, that suggests this stock could be a three bagger or more over the next few years.

Recent weakness

Birch Mountain shares have been weak since May for at least two reasons. First, oil prices have come down and costs are rising for oil sands producers – which suggests projects might not develop as rapidly as once expected. Next, Birch Mountain has almost run out of money, and it needs to raise capital to fund projects. This could dilute the value of existing shares.

But these concerns may be overblown – and they are probably already priced in to the stock. Oil is likely to stay above $55 because of strong global growth and geopolitical risk in oil-producing regions. So oil sands projects won’t be put on hold. And Birch Mountain could scale back on the amount of capital it raises by deferring some projects. Meanwhile, cash flow from the sale of aggregate could help pick up the slack in the quarters ahead, suggests RBC Capital Markets Bouvier.

“There are some questions about how much market share they will have, and there are equity financing concerns,” says another analyst who has pointed me to several successful Canadian energy plays over the past few years. “But at $3 it is a good deal because oil sands projects will get built and they will need limestone for the scrubbers.”

Davenport & Company’s Norfleet says orders are “just at the cusp of accelerating” and that the stock is “significantly undervalued” at current levels.

The bottom line: This is definitely a “show me” story in the sense that it’s not clear whether the piece of the story with the biggest potential – the quicklime – will ever materialize. On the other hand, the Canadian tar sands development is obviously for real. And to get the task done, the tar sands regions of northern Alberta will have to go through a construction boom – supporting demand for basic building materials like crushed rock. Given the damage this stock has seen – and since the big limestone piece of the story is way in the future – I’d expect Birch Mountain shares to remain volatile. This means patient buyers should be able to pick up shares at $3.10 or lower – and it’s worth using limit orders to get those kinds of prices.

Disclaimer
At the time of publication, Michael Brush owned shares of Birch Mountain. Mr. Brush is an independent columnist for this web site.
For more on Insiders Corner disclosure, see the disclosure section in About Insiders Corner: http://www.investorideas.com/insiderscorner/. InvestorIdeas.com Disclaimer: www.InvestorIdeas.com/About/Disclaimer.asp. InvestorIdeas is not affiliated or compensated by the companies mentioned in this article.

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