Suncor Energy: Positioned to Benefit from Worldwide Economic Growth

Nov.19.09 | About: Suncor Energy (SU)

International Energy Agency (IEA) executive director Nobuo Tanaka noted that “world leaders gathering in Copenhagen next month for the UN Climate Summit have a historic opportunity to avert the worst effects of climate change” in a statement released following the publication of the 2009 World Energy Outlook.

This analysis also concluded that, if more efficient methods of production can be implemented on a large scale, Canada’s carbon-intensive oil sands will prove critical to satisfying global energy demand in coming decades.

At this point, oil sands production of 3.2 million barrels a day by 2020 seems more inevitable than a United Nations-brokered agreement on climate change. Global leaders managed expectations for a treaty down to zero even before they got to the Copenhagen Climate Summit, while Suncor Energy (NYSE:SU), after its recent acquisition of Petro-Canada one of the biggest players in the oil sands, accelerated its efforts to reorient toward Athabasca.

The IEA report echoes an American Petroleum Institute-sponsored report by the Canadian Energy Research Institute on the potential economic benefits of oil sands development for North America. The CERI report concludes that oil sands development would add USD40 billion to the US economy by 2020. The IEA notes that USD150 billion in new projects that would have added 1.7 million barrels of daily production were suspended or cancelled because of the global recession.

Global upstream oil expenditures--spending by exploration and production (E&P) companies--is forecast to fall by nearly 20 percent, or more than USD90 billion, in 2009 alone. This is the first such decline in a decade.

How fast--or even whether--E&Ps should resume normal capital investment is a difficult question, and the variables facing these companies right now are many.

This is the worst economic downturn since at least the early 1970s, and it’s still an open question whether the nascent recovery can take hold without government intervention. These interventions--both the monetary and fiscal varieties, particularly in the US--in turn are driving inflation expectations and a corresponding appetite for commodities, gold, obviously, and oil. Recent data suggest prices for more and more commodities--hard and soft--also correlate with the inflation trade.

Speculation can drive up prices, but at a certain point those prices get so high that recovery is hampered--consumers will have to spend more and more of what little disposable income they have left on fuel to power their cars and heat their homes.

It’s difficult to isolate any specifically negative role the oil-price spike from late 2007 to mid-2008 played in the recent downturn. Trouble in the financial markets played a much greater role than the price of crude oil in exacerbating what was a rather run-of-the-mill recession until Lehman Brothers collapsed. There is, however, some predictive value for the price of oil when it comes to making GDP forecasts.

Suffice it to say at a certain point consumers started driving less, flying less, spending less--using less carbon-based fuel. As aggregate demand for energy declined steeply along with the global economy, however, companies began to scale back, postpone and/or cancel planned development projects.

At the same time, the era of easy energy is over; more and more development is focused on hard-to-reach and/or difficult-to-produce reserves. Satisfying global energy needs is becoming more and more complex. Marginal production costs are clearly rising, and realized prices must remain at elevated levels to make certain critical projects economic.

Determining what seems a magical level of sustainability--the per barrel price that allows E&P companies to efficiently find and deliver supply and demand isn’t destroyed because prices at the pump are too dear-- is difficult, to say the least. But even in the model described here oil has to get back above USD130 before it would matter again for GDP growth.

But against (and to some degree contributing to) this murky backdrop there are powerful new forces impacting long-term demand, namely China and, to a lesser degree, India.

Niall Ferguson, a professor of history at Harvard and one of the more compelling if a little dramatic talk-show circuit riders, likes to point out that China’s economy might be bigger than the US economy as early as sometime in the 2020s. Most of those who make these kinds of guesses put the date closer to the middle of the century. But the common thread is that China will one day, relatively soon, be bigger than the US.

But at the same time, a vocal and growing movement would impose behavior-altering levies on carbon-based fuel consumption that would drive up costs in favor of environmentally friendlier energy solutions. Developed economies benefited mightily from the availability of cheap, carbon-based fuel. Resistance to any legislation that raises the price of carbon-based fuels in these jurisdictions is fierce; populism is easy to come by when you’re in the minority and there’s a recession on.

Imagine how citizens and governments of emerging economies, just now getting a taste of “middle class” life, would react to strict controls on carbon dioxide and other greenhouse gas emissions. Putting a price on carbon in the absence of a viable, large scale and cost-effective alternative for generating, for example, baseload electricity could stunt these new engines of economic growth.

The primary long-term driver of global energy demand trends is perhaps the most significant force in economics: demographics. This trend--more people consuming more of what is an increasingly costly resource--will keep oil prices at historically elevated levels, perhaps in an entirely new neighborhood for the duration.

The question for E&P companies is when is it time to ramp up production? Is there another “demand shock” looming that will force the shut-in of development projects?

E&P managers downshifted in 2008 as demand slackened because of the deteriorating global economy. It would cost a lot of money to get projects back in gear. Although recent data suggest a broad recovery for the global economy--the signs are particularly strong in China, where the government is on track to deliver 8 percent-plus growth, again--management must appreciate the short- as well as the medium- and long-term consequences of decisions about ramping up production.

On the other hand, and this is as much a concern for policymakers as it is for private managers, will capital investment rebound quickly enough to prevent a supply shortage? A supply shortage could mean a surge beyond the (potentially) demand-destroying USD130 per barrel threshold.

Into this breach steps Suncor Energy, which is now firing up projects shelved amid the economic downturn and corresponding oil-price slide; it’s also lifted an internal hold on new spending in place since it completed the takeover of Petro-Canada in August.

Management describes its recent path as conservative. “Can we bring some projects back? Yes,” CEO Rick George said on a conference call to discuss the spending plans, reported Bloomberg. “But what I don’t want to do is go back to a world where we were making $10 billion project commitments upfront and then at some point have to pull back in.”

Management also described a CAD5.5 billion capital budget that includes CAD1.5 billion to grow production in the oil sands; Suncor is re-starting the delayed Firebag project in northern Alberta, which was 50 percent complete before the economy went deep in the tank in early 2009.

Suncor will spend CAD900 million on the third phase of its Firebag SAGD facility. Suncor now expects production to start in the second quarter of 2011 but wouldn’t say when production would approach capacity of 68,000 barrels a day. The company will spend another CAD50 million to target first production from the fourth phase of Firebag, which has the same potential capacity, in the fourth quarter of 2012. Existing Firebag operations produced about 54,300 barrels a day in the third quarter.

Although Suncor noted in its third-quarter earnings announcement that it may sell up to CAD4 billion in non-core assets, as much as CAD3.7 billion worth in 2010, to focus on the oil sands, the company will hold off until the fourth quarter of 2010 an announcement of plans for re-starting the 200,000 barrel-a-day Voyageur upgrader, the refinery-like plant that was 15 percent complete at the end of 2008, and the Fort Hills oil sands mine acquired along with Petro-Canada.

The third quarter was marked by cost-cutting, shut-in production, drastically lower commodity prices on a year-over-year basis, generally horrible comparables to 2008. (CE subscribers can read about Suncor’s third quarter as well as that of all non-Portfolio Oil and Gas companies in the How They Rate coverage universe in The Roundup.)

However, the best oil and gas companies reduced debt, hedged well and maintained production within reasonable range of historical averages. Their balance sheets relatively healthy, these companies are positioned to grow once the global economy approximates normal.

For E&Ps it’s a matter of “be quick, but don’t hurry.” Suncor’s move suggests the time to move, at least, is now.