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We have looked at enough of these companies at this point that we can step out of the box a little and try to understand what is going on at Suncor (NYSE:SU), which is the big Canadian outfit that is working on that oil sands project.

To summarize the process, there is a deposit of oil sands in the Athabasca region of Canada. This material is mainly minerals, but on average is 11% hydrocarbon, which is comparable to the level found at a lot of the solid waste landfills in the nation.

There are two processes for extracting this stuff: strip mining, which involves removing several meters of overburden material, and extracting the sands using enormous cranes and trucks. The resultant material is then heated with water into a slurry, as much of the hydrocarbons are extracted as possible, and then the material is cracked into a crude-oil-like substance which can be used as the feedstock in a more or less normal refinery.

The In-Situ process is that holes are drilled into the deposit, there is a quantity of steam pumped into the hole to extract the hydrocarbons which are then re-pumped to the surface. In-situ extraction is still in the developmental stage and as a result about 90% of the material is still extracted the old fashioned way.

Thus, it is vastly more complicated, more water intense, more capital intense, and even more environmentally destructive than just drilling for oil somewhere, but the benefits are that the source is enormous and the source is relatively friendly, as the peaceful nation of Canada is more than willing to sell its oil without political problems.

So, the two questions are:

  1. Is Suncor really an oil company?
  2. If so, are you better or worse off owning Suncor rather than one of the “real” oil companies like Marathon (NYSE:MRO) or Exxon Mobil (NYSE:XOM)?

Luckily, the recent history provides us with a little laboratory for studying these companies under variable conditions. The greatest quarter in the history of the oil industry was the second quarter of 2007 when demand was strong and prices were high. The worst quarter in history was the fourth quarter of 2008 when the price collapsed. We can also look at the most recent quarter, 2Q 2010, which is a little better than it was but still not what you would call “good.”

2Q 2007

4Q 2008

2Q 2010

Revenues

4.358

7.196

9.639

Earnings

641

-215

480

Profit Margin

15%

5%

Cash Flow

884

551

1758

Oil Sands Prod. TBPD

202

243

299

Cash Oper. Cost

32.70

35.35

35.90

EPS

1.39

.34

.20

Note that the company’s revenues doubled since 2007, which was due to the merger of Suncor with PetroCanada in 2009. Note also that the performance of the company behaved exactly like the oil companies behaved during this period, which was the first piece of information we needed.

The merger with PetroCanada makes a lot of sense from the standpoint that with upstream activities in the “real oil industry” and also with some downstream activities like refining, the combined company can be assured of some positive cash flow even when times are a little lean, like they are now, and still have the opportunity to do really well when the oil pricing is high enough that the oil sands business is making money. Note that in the most recent quarter, they had cash flow that was comparable, in proportion to the size of the company, of the cash flow they had during Oil Utopia back in 2007, despite the profit margin not being all that high.

The variable production cost for the oil sands project is about $35 per barrel, but we also know that this thing is a capital hog, so depreciation and interest will always be quite high, and the company really needs WTI prices in the 60’s or higher to have a good quarter…. The current profit margin, that is, earnings divided by sales for this company is a little under 5%, if you compare this to Marathon Oil’s profit margin for its upstream operations, you are looking at roughly 15%, under current pricing conditions, so they are at a little bit of a disadvantage to the normal E&P people, which is also what you would expect.

So, with a few minor differences, I think we can say that this company post-merger will behave even more like an oil company than it did before, which I think is exactly what they want….

The second question: SU, MRO or XOM?

Let’s look at the stock chart:

(Click to enlarge)

You can see that Suncor’s stock behaved more like Marathon’s than it did XOM, and that makes some sense since both companies are smaller, and have some growth prospects, but I am ready to say that the effect of the gyrations in the industry were even greater on SU: Suncor, having a higher extraction cost, did better during good times, and worse during bad times.

Given the extra piece of information that we now have, namely that the merger with PetroCanada took place, I would suspect that the addition will cause the two to be even more similar… PetroCanada’s business will have a moderating effect. The oil sands portion of the production is about 50% of the overall company total.

So as to the second question, whether your 401K would be better off in SU than it would be in MRO or XOM, I am ready to say it depends entirely on what you believe…. Keeping in mind that MRO has a little investment in this business as well…

If you are a peak oiler, or otherwise foreseeing a higher oil price, you will be better off in SU or possibly MRO than you would be with XOM because conditions will be more like they were in 2007 or early 2008, and the ongoing growth in the oil sands business will position them favorably if this is the long-term trend. If you believe that there is a lot of oil around, and/or demand for the finished products is going to be weak because of overall economic slowness, then XOM will probably be best because you will see conditions similar to those in 2Q2009 when the bigger XOM was a refuge from financial chaos.

There are a few more pieces of information. The In-Situ method of extraction, which is now only about 10% of their overall production, has a variable extraction cost of only about half of the normal process ($16.55 versus $35/bbl) so there are some prospects if they can expand its use. Secondly, note that the variable extraction cost for the oil sands has gone up slightly since 2007….. suggesting that it is just about as efficient as it is going to be with the process what it is.

One more thing to consider is that in the grand scheme of things, at a little under 300Kb/d production, which is what they are now getting you are looking at the output of this big company being the equivalent of a couple of those big Gulf of Mexico offshore platforms, so they will always need relatively high prices to make this an interesting business.

As usual, keep in mind that the world is full of chaos, and there are no guarantees on anything.

Disclosure: No positions

Source: Is Suncor Energy the Best Oil Company for Your Portfolio?