This is the fourth in our series of CEO Interviews in the energy industry (please see our previous interviews here for Kinder Morgan (KMP), here for Marathon Oil (MRO) and here for SandRidge Energy (SD). Today’s interview is with Bart Demosky, the chief financial officer of Suncor Energy (SU), which has one of the largest positions in the Canadian oil sands. Joining Seeking Alpha Editor Leland Montgomery is contributor Power Hedge. Power Hedge’s accompanying article appears here.
The following is our interview.
Seeking Alpha (SA) – Your company is one of the biggest players in the Athabascan oil sands in Alberta, Canada. Many investors find the economics of the oil sands mining and production process confusing. Could you walk us through the opportunities facing Suncor from a big-picture view?
Suncor Energy Chief Financial Officer Bart Demosky (BD) – Almost 50 years ago, the founders of our company recognized the vast potential of the oil sands, but what was uncertain was how to extract the oil at an economically attractive cost. A 2004 study by the Alberta Energy Board put the total potential at 1.6 trillion barrels of total oil reserves. Through the use of technology over the past 40 to 50 years the industry has come up with ways to do it more economically, more efficiently and with a lower impact on the environment. The industry will continue invest heavily in technology and continue to make this a world-class resource going forward.
We, along with the other big producers here are in the position of having enough resource to easily produce for the next century and beyond. Over the next decade, we have significant growth projects that have already gotten all of their regulatory approvals in place. And we fully expect every one of them to be very profitable – certainly at current oil prices.
Now, we plan for what I characterize as a sustainable price for crude oil out over the very long-term. We may be a bit conservative, but we base the economics of our projects on $85 per barrel WTI. And in order to proceed with those projects, they need to meet our internal hurdle rates, somewhere on the order of 15%.
SA – So, that’s a 15% rate of return on your capital invested, based on the $85 a barrel final price?
BD – That’s correct, that’s what we target, and that’s the economics of the backlog of projects that we have in place that we will be focused on through 2020.
SA – Because oil and gas investors are so focused on the growth play, what fields hold the most promise for you, and is the growth story on the oil sands side or in conventional production?
BD – We are first and foremost an oil sands growth company. Because we own the resource in the ground, whether proved reserves or the bitumen resource, we have many, many decades of production ahead of us, just with the assets that we have. So, I think the story about Suncor, one of the key aspects of it is that we don’t need to go and look for the crude oil. We also have incredible resource in the form of people, as well as the technologies that we employ and a balance sheet that has never been in better shape. And so, we’ve got all of the tools we need to profitably develop the resources that we have.
More recently, we merged with Petro-Canada. And that merger provided us with some significant benefits and complementary assets that I will talk about, particularly in the area of refining assets. Being an integrated oil sands growth company, it’s important that we have the upstream production, but we also have to move all that product to market. So, our ability to refine a great deal of that product ourselves allows us to capture significant value over and above with many of our competitors probably can, and get the maximum value for the oil sands per barrel we produce.
Ultimately, we think it’s a lowest-cost position. We also have other assets that provide significant cash flow to the business, particularly our offshore assets, where we produce in the North Sea, as well off the East Coast of Canada in all of the big fields that are in that area. And those are very, very low-cost barrels that provide tremendous cash flow back to us.
So, we are in a very unique position relative to our peers of having an extremely profitable base business that can both fund our growth and return an increasing amount of cash back to shareholders through dividends and buybacks, which is something that we’ve been doing more of recently.
SA – You bring up an interesting point, your ability to refine a large portion of your output from the oil sands enhances your ability to maximize the return on that asset. For most companies, selling the output from Alberta has become a challenge given the region’s limited pipeline capacity. How important is it to Suncor to get new pipelines built to deliver either crude or refined product to either the U.S. Gulf Coast or the West Coast?
BD – Well, you know there’s billions being spent every year to develop this world-class asset we have here in Alberta and it’s going to get developed. In order for the economics to be there, it’s critical that the oil sands industry have sufficient take away capacity to get our growing production to market.
Today, we are seeing instances even now where differentials between different crude prices are moving around a lot more than they used to, because there are some constrains in the North American pipeline system. Yet, over the next four or five years, Suncor is very well positioned because of our refining capability to move our production and achieve optimal prices. The reason why we’re different from our peers is that we benefit from our extensive logistics capability, the ability to move product, to store it in various places and the assets that we have in our inland refineries in Canada and the U.S.
Now, I fully expect that new pipelines will be built to the east, to the west and south. We’ve seen numerous announcements recently by the pipeline developers [Editor’s Note: Some examples include, to the West, Kinder Morgan’s (KMP) Trans Mountain Expansion here and Enbridge's (ENB) proposed Northern Gateway pipeline here. To the South: TransCanada’s (TRP) proposed Keystone XL Pipeline here.] I can’t tell you with certainty what order those assets will get built or even the timing of them, but we believe fully that they will be built and will be in place eventually. The reason for it is simple: The oil sands are far too strategic a resource for Canada and for North America to be hobbled by a lack of take away capacity.
SA Contributor Power Hedge (PH) – What are you predicting future oil prices will do? Do you think they are going to remain at current levels, do you think they’re going to go higher going forward or fall? I know you said that $85 a barrel is what Suncor uses in its financial projections. But do you think that oil prices will remain above that? If so, would that increase that 15% IOR number that you provided.
BD – If I were to try and predict oil prices, it’s almost a certainty that my prediction would be as wrong as the rest. I think we can all count on a considerable amount of volatility in crude prices, both here in North America for WTI, and on the global scene as well with Brent and we’re seeing a fair difference between the prices of the two. We’re also seeing more volatility for products.
So, it’s important given all of that volatility for us or any producer to pursue a couple of things. First is to be the low-cost producer in our industry. If we can achieve that, then I think we’re well-positioned to write out any kind of volatility. That’s why we plan our projects on the basis of conservative crude prices and economics and that’s why I think $85 for WTI is appropriate and certainly if our projects can make the right kind of returns for shareholders at those levels.
If we see higher prices, we’re going to benefit from that. And that’s going to put us in a position to drive even more shareholder value and deliver more cash back to shareholders over time.
SA – I wanted to follow up on something that you said previously. Slide 3 of your Q4 presentation is a very interesting slide because investors are penalizing the Canadian producers because of the supposed Brent-WTI price differential and then the further differential that you received in Alberta based on product because of pipeline capacity constrains. But your slide ... (shown below, click to enlarge)
... provides a real interesting view of the earnings from your production; both oil sands and conventional. Is Suncor actually refining and marketing almost two-thirds of your raw production?
BD – That particular slide demonstrates how our integrated model can capture so much more of the global pricing than anyone who is just selling their raw crude oil production directly into the market. So we produce from two areas, first is oil sands, which in North America receives WTI-based pricing, and then we also have a healthy portion of our production, almost 30% of it that we sell into the global marketplace directly, based on Brent prices.
So we’re selling the crude portion of our production at a 70% WTI, 30% Brent price. So we’re already getting a healthy portion of global pricing, which is not something you see with most of the other Canadian producers, those who are producing here in Canada and then selling because they don’t have means to get that product to global markets. In addition to that, we own a considerable amount of refining capacity. And in total, it’s about 450,000 barrels approximately. And a little over 300,000 barrels of that is in what we call inland refineries. That’s our refinery at Sarnia, Ontario, our refinery at Edmonton, Alberta, and our refinery in Denver, Colorado. We source crude for those refineries at WTI in the local markets. We upgrade it and then we sell it at the global Brent-based prices, because they are global markets that those products are produced for.
So what all that allows us to do, if you go back to the upstream and just run the barrels through the model, about 90% or a little more of all the barrels we ultimately produce and then refine are sold at world pricing based on Brent. So we’re producing more cash, more earnings per barrel than probably anyone else out there in our space. So unlike many of the Canadian producers, we’re not subject to that spread between Brent and WTI. In fact, we are able to take advantage of that because of our physically integrated assets, and create more shareholder value that way.
And if you look at it on a “what does that mean basis,” well, last year we had a refining and marketing business that may be the most profitable in North America, producing in excess of $2.5 billion of cash, and as a company, we produced almost $10 billion of cash flow from operations.
SA – Are there capacity constraints for taking refined products out of the Midwestern Canada region just like there are for raw crude oil?
BD – No, and the simple reason for that is that the pipelines and networks and trucks and rail to move the product from those refineries has been in place for many decades, and isn’t being constrained at all and won’t be, going forward. So that’s a part of our business that’s very stable and very able to access global markets.
PH – What if the Brent-WTI spread narrows based upon greater capacity coming out of the Alberta area? Would that hurt refining margins, and how would Suncor be impacted by that as compared to the other Canadian producers?
BD – The beauty of Suncor’s model is that because we have access to global market pricing, it doesn’t matter where Brent-WTI spreads are. Today the refining part of our business is capturing a significant portion of the value by being able to sell its product at Brent-based pricing. If WTI were to rise relative to Brent, even if it didn’t close the full gap, we’d be selling our upstream barrels into the marketplace based on WTI. And we’d get more value out of our upstream operations than today relative to the refining part of our business.
So if you think of it in those terms, you would just see that value moving to a different part of our integrated model, the upstream or the downstream. Unlike players that don’t have that model and who are beholden to just the raw crude price, we have an advantage when the spread is as wide as it is now or when it is volatile, because we are able to capture the full value in any kind of market scenario.
SA – Your slide 4 (shown below, click to enlarge) ...
... in your fourth quarter presentation really captures the more detailed economics of the business. Can you just run us through those figures for total supply cost, a sustaining capital figure, etc., so that people can understand the economics of the company over the long term?
BD – This slide really portrays our current economics for new growth projects. We, overall, are targeting and expect to achieve a total cash production cost for the oil sands of mid-$30 per barrel range. We’re near that cost a majority of the time, as you can see from that slide.
Now, there’s been a lot of questions in the marketplace about whether mining it underground or producing it via a SAGD [steam-assisted gravity drainage, i.e., steam-injected] system is the most economic way to go. The point we’d make here is that in today’s world, you need to look at the full cycle economics of producing bitumen, whether you’re mining bitumen or producing it through SAGD, as this slide shows.
(Click to enlarge)
We believe full-cycle economics of producing bitumen are fairly equivalent, if you know how to build and run a very economic mine, which is something that we’re very good at.
For Suncor, because we have both growth opportunities in mining and growth opportunities in SAGD, we have a choice. So for us, the economics are laid out there fairly well, and we could put our money into either.
Mining is a little different, the upfront capital investment is higher than SAGD, but the sustaining capital over time we believe will be lower and so the full cycle of economics come out to be about the same.
We also like investing in both, because the bitumen supply and input costs between mining and SAGD are different. One of the big input costs in the SAGD is natural gas, which today is very, very low relative to where we’ve seen it for many years, which is helping SAGD economics. But that input cost will change over time and so, having a balance between mining and SAGD, we think will serve our investors very well.
SA – Can you run us through your overall expected growth profile of production over the next 10 years, on this slide?
(Click to enlarge)
BD – Suncor has, because of our big asset base and the ability to develop it, we’re able to outline very, very clear growth plans, typically a decade out. And, so this slide shows our plans through the next decade or more out to 2020 and beyond. By executing on that plan, our production compound annual growth rate is about 8% or a little bit higher than that, through 2020. But it will come through growth in the oil sands and through a mix of in-situ mining and a new SAGD upgrading project. And if you look at that growth rate relative to – I think what the other major oil companies out there are able to produce – it will stand very well against the peer group. There’s not many out there that can even think about approaching that kind of growth, and we’re able to sustain it, because we’re not fighting the steep decline curves typical of traditional oilfield producers.
So, we know those projects are going to be profitable for many years to come. Right now, we’re in the midst of completing our next phase of SAGD development, it’s called Firebag Phase 4, and it’s 62,500 barrels that we’ll start producing in the early part of next year and it takes about 18 to 24 months to ramp up to full production.
Then we’ll move on to our next mining project, which is Fort Hills, along with our Voyageur Upgrader, we have to upgrade the production that will come from there. And then we’ve got numerous projects beyond that in the oil sands, along with some new production in our offshore assets as well, both in the North Sea and off the East Coast of Canada, but combined we see a very sustained 8% kind of growth rate in our production for the next decade at least.
PH – Suncor already has some of the highest reserves in the industry as you’ve already illustrated. Do you have any plans to continue to expand those any further?
BD – We don’t need to acquire more assets because we already have reserves in the many, many billions of barrels. The reserves and resources that we believe that we can develop economically with today’s technology, plus there’s much greater opportunity beyond that, with as yet identified technology in the R&D pipeline that will show that the resource based in the Alberta oil sands are even bigger than what was previously thought.
It’s probably something larger than the 1.6 trillion barrels that you referenced in your first question. So, I don’t think we need to go out and look for more. But Suncor is a value-oriented company, and we’ll always look at opportunities to add assets and resources in the areas that we’re most comfortable developing. So if the right opportunities came along in Alberta or in the other areas that we like to produce in, we certainly would look at those for the right price.
PH – What are your goals for dividend growth going forward? Are you predicting 10% a year, 15% a year?
BD – Our first goal is, we do want to return more cash back to shareholders and we have that ability through the balance sheet and the cash flow that we generate. And that’s over and above paying for our own growth, which we think we can do largely through our internally generated cash flows. Our five-year compound annual growth rate on dividends for our investors has been about 21%, and actually, it’s been a little bit higher than that.
As I look out and compare that to our peer group, I believe at least among the more growth-oriented players in our business, that is probably the highest compound annual growth rate in the group. And we would look to try and continue that track record as we go forward.
SA – Thank you for the interview.
Bart Demosky’s career with Suncor began in 2006, when he was appointed vice president and treasurer. Most recently, Bart was senior vice president, Business Services with Suncor, responsible for enterprise-wide business services and integration of technology and processes, including supply chain management. Bart has over 20 years of industry experience in strategy and development, finance, risk management and energy supply and trading. He has also provided leadership in the areas of merger integration, energy market deregulation and as a board member for not-for-profit organizations. Bart holds a bachelors degree in economics from the University of Calgary and is an honors graduate from the University of Calgary Management Development Program. He was awarded the gold medal for academic achievement from the Institute of Canadian Bankers upon achieving Associate status. As chief financial officer, Bart directs financial operations, including investor relations and treasury and plays a key role in ensuring Suncor's significant growth potential.