Seeking Alpha offered me the opportunity to interview Suncor's (SU) CFO, Bart Demosky, on April 24. The interview proved to be quite an experience, and Mr. Demosky did an excellent job explaining Suncor's growth strategy and market position. Overall, I left the interview with an even greater confidence about the investment and growth potential here than I had going in (and long-time readers know that Suncor is one of my highest-conviction long energy positions). The interview is posted here. My goal here is to provide analysis.
Suncor Energy is the largest operator in Canada's oil sands, which were estimated in 2004 by the Alberta Energy Board to contain 1.6 trillion barrels of oil. The incredible size of these deposits is the major reason why this region has attracted billions of investment dollars in recent years. Several new and existing companies have set up shop in Alberta in order to tap into and profit from these enormous deposits. Suncor aims to be the lowest cost producer in the oil sands. This would allow the company to earn a higher profit per barrel of oil sold than what their competitors earn. Mr. Demosky emphasized the company's long-term goal of increasing the amount of cash flowing from the company to shareholders and so this additional profit seems likely to be used for dividends or stock buybacks.
One of Suncor's most appealing qualities for investors is the company's growth potential. For this reason, we spent a considerable amount of time discussing this. In previous articles, I discussed that Suncor expects to grow its average daily production by 8% annually until 2020. That certainly appears to be a very realistic and achievable goal for the company. Furthermore, this growth will be organically-driven. A typical oil company needs to spend considerable amounts of money on exploration efforts to replace oil that is extracted from the ground. A company that does not do this will ultimately exhaust its reserves and run out of oil. However, Suncor's reserves are so substantial that it can produce oil well into the next century.
In addition, Mr. Demosky stated that the company's reserves figure only includes that oil that can be extracted economically with today's technology. There is technology currently in research and development or expected to be developed that could potentially increase recoverable reserves, even on land that the company already owns. There are some benefits to this situation. First, the company has more growth potential than virtually any other oil company of the same size or larger. Second, Suncor does not have to spend large sums of money on exploration efforts. This money could be returned to investors instead, potentially increasing the total return (dividends plus the results of any buybacks) of the stock.
There are higher costs associated with producing oil in the oil sands compared to more conventional deposits. Suncor stated in its fourth quarter 2011 earnings presentation that the company aims to get production cost down to under $35 per barrel of oil.
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Source: Suncor Energy Q4 2011 Earnings Presentation.
Even at $35 per barrel, Suncor will still have higher production costs than other companies that are extracting oil from conventional sources (however, it is comparable to other unconventional extraction costs). Therefore, a significant and sustained decline in oil prices will hurt Suncor more than some of their competitors that operate outside of the oil sands.
I doubt that we will see this sort of decline in prices though, at least not for any extended period of time. Suncor is quite conservative with assumptions about oil prices when they construct their financial models. The company's internal models assume an oil price of $85 per barrel. At this price, every oil sands project that the company is currently planning returns an attractive IRR (internal rate of return) of at least 15%. Obviously, if the price of oil is above this then that return would be higher. Even if oil prices are lower though, there is a buffer there to allow the company's projects to remain profitable even in the face of declining prices. As Suncor works toward its goal of reducing production costs, this buffer should increase even more. The IRR of the projects driving the company's growth should also increase.
For some time now, there has been a significant differential between North American oil prices, as measured in WTI, and global oil prices, as measured in Brent. Suncor is uniquely positioned among Canadian companies to exploit this. The company's refining assets provide the reason.
Mr. Demosky discussed how this works in the interview. Suncor has approximately 450,000 barrels per day of refining capacity. About two-thirds of this is located at the company's inland refineries. Suncor sources the oil for these refineries and WTI prices and sells the refined products at Brent-based prices. This has resulted in Suncor having an incredibly profitable refining and marketing business, possibly the most profitable such business in North America. This refining business provides the company with considerable cash flow. Suncor would still be in good shape, however, should the spread between WTI and Brent narrow and this is because the company is a North American producer. It sells its upstream crude production at WTI prices. So, if WTI rises relative to Brent then Suncor will earn less profit from its inland refineries but it will earn more from the upstream production operations. If WTI falls relative to Brent then the margins and earnings from the refining operation will increase.
Overall, Suncor is one of the few growth plays among the large integrated oil companies. The company is also one of the few that is not dependent on successful exploration in order to drive growth because it already has the oil in the ground. Thus, Suncor could be one of the most reliable growth companies in the oil industry today.