Suncor Energy (OP/A): Continue to expect outperformance with production, costs back on track - Goldman Sachs - January 26, 2006
We continue to believe that shares of Suncor Energy (OP/A) and Canadian Natural Resources (OP/A) can continue to outperform based on the relative quality of oil sands resource and returns versus more conventional hydrocarbon producers. Suncor shares have been strong in recent months as the company has brought back online its #2 upgrader that was down for most of 2005, expanded its overall capacity and has been producing at levels above capacity. We continue to believe that cost inflation for oil sands producers will prove more cyclical relative to other oil and gas producers and that there is additional upside to Suncor shares if there is greater Street confidence in industry in-situ oil sands assets. While given the enthusiasm towards oil sands and energy there is always room for a pullback, Suncor in our view a key long-term energy holding, and as a result we would buy any dip.
SUNCOR NOW MORE THAN RECOVERED FROM JANUARY 2005 FIRE Suncor has now fully recovered from the fire at the #2 upgrader in January 2005 which shut down about half of its 2005 production potential for about nine months. We would note that Suncor not only repaired the down upgrader on schedule with its timeline set in late 1Q 2005, but there were no delays in its long-planned expansion to 260,000 bpd of upgrading capacity. During the last two months, Suncor's oil sands production has been about 270,000 bpd, above its capacity. While we do not expect production at these levels to last due to normal maintenance activities, we continue to believe that Suncor management remains disciplined in its guidance.
COST INFLATION REMAINS MORE CYCLICALLY DRIVEN FOR OIL SANDS VERSUS CONVENTIONAL PEERS We continue to believe that the Street is skeptical in general that oil sands projects can be successful in a sub-$45 per barrel WTI oil price environment. We disagree, especially when considering Suncor and Canadian Natural's expansion projects in particular. The source of the concern comes from rising operating and capital cost pressures for existing oil sands expansion projects. However, we continue to note that cost pressures are not indigenous to Fort McMurray, Canada -- conventional oil and gas producers have been facing multi-year cost pressures as well. In the case of oil sands, cost pressures are primarily the result of a stronger Canadian dollar, higher natural gas input costs, higher steel costs and rising labor costs. Each of these is highly cyclical and should fall sharply in the event oil prices decreased. In the case of conventional producers, much of the cost inflation from 2002-2004 was secular in nature reflecting the maturity of finding new sources of commercial hydrocarbons in the Gulf of Mexico and North Sea in particular. While service cost inflation seen during the last year would likely go away in a lower commodity price environment, success rates/prospect sizes would be unlikely to rise.
KEY COMPANY-SPECIFIC CATALYSTS
(1) Timing and budget of 2008, 2010-12 expansions. We continue to believe that the Suncor management will remain disciplined, and for now we are not concerned that Suncor's Voyageur project is expected to come online during the 2010-12 period, putting it in direct competition with other oil sands projects for labor and materials. While we see the potential for further cost inflation, we would note that Suncor, with its lengthy history of oil sands production and production growth, is an investor in oil sands growth during trough, mid-cycle and peak commodity price environments. Because we believe in Suncor's asset quality, we believe that its returns will remain above average going forward. Nevertheless, we believe that the ability to stay within budget on its 2008 and 2010-12 expansions will be key to the stock. On its conference call, management indicated that its expansion projects over the next two years are on track with the exception of low sulfur diesel spec changes at its Denver refinery. The Voyageur capital budget is expected to be announced when the company receives regulatory approval for the project, expected at yearend.
(2) Performance of Firebag and other industry in-situ assets. We believe that the Street continues to discount resource potential from in-situ projects relative to mining projects, a function of greater perceived project risk, less mature technology and more limited scalability. Over time, we believe that there is meaningful upside to shares of in-situ levered oil sands companies such as Suncor, EnCana (OP/A) and Nexen (IL/A) if the Street gains confidence in in-situ growth. Suncor's Firebag project has seemingly seen more consistent results during the last six months, though the recent expansion of Firebag has the potential to make natural gas consumption and other cost metrics seem worse than reality because of the lag between initial steam injection and resulting bitumen production growth. We believe that increased disclosure by Suncor regarding Firebag and by other oil sands in-situ producers would be helpful towards verifying changes in in-situ performance. There is significant in-situ resource potential that can be developed using existing technology that thus far has not received full buy-in let alone further upside from technological improvements.
(3) Operating costs. Per-unit operating costs and DD&A rates rose sharply in 2005 as a result of the impact of lower production due to the upgrader fire. These higher costs on a one-time basis masked the true non-natural gas-based operating cost inflation. During 4Q 2005, an essentially normal quarter given that full production was restored, operating costs excluding natural gas costs fell sharply and were about 9% above 4Q 2004 on a gross basis (versus our expectation for 13% above 4Q 2004). Implied natural gas consumption per barrel produced stayed relatively flat with 3Q 2005 for the Firebag in-situ project and fell to very positive rates for mining. Going forward, we believe operating cost control will be a major catalyst for cash returns and for Suncor shares.
4Q 2005 EPS, CASH FLOW STRONGER THAN EXPECTED Suncor reported 4Q 2005 operating and financial results generally above expectations. Adjusted EPS of US$1.24 was above our estimate of $0.73, and operating cash flow was $1.02 billion versus our estimate of $705 million. Net oil sands production of 253 Mb/d was above our estimate of 231 Mb/d, with most of the variance due to a lower than expected royalty rate. Suncor realized $50.24 per barrel for oil sands output, and $9.70 per Mcf for its natural gas production. All-in oil sands operating costs were $15.39 per barrel, lower than our forecasted $17.61 per barrel. Downstream volumes were lower than expected, but this was more than offset by very strong refining margins of $20.20 per BOE in Canada and $14.77 per BOE in the US. Total refining EBITDA was $124 million, above our estimate of $85 million.
INTRODUCING AND UPDATING ESTIMATES We are introducing 2006 quarterly EPS estimates and updating our 2006 and 2007 annual EPS estimates to reflect revised assumptions for costs, commodity price realizations, and minor other adjustments. Our 1Q, 2Q, 3Q, and 4Q 2006 EPS estimates are $1.17, $1.18, $1.22, and $1.28, respectively. Our full year 2006 EPS estimate is now $4.85 versus $4.71 previously. Our 2007 EPS estimate is now $4.34 versus $4.61 previously. There are no changes to our 2008-2010 (normalized) EPS estimates.
Each of the analysts named below hereby certifies that, with respect to each subject company and its securities for which the analyst is responsible in this report, (1) all of the views expressed in this report accurately reflect his or her personal views about the subject companies and securities, and (2) no part of his or her compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed in this report: Brian Singer, Arjun Murti. |
