Globe and Mail on COS distributions
Cash flows at oilsands trust
Positioned to pay debt
Claudia Cattaneo, Calgary Bureau Chief
Financial Post
March 21, 2005
Barely a year ago, Marcel Coutu, president and chief executive of Canadian Oil Sands Trust, had to own up to the biggest of oilsands sins -- a big cost overrun and a delay to complete a major expansion of the Syncrude Canada Ltd. project in Northern Alberta.
The expense of adding 100,000 barrels a day of production to 350,000 b/d had ballooned a stunning $2.1-billion to a cost of $7.8-billion, after partners realized they had underestimated the scope and complexity of expanding an existing facility. As well, completion was kicked back by more than a year to mid-2006.
Canadian Oil Sands' unit price collapsed, a major overhaul of the project got underway, and Mr. Coutu worried the trust might have to issue equity to pay for its share of the cost overrun.
Since then, so much has gone right, Mr. Coutu is looking forward to boosting distributions once the debt-reduction program begins in the fourth quarter. "Investors have been patient," he said recently. "We have withheld their cash flow. We are positioned to pay people back with the ability to grow distributions quite dramatically once we get our debt down."
With a market capitalization of more than $7-billion, Canadian Oil Sands is the largest trust in the Canadian energy sector. As the owner of 35% of Syncrude, it's the largest of seven partners in the world's largest oilsands project. It's also one of only three major pure oilsands plays. The other two are publicly traded companies: Suncor Energy Inc. and Western Oil Sands, a partner in the Athabasca oilsands project led by Shell Canada Ltd.
Syncrude uses big trucks with shovels to scoop up oil mixed with sands in the Athabasca deposits, which next to Saudi Arabia contain the largest accumulation of crude. Then, using a complicated technological process, it upgrades bitumen into light oil.
The trust was launched in the mid-1990s by Texas oilman J.P. Bryan, when he bought the Alberta government's stake in Syncrude to convert it into a royalty trust. The deal was so successful it was emulated by others, creating the oilsands industry. Canadian Oil Sands grew by buying out Syncrude partners, including EnCana Corp.'s stake two years ago.
It is only in the past year the trust has taken centre stage in the investment community. So what changed? Mainly oil prices. With crude prices at more than US$50 a barrel, the trust was able to pay for expansion from cash flow.
Under tight control of the partners, expansion plans have stayed on track and on budget. Operations performed well and the oilsands business has become a market darling.
Canadian Oil Sands' unit prices rebounded quickly from a setback last March blamed on cost overruns to a total return of 54% in 2004. Units have appreciated 19% year to date.
The end of forward sales of crude production also played a role in the price increases. The trust as stopped its hedging program, fully exposing it to spot market prices, which Mr. Coutu expects to stay near current levels.
Last year, 45% of the trust's production was hedged at about US$26 to US$27 a barrel, resulting in big losses. Mr. Coutu, who is also chairman of Syncrude, said the call to end hedging was made last year, ahead of competitors.
"The official company view is that crude will be US$35 to US$45 a barrel," he said.
"My view is crude will outperform that. It will average close to close to US$50, which is a major step forward on the commodity. Longer term, my view is the prices will continue to escalate, probably at rates that are ahead of most other important commodities."
If Mr. Coutu's scenario plays out, the increase in distributions could be substantial. "Last year, we cash-flowed $6.47 a unit. Had we not had any hedges, that would have been over $9 a unit. This year, it's kind of the same story. We forecast that at US$40 oil, cash flow will be $6 a unit, but it will be closer to $10 if crude is at US$50 or better.
"If you fast forward to the point where you don't have to use any of that cash flow for debt reduction, and you can use a large portion of it for distribution, distribution levels could be from $5 to $10 in the not-too-distant future per unit, per year." The current distribution is $2.
Those prices do not take into account production growth from expansion, he said. When Stage 3 is up and running, the trust's share of Syncrude production will rise to 125,000 b/d, from 80,000 b/d.
Bruce McDonald, royalty trust analyst at Canaccord Capital Corp., said he would not be surprised to see distributions grow after Stage 3 is completed, although the size and timing remain uncertain. He projects annualized distributions of $4 a unit by mid-2006.
"This is a multi-billion dollar project investors have been financing and the rewards are starting in 2006," he said. "But we are also in a very high commodity-price environment. As long as crude prices are over US$40, you are likely going to see a distribution bump up and you are going to see debt come down in the company."
Tight global supplies have been supporting crude and that will become more obvious this year as major oil companies fail to replace what they produce and finding costs escalate, Mr. Coutu said. And that makes oilsands sector, which is based on mining large, known deposits of crude in sand, look good. "Our business is starting to look very robust, more robust than the conventional sector, and it used to be the inverse."
The biggest challenge is finding people to build and man new and expanding operations. This month, Canadian Oil Sands said its maintenance turnaround was being extended because of labour shortages, resulting in reduced production in the first quarter.
Syncrude, though, is less affected by labour shortages than other firms because its Stage 3 expansion is 80% complete, and further expansion plans will be smaller in scale. The next step involves debottlenecking -- or boosting capacity at existing facilities -- to expand production 25,000 b/d to 50,000 b/d, likely by the end of the decade.
"We have the capacity, in terms of our reserve base, to do another project similar in magnitude to Stage 3, i.e., 100,000-plus of additional production," Mr. Coutu said. "We definitely have the reservoir quality to go and tackle that."
The improved outlook for oilsands projects in the past few years has encouraged the formation of new companies, such as OPTI Canada Inc., UTS Energy Corp. and Deer Creek Energy Ltd., resulting in more competition for investment.
Wilf Gobert, vice-chairman at Peters & Co., sees benefits and drawbacks to Canadian Oil Sands as an investment.
While distributions have been low, "once the expansion is behind them, along with the decline in hedging losses, the potential distribution is four to six times what it is now."
However, because the fiscal system encourages expansions, Syncrude's other partners will want to continue expanding, restricting the trust's ability to boost distributions.
© National Post 2005 |
