Suncor Energy Gushes Over Oil Sands Prospects

Suncor Energy estimates that its August 2009 merger with Petro-Canada, which created Canada's largest energy producer, will achieve savings in operating costs and capital spending of (Canadian) $400 million and approximately C$1 billion per annum. The elimination of redundancies in spending and a selected focus on high-return projects required to realize these performance gains, however, could be offset by identified risks, from delays in planned asset sales to unexpected increases in pipeline transportation costs.

The oil sands giant is a long way from achieving the significant synergies envisioned from its all-stock C$19.63 billion acquisition of Petro-Canada (at C$30.39 per share): Net debt increased to 4.8 times cash flow from operations at year-end 2009, from 1.8 times in 2008. Return on employed capital, excluding major projects in progress (such as its Firebag bitumen in-situ mining operations) plummeted to 2.6 percent, from 22.5 percent in the prior year. Chief executive officer Rick George reiterated on the fourth-quarter 2009 conference call with analysts that near-term Suncor Energy (NYSE:SU) would focus on shedding non-core assets, with an eye on reducing long-term debt of C$13.8 billion. Net interest on this debt climbed C$437 million, due to the assumption of C$4.4 billion in long-tem liabilities from Petro-Canada.

Noble Energy's (NYSE:NBL) previously announced C$517 million acquisition (about equal to its net book value) of the company's Colorado gas properties is expected to close in March. In total, George said that Suncor was very much on target in terms of reaching its objective of $1.5 billion to $2 billion in divestments of North American gas assets by the end of this year. Along with the U.S. properties, the sale of its Trinidad and Tobago assets was likely in the first or second quarter, he said. Other identified holdings considered secondary to its primary business alignment (oil sands) include all assets in The Netherlands and certain North Sea holdings.

An unforeseen risk that could crimp property sales is events unfolding in Europe: A debt-ridden Greece sliding into bankruptcy due to its ballooning deficit, could freeze up global credit markets -- especially if unwanted attention redirected toward the $12 trillion U.S public deficit (and still growing) sinks confidence in both the U.S. dollar and a rebound in economic activity.

Suncor's total upstream production during the fourth quarter of 2009 averaged 638,200 barrels of oil equivalent (boe) per day, including additional production of 325,600 boe per day resulting from the merger. Of this, production from in-situ oil sand mining (excluding synthetic crude joint ventures) contributed an average of 278.9 boe per day. Going forward, management projects oil sands growth of some 10 percent to 12 percent per year could support an overall annual company growth rate of seven percent to eight percent through 2020.

Critical to achieving this targeted profitability is controlling oil sands operating costs, which averaged C$38.70 per barrel during the fourth quarter of 2009. Improvements in bitumen extraction methods (leading to higher production) and new tailings pond technology (stored waste from oil sands extraction), decreases in natural gas input prices, and the synergy savings in overhead expenses resulting from the merger (SG&A totaled C$35.10 per barrel in Q4) -- the cash operating cost per barrel could fall back to the C$32 to C$33 range by year-ending 2010, said chief financial officer Bart Demosky.

Cost to ship its oil totaled C$427 million, or 1.7 percent of aggregate operating expenses, during 2009. Though not material enough to impact near-term profits, it is worth mentioning that Suncor is embroiled with pipeline carrier Enbridge over ultimate responsibility for costs associated with a newly constructed pipeline. Suncor is looking to U.S. regulators to prevent Enbridge (NYSE:ENB) from raising tolls to pay for its cost of building and operating the under-utilized 520-kilometre U.S. portion of the $3.7 billion Alberta Clipper, which will take oil from Hardisty, Alberta, to Superior, Wisconsin. An adverse outcome combined with competitive pipelines under construction could increase Suncor's transportation costs as much as $315 million per annum by 2013.

If commodity prices hold this year and [if] oil sands production performs as anticipated (average of 300,00 boe per day) and [if] the asset sales are completed -- putting Suncor in a position to get its debt paid down towards the $10 billion range by the end of 2010 -- synergy savings on the operating side would [have started to] exceed the merger cost come the first quarter of 2011, opined CFO Demosky on the conference call. That's an awful lot of "ifs" in the profit equation.