Fort Hills’ Future Uncertain

In September 2007, Teck (TCK. B-T, TCK-N) raised its stake to 20% in the Fort Hills Energy Partnership, which is developing the Fort Hills oilsands project in Alberta.

At the time, president and chief executive Don Lindsay said the asset would “contribute significantly to the portfolio of Teck Cominco for decades to come.”

Fast-forward a year-and-a-half and the debt-laden diversified miner isn’t ruling out selling its stake in the capital-intensive project.

Teck doesn’t have much cash to spare after its US$14-billion takeover of Fording Canadian Coal Trust last year, which left it mired in US$9.18 billion of debt.

In a slide presentation at the Bank of America Merrill Lynch Global Metals & Mining conference in Barcelona this month, Lindsay said the company was exploring “strategic alternatives” for Fort Hills.

The multibillion-dollar project is one of the largest remaining undeveloped oilsands leases in the Athabasca region of Alberta, 90 km north of Fort McMurray in the main Athabasca oilsands fairway, and Teck will have to meet heavy future funding commitments on the project.

“We continue to keep our options open with respect to asset sales as part of our broader plan to reduce debt and position the company for short and long-term success,” Catherine Hart, Teck’s manager of corporate communications wrote in an emailed response to The Northern Miner’s questions. “This includes exploring strategic alternatives in connection with this asset.”

Teck’s share of project expenditures to the end of 2008 was $667 million. Its total investment commitment this year is $330 million. Of that amount, Teck spent $226 million in the first quarter.

To fully earn its 20% share in the Fort Hills Energy Partnership, Teck is required to contribute 34% or $850 million of the first $2.5 billion of project expenditures made after March 1, 2005, and fund 27.5% or $1.375 billion of the next $5 billion in project costs. From the start of the Fort Hills project until March 2009, the partnership has spent about $2.7 billion.

“It will be gone by the end of the year,” said one analyst who requested anonymity, of Teck’s Fort Hills stake. “With Teck’s recent five-to ten-year long-term bonds, the immediate urgency is gone but Teck still carries a lot of debt. . . (and) a lot of Teck’s cash flow has to go to interest on its debt. Bottom line is, it’s a seller.”

Others aren’t as convinced — partly because the investment partnership that owns Fort Hills — which includes Petro-Canada (PCA-T, PCZ-N) with a 60% interest and UTS Energy (UTS-T, UEYCF-O) with 20% — has decided to defer the final investment decision on the mining portion of the project until a cost estimate consistent with the market environment can be made.

“I think they want to stay in there,” says Kerry Smith, an analyst who covers Teck for Haywood Securities in Toronto. “They don’t have big cash calls on it in the short term so I think they will try to stick it out. They restructured the lease agreement with the government so the urgency to do something has changed. If they really wanted to sell it, they would have done it by now.”

The decision to delay the project came in November 2008 after the partnership realized that phase-one costs for an integrated project including an upgrader producing 154,000 barrels per day jumped to $23.8 billion (estimated in September 2008) from $14.1 billion (estimated in June 2007).

At that point, the partnership decided to defer the final investment decision on the mining portion of the project. The companies also decided to put on hold plans to build the Sturgeon upgrader portion of the project, which would capture the full value chain by upgrading mined bitumen into synthetic crude oil. The upgrader was to be potentially located about 40 km northeast of Edmonton.

“The final investment decision for Fort Hills is on hold until commodity prices including oil and financial markets stabilize,” Kelli Stevens, Petro-Canada’s communications adviser on the oilsands, wrote in an email.

A revised cost estimate for the first phase of the mining and extraction project is now expected in the fall, or the first half of 2010. In the meantime, Petro-Canada has cancelled all engineering work and the vast majority of equipment orders and plans to negotiate and mitigate cancellation charges.

“We were hit in the middle of last year with a huge bump in costs that clearly made the project uneconomic,” Harry Roberts, Petro- Canada’s executive vice-president and chief financial officer explained in a speech in February.

But Roberts added that his faith in the project remained unwavering. “The fact that a knowledgeable player like Total wants to buy into this project speaks to the quality of what we have here, so it will go ahead at the right time,” he said.

Total (TOT-N), the French oil and gas super-major, launched a hostile takeover bid for UTS Energy earlier this year, eager to get its hands on the company’s 20% stake in Fort Hills. But Total abandoned its bid in early May because not enough shareholders tendered their shares.

According to UTS, the deferral of the project work is reflected in the revised capital expenditure forecast of about $360-400 million for 2009 on a gross basis, with the UTS share being in the range of $18-20 million.

“The Fort Hills partnership has only approved $339 million of the 2009 budget at this stage and UTS believes that continued downward pressure on costs and expenditure will result in total expenditure for the year less than $400 million,” Michael Stevens, the company’s manager of financial analysis wrote in an emailed response to questions.

In a conference call with analysts on April 28, Petro-Canada confirmed that in relation to the Fort Hills project, costs were down about 30%, now under $10 billion, due to a combination of lower steel prices, lower pipe prices, lower expected wage rates, less escalation through the course of the project and somewhat better productivity because of the improved construction climate in Alberta, Stevens added.

“UTS believes that there is potential to reduce the standalone phase one of a mine and bitumen extraction project of 160,000 barrels per day cost to $8 billon, which is below the previously indicated UTS determined range of $8.5 billion to $10.5 billion,” Stevens said. (All costs are go-forward capital cost estimates excluding sunk costs.)

Stevens also noted that Petro- Canada’s pending merger with Suncor Energy(SU-T, SU-N), could bring important synergies and the potential for significant capital and operating cost reductions between Suncor operations and the Fort Hills project.

The Fort Hills block of oilsands leases covers an area of about 189 sq. km and contains more than 4 billion barrels of recoverable bitumen resource, which according to Petro- Canada, is greater than Alberta’s remaining conventional crude reserves. (Alberta’s remaining established crude oil reserves come to 1.5 billion barrels.)

The first phase of the project is planned to produce 140,000 barrels per day of synthetic crude oil. Associated bitumen production is expected to be about 160,000 barrels per day.

Petro-Canada estimates that once all phases of the project are complete, Fort Hills will produce up to a total of 280,000 barrels a day of synthetic crude oil if the project includes an upgrader. Otherwise, a mining extraction-only project would produce up to 340,000 barrels a day of bitumen.

The partnership has bought itself more time to make a decision on the project, after reaching an agreement with the Alberta government on March 20 to extend the term of the Fort Hills oilsands leases until 2019.