Calgary-based integrated oil giant
This latest expansion is part of a multi-phase plan designed to boost production to 500,000-550,000 barrels per day by 2010-12. Suncor’s current output is 225,000 barrels per day, more than double 1999 levels, while cash costs are about US$8 per barrel.
“This looks like a great next step for us on our journey towards half a million barrels per day,” says President Rick George. “We’re closer to our goal of becoming the single largest supplier of oil-sands products and the lowest-cost oil producer in North America.”
George says the expansion reflects Suncor’s strategy of “securing oil supply in North America and maintaining our ability to market crudes directly into the United States, especially at a time when [North America’s] conventional supply of crude is in fairly steep decline.”
Suncor will fund the expansion largely from internal cash flow, with an eye to achieving a return on capital of at least 15%, based on a West Texas Intermediate (WTI) crude oil price of US$22 per barrel.
The expenditure will be divided equally between two projects: expansion of the sprawling Oil Sands upgrading facility, north of Fort McMurray, Alta., and development of the Firebag in situ oil-sands project, 40 km northeast of the Oil Sands plant.
Expansion of the upgrader will entail building a pair of coke drums, a sulphur-recovery plant and other crude-oil processing equipment. Pending regulatory approval, Suncor plans to begin this work in early 2004. About 2,800 people are expected to be employed during the construction phase, and over the longer term, 50-60 permanent jobs will be created.
“We expect to be able to complete this $1.5-billion project without a problem,” comments George.
At Firebag, $1.5 billion will be spent developing three additional stages of the project.
Regulators had previously approved development of Firebag in four stages, and construction of the first, $600-million stage is 80% complete. Commercial production from stage 1 should start in 2004, hitting a full production rate of 35,000 barrels per day in mid-2005. (Financing for this stage is separate from the new, $3-billion commitment.)
“I’m glad to say that stage 1 is being completed on time and on budget,” says George.
Suncor is engaged in public consultation for stages 5-7 and expects to release further development plans for Firebag later this year.
Cost control is critical for Suncor during the upcoming work, as its last, 4-year expansion effort, known as the Millennium project, saw costs rise 70% over budget to $3.4 billion before commissioning in December 2001. The overrun was due in part to labour shortages and high wages in the Fort McMurray area.
George says the Millennium experience taught Suncor that it must break these expansion projects into smaller pieces if they’re to be managed effectively. “We’re not doing this as we did with the Millennium project, as one big push all on one site,” says George. “What we’re doing is working with smaller engineering firms that are tied to our values and reward systems. This way, we’ll have more direct control . . . and more of a direct line of sight between us, our contractors, and ultimately the hard-working people who put these [facilities] together.”
To reduce costs and tighten its grip, Suncor has formed its own “major-products” group, which manages engineering, procurement and construction.
Cost control
“That group is well under way and I’m pleased with its performance so far,” says George, who adds that “most of what can drive the cost down in our business relates to getting bitumen into the tanks as cheaply as possible. We’ll be working hard, both on the mining side and on Firebag, on technologies, productivities and a host of other things to get those costs down.”
Significantly, all the additional 70,000 barrels per day of production will be sour, that is, high in sulphur content, and less valuable than low-sulphur, or “sweet,” crude, particularly in the face of ever-tightening federal standards for sulphur content in gasoline and diesel fuel.
As a result, Suncor is considering several courses of action, such as: modifying its refinery in Sarnia, Ont., to handle sour crude oil; expanding downstream capabilities by buying a refinery in the U.S.; or adding de-sulphurization capacity at its oil-sands operation.
“When it comes to sour versus sweet, I don’t see a case where we’d go one hundred per cent sweet,” says George. “Part of that is competition: we see a real demand for our [sour] product. This doesn’t mean our returns are lower — in fact, we calculate they’re higher, because there’s less capital investment up front.”
Hedging
On the subject of Suncor’s hedging of its oil production, George says the company has “scaled back hedging and will continue to scale it back, but we’re not going to stop our hedging program overall. Where I’m really comfortable is about 30% hedged, unless there’s something very unusual going on.”
The only other derivative tool Suncor has been using is a “synthetic put,” with a floor of around US$24 per WTI barrel set for 2004.
A detailed account of the hedge book will be released with Suncor’s first-quarter results. Last year, Suncor’s hedging losses were $160 million after tax, compared with $148 million in 2001.
“One of our objectives is to maintain an investment-grade credit rating,” says George. “Our balance sheet has repaired itself quite quickly [after Millennium’s cost overruns], and we expect to be solidly in that range.”
In 2002, Suncor posted record net earnings of $761 million (or $1.64 per share) on revenue of $4.9 billion, compared with the previous record earnings of $388 million (79 per share) on $4.2 billion in 2001. The improvement is attributed to expanded output (despite production hiccups in the first half of 2002) and higher oil prices.
Record cash flow
Cash flow from operations between the two periods more than tripled to a record $1.5 billion, while the net cash surplus stood at $729 million, up from a $1-billion deficit a year earlier.
Among several royalties, Suncor pays a minimum 1% gross-revenue royalty to the provincial government, and the company expects it will be able to keep paying this low rate until 2010, including on revenues from Firebag.
Suncor ended the year with $2.7 billion in net debt, down $461 million from a year earlier. The company still has $1.1 billion in undrawn credit lines.
With 449 million shares outstanding and shares trading at $24.12 at presstime, Suncor has a market capitalization of $11.2 billion.
This year, Suncor intends to produce 215,000 barrels per day from oil sands at a cash-operating cost of C$12.50 per barrel, and a further 35,000 equivalent barrels of natural gas. This forecast takes into account a scheduled maintenance shutdown, in May, of one of the two upgraders at the Oil Sands plant.
While the latest proposals move through the regulatory process, Suncor says it will continue to plan the next step in its overall expansion, which includes building a third oil-sands upgrader.
Suncor remains the single largest investor in the oil-sands sector, and was the first company to produce oil-sands crude commercially, in 1967. Its leases in Alberta’s Athabasca region contain nearly 13 billion barrels of recoverable bitumen, including 9.6 billion at Firebag, or enough to sustain production for at least 50 years.
Not surprisingly, Suncor’s exploration expenses are fairly low, with only $48 million spent over the past two years, mostly related to lease-retention costs at Firebag.
The emerging in situ technology to be used at Firebag will allow Suncor to exploit oil sands that are too deep to be mined economically using open-pit mining. The in situ technique, though energy-intensive, also minimizes the environmental effect of oil extraction.
Specifically, Suncor and competitors such as
Overall, the Athabasca region contains a whopping 300 billion barrels of recoverable bitumen, of which 10-20% can be recovered from open pits, and the remainder, by some form of SAGD.
Natural gas
Although Suncor accounts for about 85% of Alberta’s oil sands business, the company also produces natural gas in western Canada and operates a refining and marketing business in Ontario with retail distribution under the Sunoco brand.
Most of Suncor’s natural-gas production is used internally for heat, steam and power generation, with one barrel of SAGD-derived crude oil set to consume 1 thousand cubic feet of natural gas.
However, if natural-gas prices rise too high, Suncor has the option of switching its steam-generation plant over to diesel-fired, tapping into its own 45,000 barrels per day of diesel production.
As for the contentious Kyoto climate protocol, which the federal government ratified in December 2002 in stark defiance of the oil patch, Suncor estimates that the impact on Oil Sands’ cash operating costs will be C20-27 per barrel in 2010. That’s assuming among several factors that the maximum price for carbon credits will be capped at $15 per tonne of carbon-dioxide equivalent.
“Based on these assumptions, we do not anticipate that the cost implications of the Kyoto protocol will have a material effect on our business or future growth plans,” states Suncor.
Regarding the expensing of stock options, Suncor management and directors will not support a new pro-expensing proxy circular that will be put forward at the company’s annual meeting.
Suncor stresses that it generally favours the expensing of stock options but that it wants to wait until after the Canadian Association of Chartered Accountants has issued guidelines on the matter.
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