Wednesday, October 27, 2021

Suncor Energy Inc. (SU)

Suncor Operations and History
We wrote about long reserve life Canadian oil company Cenovus Energy back in July. Another Canadian oil company is Suncor Energy (SU), which is fully integrated with oil sands, conventional oil production, refining (462k bbl/d), and retail operations. Together, Cenovus and Suncor produce about as much oil (~1.2mm boe/day) as the entire Bakken region in North Dakota, or a smaller OPEC member like Algeria or Angola.

The big story with Suncor's business is the upstream (oil sands and conventional) production, which produced almost 700k barrel of oil equivalents per day in the third quarter, of which 600k was from oil sands production. Oil sand is a mixture of bitumen, sand, clay and water. It does not flow like conventional crude oil which is a liquid; it must be mined or heated underground before it can be processed. Suncor extracts bitumen in two ways: mining and in situ. 

About 20% of the oil sand is close enough to the surface (under 200' depth) to be mined. They use large trucks and shovels to extract these, and then use hot water to separate ("extract") the bitumen from the sand. Bitumen is heated and sent to drums where excess carbon (in the form of petroleum coke) is removed. Vapors from the coke drums are sent to fractionators where they condense into naphtha, kerosene and gas oil. The end product is synthetic crude oil, which is shipped to refineries across North America to be further refined into jet fuels, gasoline, and other petroleum products.

The other 80% of oil sands are too deep to be mined with trucks and shovels. This is extracted in situ, using Steam Assisted Gravity Drainage. Horizontal wells inject steam to heat the reservoir of underground oil sands. The heat separates the bitumen and gravity brings it into a lower horizontal well bore which collects it and pipes it to upgrading facilities.

Suncor was founded in 1919 as Sun Company of Canada, a subsidiary of Sun Oil. In 1979, Sun formed Suncor by merging its Canadian refining and retailing interests (Great Canadian Oil Sands) and its conventional oil and gas interests. In 1995 Sun Oil divested its interest in the company and Suncor became an independent public oil company.

In 2009, Suncor merged with Petro-Canada, a downstream refiner and retailer. In 2016, Suncor acquired Canadian Oil Sands, which had a 37% ownership stake in a project called Syncrude in Alberta. Together with Suncor's existing 12% ownership of Syncrude and the purchase of Murphy Oil's 5% stake, Suncor became the majority shareholder in the project, which produces 350k bbl/d from the Athabasca Oil sands outside Fort McMurray, Alberta.

Q3 Earnings Highlights
Suncor’s total upstream production increased to 698,600 barrels of oil equivalent per day (boe/d) in the third quarter of 2021, compared to 616,200 boe/d in the prior year quarter, due to continued strong performance from the company’s In Situ assets and increased production volumes at Syncrude.

In the third quarter of 2021, the company returned $1.0 billion to its shareholders through $704 million in share repurchases and payment of $309 million of dividends, and reduced net debt by $2.0 billion.

Since the beginning of 2021, Suncor has reduced net debt by $3.1 billion and repurchased $1.7 billion of its common shares since the start of its normal course issuer bid program (NCIB) in February 2021, representing approximately 63 million common shares at an average price of $26.39 per common share, or the equivalent of 4.1% of Suncor’s issued and outstanding common shares as at January 31, 2021.

Subsequent to the third quarter of 2021, Suncor’s Board of Directors (the Board) approved a quarterly dividend of $0.42 per share, which represents an increase of 100% over the prior quarter dividend, reinstating the dividend to the 2019 level. The Board also approved an increase to the company’s share repurchase program to approximately 7% of Suncor’s public float as at January 31, 2021.

Suncor is listed on the NYSE (SU, US$24.18) and the Toronto Stock Exchange (SU.TO, CAD$29.81). (As you can see, a CAD$ is equal to 0.81 US$). The market capitalization is $34 billion. (This and other figures in US$.) They have $15 billion of debt at Sept 30 and $1.9 billion in cash for net debt of $13.5 billion and an enterprise value of $47.5 billion. As we have noted in the past, Suncor has borrowed long term very cheaply. They have debt due in 2047 that yields only 3.2%. 

For the third quarter, Suncor's cash from operations (excluding changes in working capital) was $2.1 billion and its capital expenditures were $990 million, for free cash flow of $1.2 billion. That's just for the quarter: annualized that would be $4.8 billion. They have another metric that they call "discretionary free funds flow," which was $1.2 billion for the quarter as well. So no wonder they are buying back stock aggressively. You will also notice that in the third quarter they returned 83% of free cash flow to shareholders through dividends and buybacks.

The FCF yield on the current enterprise value is 10% at a lower oil price than today. That provides room, even if oil prices were to retrace from here, to pay a 5.6% dividend ($1.36 US on $24.18 share price) and buy back significant amounts of stock, i.e. 4.4% of the market cap annually if the share price and earnings stay at this level.

Keep in mind that WTI oil in the third quarter averaged $71 and WCS crude sold at an average $13.6/bbl discount to this. Crude oil is now $10 higher (low $80s) and the differential is about $16/bbl, for a crude oil realization that's about $7.5 higher.

As of December 31, 2020, Suncor had proved and probable (2P) reserves, net of royalties, of 6.7 billion barrels of oil equivalent. This was calculated when oil prices were lower, which would mean that less of the resource was booked as being profitable to extract than may ultimately be extracted.

At the present production rate of ~0.7 million barrels of oil equivalent per day, or 255 million barrels per year, those 2P reserves are enough to last for 26 years. And the enterprise value per 2P barrel of oil is $7, a figure about the same as Cenovus. (This also ignores the value of Suncor's refining and marketing operations.)

The oil sands business spent $2.2 billion to produce about 54 million barrels of oil during the quarter, which is a production cost of $40 per barrel.

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