Suncor cancels Voyageur upgrader

It’s not just companies mining metals that are tightening their belts and concentrating on capital allocation discipline.

Suncor Energy (SU-T, SU-N) — Canada’s biggest oil company — has decided not to proceed with the costly Voyageur upgrader near Fort McMurray, Alta. 

“Since 2010 market conditions have changed significantly, challenging the economics of the Voyageur upgrading project,” president and CEO Steven Williams said on March 27. “This decision is in-line with our commitment to capital discipline and our stated plan to allocate capital with priority given to developing higher-return growth projects and accelerating the return of cash to shareholders through dividends and share buybacks.”

Suncor said it reached the decision to abandon the multi-billion dollar project after a strategic and economic review with its joint-venture partner Total E&P Canada. 

Suncor also acquired Total E&P’s interest in the Voyageur project for $515 million to gain full control over the partnership’s assets, including a hot bitumen-blending facility and tankage that the company says will provide more flexibility and storage capacity to support its oilsands operations.

Andrew Potter of CIBC World Markets said in a research note following the Voyageur announcement that it was the right time to abandon ship, and that shareholders should be pleased by the news.

“The cancellation does not come as a surprise, and we believe that investors will view the cancellation as being positive, since it will free up immense capital in the long-term, which will now be available for share buybacks, dividend increases and other high-return projects.”

When Suncor released its first-quarter results on April 30, the integrated oilsands pioneer raised its dividend by 54% to 20¢ per share, announced it would buy back another $2 billion of its own shares this year, and emphasized its commitment to disciplined capital spending and operational efficiency.  

The dividend hike exceeded expectations,” Chris Feltin and Brian Bagnell of Macquarie Capital Markets comment in a note. “Management has sent a strong signal that it is focused on improving total shareholder returns.”

As for Voyageur, Williams said on a conference call that it “was at odds with profitable growth” and that increasing U.S. light oil production in places like North Dakota and Texas made it uneconomic to pour billions of dollars more into Voyageur so that it could upgrade heavy oil into a lighter grade.

Suncor reported an after-tax charge to net earnings in the first quarter of $127 million, which represented the expected cost of not proceeding with the Voyageur project.

Upgraders, which process heavy bitumen from the oilsands into light crude, have become more expensive to build over the last decade, according to New York-based Energy Intelligence Group. The cost of building an upgrader rose by 70% between 2000 and 2008, EIG reported recently.

“That cost inflation, when coupled with flat demand south of the border for Alberta light oil given the surge in the U.S. in light oil production, knocked the stuffing out of Voyageur’s economic viability, leaving Suncor and Total to opt to sell diluted bitumen from their upstream mining projects instead,” writes James Irwin, EIG’s oilsands correspondent. He  points out that only three of eleven upgraders that were in the works in 2008 have been built.

Suncor’s commitment to exercising capital discipline and focusing on investments that deliver strong results for shareholders also resulted in an agreement in April to sell a portion of its natural gas business in Western Canada for $1 billion.

On Suncor’s first-quarter conference call the company also unveiled plans to produce another 100,000 barrels a day from its existing oilsands portfolio — a combination of mining and steam-assisted gravity drainage (SAGD) — through efficiency strategies and debottlenecking. Management estimates the incremental production will come at a low cost averaging $20,000 to $30,000 per day, which according to Potter of CIBC “should generate industry-leading incremental returns.”

He adds that “the capital is not expected to be incremental to current spending plans and will simply result in reallocation of capital — meaning that capex will not see a step change and should remain in the $7-billion to $8-billion range for the next five years. With some of the logistical debottlenecking already underway, the company expects to realize the incremental production over the next three to five years, with the majority of the production expected in the 2015–2016 time frame.”

Suncor reported its oilsands production rose to 357,800 barrels per day in the first quarter from 305,700 barrels per day in the same period last year. First-quarter cash costs in the oilsands fell to $34.80 per barrel from $38.10 per barrel in the first quarter of 2012.

“Despite a harsh winter in northern Alberta that impeded our production at times, our oilsands price [per barrel] dropped almost 9% from the same quarter last year,” Suncor’s chief financial officer Bart Demosky said on the conference call.

CIBC’s Potter notes that the reduction in cash costs “stems from higher overall output,” but also because “most of the incremental barrels are lower-cost in situ.”

Suncor’s oilsands mining operation near Fort McMurray includes both the Millennium and North Steepbank sites. The company also holds a 40.8% interest and is operator of the Fort Hills oilsands project in development with partners Total and Teck Resources (TCK-T, TCK-N), and a 36.75% stake in the Total-operated Josyln mining project.

In addition Suncor uses SAGD at its Mackay River and Firebag operations. MacKay River produced oil in 2002, while stages one and two of Firebag produced oil in 2004 and 2006. Firebag stage three produced oil in 2011 and stage four in December 2012.

Steady ramp-up of bitumen production from Firebag resulted in a 64% increase in production to 137,000 barrels per day in the first quarter of 2013 from 83,600 barrels per day in the first quarter of 2012. The company expects Firebag’s production to hit capacity — about 180,000 barrels per day — in 2014.

The first quarter also demonstrated the flexibility of Suncor’s integrated business model, management says, as the company diverted additional bitumen from Firebag to its upgrading facilities to compensate for reduced mining output due to unplanned maintenance in extraction. This helped the company maximize profitability during a period of low bitumen pricing.

“The strength of our integrated business model enabled the company to achieve solid results despite a challenging price environment for oilsands crudes,” Williams told analysts and investors on the conference call.

Chief financial officer Demosky says that discounts for Canadian oil compared to other North American crude benchmarks make cutting costs even more imperative.

“The differential was as much as US$50 in the first quarter, but differentials are the norm in Western Canada, and we expect them to continue for the next few years until market access issues get balanced out,” Demosky says.

Suncor will decide on whether to go ahead with the Fort Hills oilsands mine later this year. Williams says Suncor will abandon the project if the numbers don’t make sense.