2 Unconventional Ways to Make Gains in the Oil Sector

Suncor Energy and Occidental Petroleum Corporation are two unconventional ways to profit from oil.

May 2, 2014 at 9:40AM

It's well known that oil, or black gold as it's otherwise known, has the capability of making you rich; it's as simple as that. However, while conventional oil plays are easy to understand and highly lucrative to invest in, unconventional plays can be even more profitable.

Right now there are two companies that provide unconventional ways to invest in the oil sector with plenty of potential for profit.

Firstly, there's Suncor Energy (NYSE:SU) an unconventional oil-from-sands producer, and secondly, Occidental Petroleum Corporation (NYSE:OXY) is a traditional oil producer in which a special situation has created opportunity for profit.

Long-term free cash flow
Unconventional oil sands producers such as Suncor Energy are relatively misunderstood companies, although they have plenty of potential.

Now, oil production from sand is a relatively high-cost method of producing oil. For example, Suncor stated that the cost of extracting oil from sand was around $35 per barrel on average during 2013. In comparison, based on figures from 2011, ExxonMobil's average cost of production was around $11 per barrel.

Nevertheless, as the price of oil remains around $100, Suncor was able to pocket a solid 60% gross margin during 2013, and there is no reason why this should change soon.

What's more, technological developments have driven the cost of oil production from sand lower during the past few decades, and this is set to continue.

Suncor is in the process of introducing a new technology at its mines -- the Autonomous Haulage System -- which involves operating autonomous trucks in a continuous fashion. The greatest advantage for using this system is lower costs realized from a combination of greater fuel efficiency, less wear and tear, and more volume hauled.

In addition, Suncor has a reserve base with plenty of potential. At present, the company has enough proved and probable resources to last for 30 years of production at current rates. Exxon's reserves life at current production rates is 16 years. Suncor's Fort Hills project, which is expected to start up late 2017, is expected to generate a strong stable cash flow for up to 50 years.

And it's not just Suncor's long-term production that's attractive. Over the past five years Suncor's dividend payout has risen at a compound annual growth rate (CAGR) of 35%, and the company has increased its payout for 12 consecutive years.

Aside from this payout growth, Suncor has devoted a total of $3.8 billion to repurchase its own shares at what management describes as "opportunistic" prices. Since September 2011, the company has reduced its number of shares outstanding by 7% with this $3.8 billion allocation; a further $1.7 billion remains in the authorization.

On a diet for growth
While Suncor is ramping up production, Occidental is cutting production, although these cuts are designed to drive profits higher as the company sheds non-core assets in favor of higher margin, high-growth projects with plenty of potential.

For example, Occidental Petroleum is selling up to 40% of its assets within the Middle East while reinvesting $300 million into new projects within the region.

But Occidental is also shedding assets within the U.S. Specifically, Occidental is looking to spin off the company's Californian oil and gas production assets, which have huge growth potential, and this is where investors can profit.

Occidental expects to complete the spinoff by the end of 2014, or early 2015 at the latest.

At present, analysts believe the new spun-off company could be worth in the region of $19 billion to $22 billion. The unit generated a pre-tax profit of $1.5 billion during 2013, implying a valuation of around 20 times earnings, assuming a 30% tax rate.

What's more, the new company will hold about 2.3 million net acres of land and be California's largest oil and gas producer.

Some opposition
However, some shareholders have stated their opposition, instead wanting Occidental to establish a more robust growth program for the Californian assets before they're separated.

Indeed, since 2010 Occidental has not been able to increase Californian production beyond 1% in any three-month period. Nevertheless, it's not as if the company does not have the potential to grow.

For example, back during 2011 some Wall Street analysts put forward the idea that Occidental Petroleum's Californian acreage could hold as much as 10 billion barrels of oil. Unfortunately, the problem is getting this oil out of the ground.

California's Monterey shale is a vast rock formation that spans much of the state and is different to other shale plays around the country. In particular, Monterey rocks are more varied that those found in the Marcellus and Bakken formations. This means that a producer might target a brittle layer of rock perfect for hydraulic fracturing, only to hit a more resilient, fracking-resistant rock farther along.

Having said all of that, there is no denying that Occidental's Californian assets will have plenty of growth potential when spun off.

Foolish summary
Overall, Suncor Energy and Occidental Petroleum look to be two interesting plays. Occidental's spinoff has plenty of long-term potential and room for growth, and Suncor's assets have similar qualities.

Having said that, if I had to pick one, Suncor would be my company of choice. Why? Well, the shareholder returns of course, and the potential for more returns in the future.

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Rupert Hargreaves has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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