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Suncor Energy's Management Has a Surprising View of the Next Decade

By Tyler Crowe – Feb 23, 2017 at 12:18PM

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It's not often that a company will wholly admit that there aren't many growth opportunities in its industry for several years into the future.

2016 wasn't a particularly good year for Suncor Energy (SU -0.60%), but the company did finish on a high note that should set it up well for 2017 and beyond. Suncor used the downturn in the oil and gas industry to increase its ownership of the massive Syncrude oil sands project. This was a transformative acquisition that has the potential to produce loads of free cash flow for years into the future.

Now that this acquisition is complete, though, it looks as though the company is starting to take a new tone with how it delivers value to shareholders. Here are a few quotes from Suncor's most recent conference call that highlight some of the changes that investors can expect in the coming years. 

Athabasca oil sands mining

Image source: Getty Images.

Oil sands isn't the high-cost product you thought it was

One of the biggest knocks on oil sands as an investment in the oil and gas industry is that it is a high-cost source of oil that takes a long time and a lot of upfront capital to develop. There is one part of that statement that simply isn't true, though, and CEO Steven Williams was quick to point out that the operational costs for Suncor's oil sands are much lower than many investors might think:

Our blended oil sands operations cash costs for the quarter were just under $25 per barrel, bringing our average cost for the year down to $26.50 per barrel; that's a reduction of 11% for the quarter and 5% for the full year. And again, that was accomplished despite the significant impact of the forest fires on the second-quarter production and this did sharply increase our per-unit cash costs. And of course, those cash costs often remind us that those numbers are all measured in Canadian dollars, so in U.S. dollars, we're comfortably below $20 per barrel at current exchange rates.

A large portion of that gain was from its larger investment in, and optimization of, the Syncrude project. Williams said:

Suncor's share of Syncrude production increased to just under 190,000 barrels per day with cash costs of $32.55 per barrel, so that's down 19% from the similar quarter in 2015.

These numbers are promising as is, but it also makes for something interesting for Suncor investors to follow in 2017. If those low costs can be achieved when there were major outages for the wildfires in Alberta this past year, it will be worth seeing what can be achieved when it has a full year of uninterrupted operations. 

Winding down spending, winding up dividends

2017 is going to be another big year of milestones for Suncor as it expects to see first oil from both its Fort Hills oil sands project and its Hebron offshore platform off the coast of Newfoundland. Not only are these two projects significant sources of new production, but they are also large portions of the capital spending budget. Once these projects come online, Williams says it is going to be a boon for its investors:

[O]ur capital spending is expected to decline by approximately $1 billion, and we will continue to manage operating costs out of the system. With year-over-year average oil prices expected to rise, we're, therefore, well-positioned to significantly grow our earnings and generate strong free cash flow for our shareholders. And as a result of that, I'm pleased to confirm that Suncor's Board of Directors has approved a 10% increase in our quarterly dividend payment. And this means that 2017 will be the 15th consecutive year that Suncor's dividend has increased. 

Oil sands development coming to an abrupt end?

Suncor is one of Canada's largest oil sands producers. Based on the company's operational performance mentioned above, it's not much of a stretch to see Suncor developing more oil sands assets at those low costs. According to Williams, quite shockingly, that isn't the case:

Mining investments are coming to an end, not just for Suncor, but for the industry, I believe, for a considerable period, probably in excess of 10 years. So while we look at the go-forward economics of Fort Hills, when we look at the absolute economics of Fort Hills, that were there not projects we will be repeating in the foreseeable future, some substantial things in the cycle would need to change. I then look at the other opportunities we have. We have great reserves in Oil Sands. And I look at in situ opportunities, and, as you know, we've been looking at replication and new technology. And those are quite exciting in how those technological developments and the in situ costs from replication can start to come down. However, I want to be equally as clear, we have no plans to be going ahead with major capital investment in either mining or in situ in the foreseeable future. 

That is a shocking development. Basically, one of the champions of the industry is saying that no new money will be spent on this kind of development for a long time. There are a couple of things that go into that, of course. One example of this is a lack of takeaway capacity. Consumer demand in Northwest Canada isn't very big, and so almost all of the crude in the region needs to be moved somewhere for refining and consumption. Unfortunately for the industry, the current pipeline system mostly delivers to the U.S. Gulf Coast and pipelines elsewhere such as Enbridge's Northern Gateway, Kinder Morgan's Transmountain, and TransCanada's Energy East are meeting some political resistance. Without pipelines and more markets to which they can sell, oil sand producers would be fighting for limited space on the existing infrastructure and would lower price realizations for everyone in the industry. 

All quiet on the acquisition front

It wasn't that long ago that Suncor was being very aggressive by acquiring greater stakes in the Syncrude project from Canadian Oil Sands and Murphy Oil. According to Williams, though, the opportunities to grow via acquisition aren't as attractive nowadays:

On the mergers front, I hope you can see, why we were so attracted to the opportunity around Canadian Oil Sands and Murphy. And you've seen us apply discipline to very good projects there. But then, I think, I was relatively unambiguous -- in our view, the window is starting to close. It's not completely closed yet, but the spread is starting to move away from disciplined buyers, not in their favor. So we have nothing of any materiality in the pipeline around mergers and acquisitions.

If there are no new oil sands opportunities out there and the acquisition market is looking a little too expensive, then... 

...what do you do with that cash?

Plain and simple: Dividends and buybacks. Here's Williams again on how Suncor's management is looking at dividends and buybacks today. 

You will see us sustainably improve -- increasing our dividend. So you've seen us go with this 10% -- nearly 11% this time, and you will see us continue to look at dividend broadly in line with the growth of the production of the company going forward. And I teed up deliberately because we are already starting to look then. It's depending on how the year unfolds, some share buybacks later in the year. So you will see us sustainably increasing the dividend as we grow, and you will see us opportunistically buying share buybacks, and those two will be our priorities through the next few years.

If Suncor isn't going to be spending a lot on new oil sands for close to a decade and the acquisition environment doesn't look that great, there will be a lot of free cash to deploy toward these shareholder-friendly initiatives. Keep in mind that decline rates at oil sands operations is almost non-existent compared to conventional production, so maintenance and growth capital will mostly go toward its normal exploration and production and downstream business units. These are much smaller in size and scope compared to Suncor's oil sands operations, so capital spending is likely going to decline significantly once Fort Hills and Hebron are up and running. 

Tyler Crowe has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Kinder Morgan. The Motley Fool has a disclosure policy.

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