Teck Resources (NYSE:TECK), one of Canada's largest and most diversified miners, recently announced that it was dropping its plan to build a $20 billion oil sands project. That decision, however, came well before oil's precipitous drop in March following the price war between OPEC and Russia. Far from a prescient move, there were bigger reasons for the call to hold off on what was once expected to be a big earnings driver for the commodity company.
What Teck Does
The interesting thing about Teck and oil is that the company has already been in the industry since the successful start up of the Fort Hills oil sands operation a few years ago. It owns roughly 21% of this project, with the rest owned by oil sands specialist Suncor Energy (roughly 54%) and French energy giant Total (the rest). The project has a capacity of around 200,000 barrels of oil a day. But oil sands are very different from what most people envision when they think about producing oil. For one thing, oil sands are mined, not drilled. There is no well; instead, there is a facility that processes dug-up, oil-laden earth to extract so-called "black gold."
This is why it makes complete sense for Teck to be in the oil business, at least via an oil sands mine. The company's other core operations are in copper, zinc, and metallurgical coal (met coal is used to make steel). In 2019 the miner's biggest division was met coal, contributing roughly 45% of revenue and nearly 60% of gross profit (before depreciation and amortization). Copper contributed 20% of revenue and just under 22% of gross profits. Zinc was next at 25% and around 17%, respectively. And pulling up the rear was oil, which was a bit under 10% of revenue and a scant 3% of gross profits.
The basic goal with Fort Hills was to dip a toe into the oil space so that Teck could learn the business. After that it wanted to use this knowledge to build a new division and increase its diversification. That's a laudable goal, given that the company operates in the highly volatile commodity space. In fact, those revenue and gross profit numbers above can jump around quite a bit from year to year. But the big takeaway here is that while oil is just a small part of what Teck does today, Fort Hills was really meant to be a stepping stone to bigger things.
The great big Frontier
That was where Frontier came into play. This project, with an estimated cost of around $20 billion, was expected to be one of the largest oil sand mines ever built in Canada, with a nameplate capacity of roughly 260,000 barrels of oil per day. It was going to use some of the most modern technology available to ensure efficient and environmentally friendly operation. Teck owned 100% of this project (getting it built would have likely required partners), and expected it to produce oil for more than 40 years. This is notable, because oil sands cost a lot to develop up front, but produce oil consistently for decades with relatively low operating costs.
Teck had been working with local governments and local communities since 2008 to get the project done. But there were still complications and pushback on the political, local, and environmental levels. The company eventually withdrew its request for government approval in late February, despite the fact that the miner expects demand for oil to be strong enough to support Frontier's production over the long term. The issues cited by Tecks' CEO were summed up in this sentence: "Questions about the societal implications of energy development, climate change and Indigenous rights are critically important ones for Canada, its provinces and Indigenous governments to work through."
In a word, there was uncertainty as to whether or not Teck could get this project approved without years of debate and protests. This is no small issue in Canada, where the economy relies heavily on the country's natural resources. There were interested parties both for and against the project -- after all, a new oil sands mine would bring new employment and additional tax revenue.
But fighting has gotten increasingly ugly of late in Canada, with protests over the construction of a TC Energy pipeline leading to massive economic disruptions. It started with a key rail link that was blocked by protesters. That blockade, which specifically hampered pipeline construction efforts, led others in the country to protest in a similar manner, impacting transportation in Canada more broadly. Already feeling the heat from environmental groups, Teck was likely expecting a more concerted push back if Frontier was approved. That upped the risk profile of the project materially.
Meanwhile, U.S. onshore oil production has been expanding for years, upending the global market for the fuel. In fact, the price war between OPEC and Russia is really about forcing weak U.S. drillers out of the market in the hope that it will restrain supply enough for oil prices to rise. Indeed, neither OPEC nor Russia wants oil prices to be as low as they are today over the long term. However, even before oil dropped into the $30-a-barrel range, it was hovering in the $50 space. It's hard for companies to make money at that price level, which was clearly demonstrated by Teck's investment in Fort Hills. The profit margin of the company's oil business was a scant 1% in the final quarter of 2019. That's not enough of a return to justify a large and very public fight over Frontier.
With a big up-front cost for construction, increasingly complicated issues surrounding environmental issues in Canada, and the low price environment in oil today, Teck decided that now was not the time to push the Frontier project. It's worthwhile to note that it is already working on a sizable construction project in its copper division (known as QB2), so taking on the complexity of issues surrounding Frontier would probably have been an undesirable management distraction in other ways, too. All in all, hitting the pause button was probably the right call.
Not the only dig around
Teck can still revisit the Frontier project in the future when oil prices move higher again and it is easier to justify the effort, expense, and negative publicity. It also has another large oil project (Lease 421) it's considering. So there are more tough choices to be made from here in the company's nascent energy business.
That said, it can focus on its big copper project for now and wait for calmer days on the oil front. Astute investors in energy stocks, however, should keep an eye on the pipeline protests in Canada to see how they are resolved. The outcome could have a big impact on Teck's future development plans.