Those who aren't regular Sasol followers should first understand that the company's synfuels operations -- which convert coal and natural gas into liquid fuel and chemical feedstock -- have historically provided the bulk of companywide cash flow and earnings. Of course, among integrated oil names, there's nothing unusual about a single segment driving financial performance. In the case of ExxonMobil
What does set Sasol apart, however, is that its synfuels operations generate up to 10-15 times the amount of CO2 of traditional liquid fuel production. In an era of climate change politics, that puts the company at a disadvantage to cleaner-burning peers, which, according to a recent JPMorgan Chase report, included the likes of Chevron
Furthermore, the majority of Sasol's synfuels volume is produced in South Africa, where double-digit increases in electricity, unfavorable exchange rates, and high labor costs have pressured margins during recent years.
All of which suggests that the key to Sasol's future profit growth, from an internal standpoint, significantly rests with its ability to expand synfuels operations beyond South African borders. Yet a plan to do just that -- following the 2007 foray into Qatar -- may be in jeopardy.
Last week, The Wall Street Journal reported that the company's recently proposed Chinese coal-to-liquids plant faces competition from a local outfit with similar technology. For now, the issue amounts to little more than a delay in regulatory review, and Sasol isn't scheduled to complete its own feasibility study until mid-2011. Yet this development warrants investor attention.
Consider first that the China CTL plant -- which, in the context of synfuels growth prospects, management has labeled "the big one" -- would add 25% to the company's synfuels capacity. Second, a new plant is nearly guaranteed to run more efficiently, and thus more profitably, than existing South African facilities. Finally, there's China's low-cost operating environment, which in this case includes the possibility that China's full implementation of CO2 regulations may lag that of developed nations.
Sasol CEO Pat Davies addressed such concerns head-on last week, explaining,
... we have always known there are competing technologies ... But we followed up on the noise around this one, and we get the assurance from our partners and from the province in which the place will be installed, that everything is on track.
Let's hope there's nothing synthetic about Davies' confidence.