Suncor Energy is one of the most direct investments in the future of Canadian oil sands. With close to 80% of its total production coming from this particular resource, Suncor is a very unique investment in the world of oil and gas production. With that unique position, though, comes some rather unique threats that could send shares downward.
Of course I can't say that shares will fall anytime soon, but these three threats are the most likely candidates to compromise Suncor Energy's stock value over the long term. So let's take a look at these three threats and what you as an investor can do to prevent them from wreaking havoc on your portfolio.
1) Its product is market constrained
No offense to the residents of Northern Alberta, but the one place where oil sands are currently extracted isn't exactly a bustling metropolis with massive demand for oil. Also, the amount of oil that can be refined locally is rather modest in comparison to the total amount of oil coming from Suncor's and other companies' operations in the Athabasca oil sands region. This means that Suncor is highly reliant on transportation networks out of Alberta to get its oil or refined products to market.
Source: Suncor Energy Investor Presentation
Based on Suncor's current production levels and transportation network, this is not a major threat for the time being. The issue for Suncor and many other oil sands producers, though, is the growing need for more pipeline or rail access from the region. All of the major pipeline proposals out there to increase takeaway capacity from Alberta -- Transcanada's Energy East and Keystone XL, Enbridge's Northern Gateway, and Kinder Morgan's Trans Mountain -- are under harsh political scrutiny and several are suffering delays because of opposition from various political groups.
Without these pipelines, oil sands producers can rely on rail to move product, but it will take a lot of rail transport to replace the more than 3 million barrels per day capacity these pipelines would represent. A lack of transport from the region could cause a bottleneck and in turn lower prices for producers looking to move product. With so much of its revenue stream tied to oil sands, Suncor could suffer more than many others.
2) High environmental costs, both today and potentially in the future
Pretty much the first word people think of when they hear the term oil sands is "dirty," which is true to a certain degree -- although in some ways overblown. Since some oil sands processing more closely resembles mining than oil production from wells, Suncor needs to deal with other environmental issues such as managing mining tailings -- the leftover stuff after the resources have been extracted -- as well as other issues such as land reclamation.
The more bitumen mining that takes places at Suncor, the more these costs will pile up over time as tailing stockpiles increase or mining regions are no longer usable and the land needs to be restored. Also, like with mining companies, Suncor is on the hook for any environmental damage that could result from water contamination at retaining ponds or tailing piles.
Then, there is the big unknown variable when it comes to oil sands production: carbon emission regulations. Because of the upgrading and other processes needed to extract oil sands, it is a more carbon intensive oil source than others. In the event that more strict carbon emissions were to take hold, Suncor could be saddled with additional costs in the form of carbon capture technology at its facilities, or paying carbon taxes.
Suncor does have some projects that could be very helpful in mitigating this threat. It has 225 megawatts of wind power already installed to power many of its facilities and it intends on constructing another 140 megawatts. Generating some of its power from alternative sources to fuel its upgrading and in-situ extraction facilities could keep those costs down, but we don't know for certain if or when any regulations will take effect or how they would hit Suncor's shares.
3) If this one part of the value chain breaks down, the entire company suffers
Here's something that you probably haven't thought of recently. Integrated oil and gas companies like ExxonMobil and Chevron aren't really that integrated. If one part of their operations goes down like a refinery, their production business won't likely suffer. This isn't the case with Suncor; it is an integrated oil company in the truest sense of the word. Almost all of its logistics, transport, and refining operations are designed to treat oil sands and create higher value products such as synthetic crude oils or refined petroleum products.
Source: Suncor Investor Presentation
This business model for oil sands producers makes lots of sense because oil sands by itself -- mostly known as bitumen -- doesn't command a very high price in comparison to crude oil. Here's the catch: This means that there are a couple critical points in Suncor's value chain that cannot fail unless the entire system shuts down.
The most critical point in Suncor's value chain is two upgrading facilities in Fort McMurray, Alberta. These two facilities have the capacity to upgrade mined bitumen from oil sands and upgrade it to about 350,000 barrels per day of synthetic crude oil, which is more than 80% of Suncor's current oil sands production. The biggest fear here is if something were to happen at these facilities such as an operational failure or an accident that resulted in a lengthy shutdown. Without these two upgrader facilities running, Suncor would either be forced to shut down huge amounts of its mining operations or, if these facilities were down for very long stretches, sell unrefined bitumen on the open market, which currently sells at less than half the price of synthetic crude. A delay greater than a couple quarters would likely cause absolute havoc on earnings and cash flows and send shares in a tailspin.
What a Fool believes
Shares of Suncor aren't likely to see huge growth over any short time period. Its capital intensive oil sands operations take years to implement, so production and earnings between new projects starting up can be pretty flat. But if something such as an operations failure at one of its key infrastructure facilities were to get shut down or if the company got hit with some big environmental fines, shares could head down very quickly -- just ask any investor that owned shares of BP back in spring of 2010.
Things such as unexpected operational failures, environmental accidents, or political action are extremely hard to predict as an investor, so you can't really do much about it. Of the three issues mentioned above, the only one you can track that can give you an idea of what could happen at Suncor is to follow the progress of those proposed oil pipelines. The longer they take to come online, the greater chance that takeaway capacity from the region could get constrained and send oil prices -- and the share price of Suncor -- in a direction that most of us don't want them to go.
