If you're looking to find the group of oil producers least affected by the oil price collapse, look north. The rapidly weakening Canadian dollar has provided something of a cushion from the oil-price blow for Canadian producers like Suncor (NYSE: SU).
This chart shows how many "loonies" each U.S. dollar has been worth since OPEC announced its decision not to cut production on Thanksgiving weekend in 2014.
Like their American counterparts, Canadian producers have their oil priced in U.S. dollars. Back in November 2014, that meant every $1 revenue in U.S. dollars meant $1.12 Canadian. Today every U.S. dollar of revenue equates to $1.39 Canadian. Everything else being equal, that would be a 24% increase to revenue.
Unlike the American producers, most Canadian producers have expenses (salaries, administration, royalties, taxes, capex) that are based in Canadian dollars. Therefore, while these companies have benefited from the weakening Canadian dollar on the revenue side, there has been no impact on the expense side.
How big of a help is this for Canadian producers? An example might illustrate best. For a company producing 100,000 barrels of oil per day and receiving $50 USD per barrel, annual revenue at the November 2014 and current exchange rates would look like this:
- November 2014: 100,000 bpd x 365 days x $50 per barrel x 1.12 exchange = $2.04 billion of revenue.
- December 2015: 100,000 bpd x 365 days x $50 per barrel x 1.39 exchange = $2.53 billion of revenue.
The difference between those two exchange rates equates to roughly $500 million of revenue over the course of a full year. With expenses remaining in Canadian dollars and therefore not increasing proportionately, most of that additional revenue could turn into cash flow from operations.
That is certainly a material difference and could be enough to separate some companies from life and death if the oil price doesn't recover sooner rather than later.
Not all Canadian oil is created equal
One thing investors have to be careful with when looking at Canadian producers is the type of oil that they produce. According to Canada's National Energy Board, production in December by type breaks out like this:
- Conventional light oil: 890,000 barrels per day.
- Upgraded bitumen: 1,051,510 barrels per day.
- Heavy oil/bitumen: 1,859,699 barrels per day.
All of this oil is priced in U.S. dollars, but the differential for the various oil types to West Texas Intermediate is very, well, different. Conventional light oil and upgraded bitumen both are a lighter, easier to refine crude and therefore have small differentials to WTI pricing. Heavy oil and bitumen (Western Canadian select), on the other hand, are heavier and harder to refine, hence they have wide differentials. Western Canadian Select has recently been receiving a discount of $13.30 per barrel from WTI, which means it's being sold for $20 per barrel.
With oil sands producers typically being high cost producers, that low realized selling price is a problem. New oil sands projects have a break-even price for oil that is estimated to be $90 or higher. Shale oil production break-even costs are lower, but still considerably higher than the current oil price.
Unless you're certain that oil prices are going to surge higher in 2016 and are actually looking to make a short term bet, pure heavy oil/bitumen producers should probably be avoided. Since heavy oil/bitumen makes up almost half of Canada's production, that touches a lot of companies.
Suncor is a bitumen/oil sands producer, but only 19% of its production is priced off Western Canadian select.
That's because the vast majority of its bitumen production is upgraded to be a more like those lighter, easier to process crude and receives a price similar to and sometimes at a slight premium to WTI. This upgraded oil is known as synthetic crude oil (SCO), the biggest three producers of which are Suncor, Canadian Natural Resources, and Canadian Oil Sands.
That upgraded production plus the weakened Canadian dollar have been very beneficial to Suncor's cash-generating ability in 2015. Suncor's refining operations have been an even bigger help.
If you drill into Suncor's first nine months, you'll find that the company was able to generate $467 million of free cash flow. That's cash flow left over after capital spending. A closer look will reveal that the refining and marketing division is the biggest reason. While generating $2.27 billion in cash flow though nine months, the refining and marketing division for Suncor required only $465 million in capital spending. That is $1.8 billion of free cash flow created by this business line.
Free cash flow is not a common thing in the energy sector these days.
Continental Resources (NYSE: CLR) provides a view of an America producer of decent size that doesn't have Suncor's Canadian dollar and refining benefits.
While Suncor generated free cash flow, Continental's cash flow statement shows only $1.4 billion of cash flow being generated against $2.6 billion of capital spending. Suncor's balance sheet has actually strengthened while Continental has massively overspent and used debt to fund it.
Suncor's $1.8 billion of free cash flow from refining covered all of the company's $1.2 billion of dividend payments and another $600 million of spending for the E&P business. Without that $1.8 billion of free cash flow, Suncor would have either had to eliminate its dividend, cut capital spending on the E&P business, or allow its balance sheet to deteriorate.
The bottom line
The weakening of the Canadian dollar, the upgraded oil pricing, and the refining business have allowed Suncor to retain a strong financial position. That strong financial position has undoubtedly helped Suncor's share price which is allowing the company to use it as a currency to try and opportunistically take over competitor Canadian Oil Sands.
For a strong company like Suncor, capitalizing on an opportunistic takeover of Canadian Oil Sands may mean that it is entirely possible that Suncor comes out the other side of this oil crash in better shape that it went into it. That is assuming of course that at some point there is an "other side."
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