Introduction
This proposal was made last year during the decrease in oil prices.
The proposal:
-
330 Euro short Suncor, turbo with leverage of 3
(You are not able to naked-short and this approximates the 1000 euro short Suncor)
1000 Euro long Canadian Oil Sands
Duration: 3-10 months, or 20% profit
Escape plan: 10% loss, then sell the position.
Portfolio: At the moment, there were no positions in the portfolio; therefore there is no link with
the current portfolio.
Oil companies are having a difficult time with the low oil prices. Profits decline, investments are
reduced and costs are cut. Some companies are able to remain profitable after the decline, but others
need a higher oil price. The expenses and price per barrel start to play a major role, but as most
companies start to focus on the expenses other companies were able to keep their price per barrel up.
We divided the oil market in two categories: Hedged companies and non-hedged companies.
Companies which hedged the oil price were able to sell their barrels for stable higher prices, while nonhedged companies sell according to market prices. When we look at stock prices of these companies
we see that the hedged companies have a significant higher price than non-hedged companies. Nonhedged companies’ stock prices declined as far as 80%, while hedged companies’ stock prices declined
about 33%. Our proposal is made to exploit this gap by shorting the hedged companies and buying the
non-hedged companies; Short Suncor and buy Canadian Oil Sands.
Please note that all $ are Canadian dollars.
Suncor
Suncor (SUN) is a global oil & gas company with operations in North America, Europe and Africa and is
based in Canada. The company is active in the downstream, midstream as well as the upstream
markets of crude oil and NGL. The company produced 534.9 mboe/d in 2014, most of which originates
from Oil Sands operations. The company focuses on exploring oil sands in Canada’s Athabasca oil
region. Suncor has an integrated chain of services that includes exploring, acquiring, developing,
producing and marketing crude oil and natural gas both in Canada and internationally. Furthermore
Suncor markets petroleum and petrochemical products primarily in Canada. Suncor operates in 4 main
segments:
The Oil Sands segment recovers bitumen from mining and in situ development in northern Alberta,
and upgrades it into refinery feedstock and diesel fuel.
The Exploration and Production segment is involved in offshore operations in the North Sea; and
operating onshore assets in North America, Libya, and Syria.
The Refining and Marketing segment refines crude oil and intermediate feedstock into petroleum and
petrochemical products; manufactures blends; and markets refined petroleum products to retail,
commercial, and industrial customers through its dealers and other retail stations.
The Corporate, Energy Trading, and Eliminations segment owns interest in seven wind power projects
in Canada; and ethanol plant in Ontario, as well as engages in marketing and trading crude oil, natural
gas, and byproducts.
Operations
Oil Sands
Exploration & Production
Supply & Trading
Refining & Marketing
Chain segment
Upstream
Upstream
Midstream
Downstream
Production (mboe/d)
421.9
113
-
Earnings ($ million)
2,800
857
144
1,700
Operational
The company main source of revenue is its Oil Sands operations in Alberta Canada. The company
operates 4 production sites and has a stake in the Syncrude operations, where operations are not
controlled by SUN directly.
The operating costs for these barrels in 2014 were 33.80 $/bbl, a major drop in costs from 2013 when
operating costs were 37.00 $/bbl. These are mainly due to restructurings and cost cutting programs
initiated by the major drop of oil prices worldwide.
Financial
SUN booked revenues of USD 40,490 million with EBITDA and EBIT margins of 30.0% and 14.9%
respectively. Furthermore, SUN earned a total net profit of USD 2,944 million in 2014 (7.3% margin).
The company currently has a net debt of USD 7,834 million, illustrating that the company is currently
in a healthy position and receiving A- and A3 ratings from Standard & Poor’s and Moody’s respectively
with stable long-term outlooks for its Long-term debts.
Stock price
The current stock price of SUN currently trades at around CAD 30.10 and has an EPS of 1.84, leading
to a P/E ratio of 16.4. The company furthermore has a dividend yield of 3.4%
Canadian Oil Sands
Canadian Oil Sands (COS) used to be a trust fund, but due to 2010 trust-fund laws the company decided
to become a dividend paying corporation. Now Canadian Oil Sands Ltd. is an investment company
located in Canada with headquarters in Calgary. The Company is the majority owner of the Syncrude
oil Joint Venture with a share of 36.74%. Syncrude consists of sand mines, plants, bitumen extraction
and a facility to process bitumen into crude oil. Besides Canadian Oil Sands the Syncrude Joint Venture
is controlled by six other owners. Canadian Oil Sands represents the only opportunity for direct
investment in the Syncrude Joint Venture that is open to the public. Syncrude is involved in the mining
and upgrading of bitumen from oil sands near Fort McMurray in northern Alberta. The Syncrude
Project consists of open-pit oil sands mines, utilities plants, bitumen extraction plants and an upgrading
complex that processes bitumen into Sweet Crude Oil. Syncrude produces the Sweet Crude Oil by
mining the oil sands, extracting the bitumen from the sands, upgrading the recovered bitumen into
lighter oil fractions and combining those fractions into a final, single Sweet Crude Oil product.
COS steadily produces around 105000 barrels of Oil per day (Syncrude around 290000). Average
operating expenses per barrel are $37, while total cost per barrel is $69. The sale price closely
resembles the crude-oil price, as COS does not hedge the oil price. The recent decline in oil prices
negatively affected the company and pushed it into negative incomes. COS reported a CAD 186 million
loss (0.38 per share) in the first quarter of 2015, with a revenue of CAD 634 million. The cost per barrel
is relatively high, influencing COS’ ability to make a profit. In order to be able to keep liquidity COS
decided to cut dividends from CAD 0.35 to 0.05, which saves the company CAD 145 million each
quarter. Furthermore, COS is making cost reductions in operation, development and capital expenses
totaling CAD 260 and 400 million in 2015.
The first signs of improvement were seen in the first quarter of 2015, as operation and capital
expenditures declined 24% and 66%. COS has finished its major capital expenditures in the last two
years. Train replacements, centrifuge tailings and Coker turnarounds will results in a 20% higher
capacity of Syncrude. Expected is that this new capacity will be used in the coming years, but their
depreciation cost is decreasing net income for now.
Next to the low oil price, COS is having problems with its long-term debt. COS’ debt is paid in USD,
while the company is transforming all its cash to CAD. In the last two years the CAD-USD exchange rate
has decline from lower exchange rate between CAD and USD, resolving in a loss of CAD 50 -150 million
each quarter. The first principal payment of the long-term debt is USD 500 million in 2019. Cash to
perform these payments are provided by the daily operations. In the case this does not suffice, COS
has a CAD 1.7 billion credit facility to use. In the past three quarters COS used total CAD 400 million
from this credit facility. Cash from operations are able to cover capital expenditures and the company
is not expected to have cash problems in the next years. With the low oil price, COS is able to pay its
obligations, without issues, until the end of 2016 (average withdraw of CAD 167 million per quarter
out of the credit facility).
COS sells its crude oil to refineries in the US and Canada. Transportation is done by pipeline, but
pipeline capacity in Canada is at its maximum. COS make a commitment of total CAD 2.1 billion for the
next 25 years to ensure transportation and reduce volatile transportation prices. Additional pipeline is
constructed, which will help Syncrude expand. Syncrude made an application to mine an adjacent
location, enabling production for another 10 years. Syncrude was estimated to provide 103 million
barrels per year for 43 years (starting in 2015). If permission is granted capital investments and
construction start around 2020.
Acquisition rumors are entering the market, now the oil price has decreased share prices. COS has
been named by several speculators to be in the interest of its partners with Syncrude. Exxon, Sinopec,
CNOOC and Suncor are all named, but no concrete negotiations have been performed. Since these
rumors the stock price of COS has increased from CAD 7 to 11, but is still far below its original 24.
Evaluations of COS ranged between CAD 27 to 32 per share
in 2010, but have decreased to CAD 14 to 19 now. The
current stock price reflects a market cap of CAD 5.3 billion,
at 53% of the book value.
If the oil price remains below CAD 69 for several years then
COS will have substantial problems, but as the oil prices
recovers above CAD 69 COS will be profitable and stock
prices will rise. Considering the low market cap, low risk of
bankruptcy in the next years, cost reductions, ensured
transportation, increased capacity and expansion opportunities we recommend buying Canadian Oil
Sands.
Oil
Both Suncor and Canada Oil are exploiting the oil sands of Alberta, a province in Canada. With
recoverable reserves of about 27 billion cubic meters of bitumen, a thick and heavy form of oil,
Alberta’s oil sands are among the largest deposits of crude oil in the world.
World
In the supposed standoff between OPEC and US light tight oil (LTO), LTO appears to have blinked.
Following months of cost cutting and a 60% plunge in the US rig count, the relentless rise in US supply
seems to be finally abating. LTO production growth buckled last month, sending US crude output
growth into reverse and bringing a multi-year winning streak to an apparent close. Inventories already
feel the pinch. US crude stocks, the top source of recent OECD builds, posted their first weekly draw in
17 weeks at the end of April. Expectations that the market would start tightening by mid-year seem to
be coming true - or so would have it the bulls who over the last month have given WTI crude a 14%
price lift, and counting.1
Pipeline
Alberta's finance minister, Doug Horner, claimed stated that Alberta's bitumen is fetching more than
$40 per barrel less than oil in Mexico or Texas. Many Canadian politicians argued this was the result of
under capacity of the pipelines. Additional pipeline should transport the oil to tidewater ports where
it would attract higher prices. Therefore the completion of major pipelines like the Keystone XL project
and the Northern Gateway through British Columbia are expected to be game changers. However,
both projects are uncertain and still do not have a final date.
Moreover, experts argue World prices are based primarily on quality and so Canada’s bitumen, which
has the lowest quality of the heavy oils, naturally fetches lower prices. Sending the oil sands bitumen
to Gulf Coast refineries is not going to change that fact, they note.
Regulations
Although Canada’s oil sand company is responsible for 5% of its total greenhouse gas emissions, causes
major landscape disruption due to surface mining and demands major consumptive water use,
1
https://www.iea.org/oilmarketreport/omrpublic/
regulations are not likely to keep pace with the rapid expansion of this industry. This is mainly due to
the fact that the industry has been a major source of investment in Canada, supporting not only the
province, but also the federal government, the manufacturing sector and skilled tradespeople. The oil
sands industry represents about two per cent of the Canadian economy, is responsible for 144,000
direct and indirect jobs in Canada, and is expected to contribute about $1.7 trillion to the economy
over the next 25 years.
Oil index of West Texas Intermediate
Corporate governance
This section presents a brief overview of the key executives operating at Suncor Energy Inc.
Mr. Steven W. Williams has been the President at Suncor Energy Inc since December 1 2011 and has
been its Chief Executive Officer since May 1 2012. Mr. Williams is responsible for Operational
Excellence in Suncor Energy Inc. and ensuring that a commitment to safe and sustainable development
continues to be a Suncor hallmark. He served as the Chief Operating Officer of Suncor Energy Inc. from
March 5, 2007 to May 1, 2012. He served as the Chief Financial Officer and Executive Vice President of
Corporate Development at Suncor Energy Inc. until May 30, 2003. He served as an Executive Vice
President of Oil Sands at Suncor Energy Inc. He joined Suncor Energy Inc. in May 2002. He held various
executive positions with Octel Corporation, a global chemicals company. Prior to joining Octel
Corporation in 1995, he held executive positions with Esso Petroleum Company Limited, an affiliate of
Exxon. He has been a Director at Suncor Energy Inc. since December 1, 2011.
Mr. Alister Cowan has been Chief Financial Officer and Executive Vice President of Suncor Energy Inc
since July 21, 2014. Mr. Cowan served as the Chief Financial Officer at Husky Energy Inc. since July 2008
until July 18, 2014, and its subsidiary Husky Oil Operations Limited since April 28, 2008. He served as a
Vice President of Husky Energy Inc. since July 2008. Prior to this, he held executive positions in the
energy and utilities sectors. He served as Executive Vice President, finance and Chief Financial Officer
of BC Hydro until April 2008. He served as Vice President and Comptroller of TransAlta Corp., from
2000 to July 2003. He served as Executive Vice President and Chief Financial Officer of British Columbia
Hydro & Power Authority from 2004 to 2008. He served as Vice President of Direct Energy Marketing
Limited from 2003 to 2004. Mr. Cowan is a Chartered Accountant and holds a Bachelor of Arts degree
in Accounting and Finance from Heriot-Watt University in Edinburgh, Scotland.
This section presents a brief overview of the key executives operating at Canadian Oil Sands Ltd.
Mr. Ryan M. Kubik, CA, CFA has been the Chief Executive Officer and President at Canadian Oil Sands
Limited since January 1, 2014. Mr. Kubik served as the Chief Financial Officer at Canadian Oil Sands
Limited from April 2007 to December 2013 and also served as its Treasurer from September 1, 2002
to April 2007 and Acting Controller from July 2005 to July 2006. He served as an Advisor of Corporate
Finance of EnCana Corporation from April 2002 to August 2002 and prior he served as Treasury of
PanCanadian Energy Corporation. He serves as the Chairman of Syncrude Canada Ltd. Mr. Kubik has
been a Director at Canadian Oil Sands Limited since January 1, 2014 and Canadian Arctic Gas Ltd. since
August 29, 2006. He served as an Associate Director at PanCanadian Energy Corporation. He is having
more than 10 years of corporate finance and accounting experience (EnCana, PanCanadian &
PricewaterhouseCoopers). He holds Bachelor of Commerce degree from University of Calgary;
Chartered Accountant, Chartered Financial Analyst.
Mr. Robert P. Dawson CA, CFA has been the Chief Financial Officer at Canadian Oil Sands Limited since
January 1, 2014. Mr. Dawson served as a Vice President of Finance at Canadian Oil Sands Limited from
January 2011 to December 2013 and served as its Treasurer from May 2007 to December 2010. He
served as Director of Financial Governance and External Reporting at Suncor Energy Inc. from March
2004 to April 2007.
Hedges
In the average sales figures of the first quarterly report of 2015 from Suncor, we see that the average
sweet sco price sold is 63.36, while the average market price is 49.75 over this period. The current
price of a barrel of sweet sco is around 58.4$. As such the end of the hedging contract will constitute
a loss of approximately 5$ per barrel, if no new hedge futures contracts have been gone into by the
management. If that has occurred, the likelihood is that this price will not be higher than the current
price, since the market has been recuperating over the past months. Assuming a stable oil price and
the hedge futures have ended or will end in the next quarter, this could lead to a negative difference
in operating revenue of around 560 million $ despite the recovery of oil prices, effectively consolidating
the gap in share price drop observed between Suncor and competitors at the time of the oil market
decline (offset by the current higher price of oil).
The assumptions made in the previous sections can be explained quite reasonably. Futures contracts
can hold for a lengthy amount of time, however considering the consolidated under the contract, the
nature of the oil industry and the history of Suncor’s hedging strategy (typically on a yearly basis), it is
not impossible to surmise that these hedging contracts are due to expire this calendar year. The effect
upon the stock price, however, is not definable under the circumstances of the oil market and the
unknown length of time remaining.
The assumption of a stable oil market is not relevant, as we have hedged our short position in Suncor
by taking a long position in Canadian Oil Sands. Therefore, if the hedged price is reached in the market
by the time of expiry of the futures contracts, the expected shortfall in Suncor stock will be offset by
the growth in the COS stock. If the oil price lowers further, then the short position will compromise the
long position and no further gains will be reached. However, the core principle of our proposal still
rests in the offset of the hedged oil price versus the market oil price.
Proposal
Our proposal is to short Suncor and buy Canadian Oil Sands until remaining hedges expire. Canadian
Oil Sands had not hedged the oil price and Suncor had. The investment idea can be expended by
applying the arguments to a broader market, improving diversification and reducing other
fundamental differences between companies. Both Suncor and COS are reporting negative net
incomes in the first quarter of 2015 due to lower oil prices. However, Suncor’s price has seen a less
dramatic decrease in stock price and still remains relatively high. In case the oil price remains low for
several years both companies will have financial trouble, Suncor’s hedges will expire and its stock price
will decline approximately 50% to 80%. In case COS is not acquired, the stock price will probably decline
to the lower level of CAD 8, about 30% decline. Might the oil price decrease further and maintain that
level for several years then both companies will have financial troubles. Hedges might buy Suncor some
time, but are not able to sustain the company on the long-term. In case the oil price increases, both
companies will profit. An oil price of CAD 70 will make both companies profitable. An increase to the
original level will result in a stock price increase of COS to CAD 24 (120%) approximately and the stock
price of Suncor will increase to CAD 45 (50%). Price levels are based on operations in similar markets
prior to the oil price reduction. Possible drawbacks are the higher stock price of COS due to acquisitions
rumors and the unknown contract length of the remaining hedges of Suncor.
Oil
Increase
Decrease
Stable
M&A COS
Suncor
50% increase
Hedges buy time, but
do not sustain the
business.
100%
decrease
Hedges expire,
50%-80% decrease
Buy side or neutral
COS
120% increase
Real financial trouble
after two years.
100% decrease
Total
37.5% profit
0% return
0%-30% decrease, as
balance sheet worsens
Premium
25%-30% profit
profit
Since both companies follow the same patterns, technical analysis is indecisive.