Integrated producers such as Suncor Energy Inc. (SU) and Cenovus Energy Inc. (CVE) are countering the slump in Canadian crude prices by cutting costs, shipping by rail and maxing out capacity at refineries.
“What you’re seeing coming through in spades is that those companies with integrated operations, like Suncor and Cenovus, are the ones that are doing better in this environment,” said Chris Theal, chief executive officer of Kootenay Capital Management Corp., which owns shares of both companies.
Canadian oil producers wrestled with a 13 percent decline for Western Canada Select, a crude blend sourced from the land- locked oil sands, in the second quarter as demand for its products stagnates in the U.S. The drop was bigger than the fall in U.S. and international benchmarks.
While Enbridge Inc. (ENB), TransCanada Corp. (TRP) and Kinder Morgan Energy Partners LP (KMP:US) are proposing pipeline expansions to the Pacific, Gulf and East coasts in the coming years, much of the new output is stranded in Canada or places like Cushing, Oklahoma, depressing prices. Suncor and Cenovus, both based in Calgary, are finding ways to circumvent the blockage.
Suncor’s cash flow from operations rose 18 percent to C$2.34 billion ($2.33 billion) in the second quarter, while net income declined after the company took an impairment charge after suspending its Syrian operations. At Cenovus, cash flow slipped 1.5 percent while Canadian crude prices fell almost 10 times as much.
Cenovus has a price-to-earnings ratio of 18, while Suncor’s price to earnings ratio is 9.1 in the most recent period, according to data compiled by Bloomberg.
“Cenovus continues to deliver quarter after quarter,” Raymond James Ltd. analysts Justin Bouchard and Kristopher Zack said in a July 26 note. “Although some may point to the lack of catalysts and a valuation premium as reasons to not own the stock, we continue to like the company’s excellent growth visibility and think the multiple is warranted.”
“Suncor really is in an enviable position,” the Raymond James analysts said. “It has significant balance-sheet flexibility, generates a lot of cash and is opportunity rich.”
Meg Energy Corp. (MEG), which doesn’t own a refinery, reported a 32 percent drop in cash flow from operations and a net loss of C$29.5 million in the second quarter, the Calgary-based company said on July 26. Athabasca Oil Corp., which also has no refineries, widened its loss to C$14.4 million in the period from C$10.5 million a year earlier.
Imperial Oil Ltd. (IMO), which owns four refineries and is the only Canadian company to have a AAA rating from Standard & Poor’s Ratings Services, said second-quarter cash flow from operating activities more than doubled to C$1.32 billion. Net income at Imperial, majority owned by Exxon Mobil Corp., matched the decline in the price of Canadian crude.
“The volatility in the oil price itself has spooked a lot of non-resource investors away from this segment of the market,” said Eric Nuttall, a portfolio manager who helps manage C$9.7 billion at Sprott Asset Management LP in Toronto. “Previously the biggest challenge of an oil executive was to find oil, it wasn’t how to sell it.”
The average price for Western Canada Select fell to $73.53 a barrel in the second quarter from a year earlier. That translates into a bigger drop than the 8.8 percent decline for West Texas Intermediate, a U.S. benchmark, which averaged $93.35 a barrel in the second quarter. It was a bigger drop than the 7 percent decline for Brent, an international benchmark, which averaged $108.76.
Suncor operates refineries in North America, including Montreal and Sarnia, Ontario, where it refines products such as jet fuel. That allows the company to price 96 percent of its output to Brent, said Chief Financial Officer Bart Demosky.
“It’s important to reiterate that Suncor is effectively hedged against these crude discounts because we’re able to recapture the majority of the spread through our inland refining operations,” he said on a conference call with analysts last week.
Suncor also cut costs per barrel produced at its oil-sands operations by 19 percent to C$39 a barrel. The company credited the decline on higher output, less maintenance and a drop in natural-gas costs.
“We think the second-quarter earnings result again demonstrates the benefit of the company’s integrated business model under the current elevated North America crude oil differential outlook,” Paul Cheng, a New York-based analyst at Barclays Capital Inc., said in a July 26 note. “We believe the shares will outperform over the next 12-18 months.”
The producer also may delay a plan to expand production to 1 million barrels a day by 2020 in order to maintain profitable growth, said Chief Executive Officer Steve Williams.
“We are heavily involved in these profit-improvement reviews at the moment,” Williams said on the Suncor conference call. “The indications are that some of these projects are moving backwards, not forwards.”
Suncor has gained 8.5 percent this year, beating the 3.8 percent decline of the S&P/TSX Energy Index. Cenovus’s shares have declined 6.7 percent.
Cenovus is currently shipping about 11,000 barrels a day to Vancouver on Kinder Morgan’s Trans Mountain pipeline. The oil is then sold at the port to international shippers, earning an extra $10 to $20 per barrel, Chief Executive Officer Brian Ferguson said in an interview. Those prices are closer to those paid for Brent and at a premium to West Texas, Ferguson said.
“Innovation is really important,” Robert Schulz, a professor at the University of Calgary business school, said in an interview. “If Cenovus is first on the Trans-Mountain pipeline, that’s going to constrain others’ ability to do the same.”
Cenovus is also shipping almost 5,000 barrels a day of oil by rail to move oil to the Gulf Coast and unspecified amounts to the East coast, where the company also captures higher prices.
“Companies like Cenovus that are becoming more innovative in reaching more markets are also showing advantages,” Kootenay Capital’s Theal said.
The company next year will look at ways to revamp its Wood River, Illinois refinery, a joint venture with Phillips 66 (PSX:US), to take more Canadian heavy crude, while continuing to look for more opportunities to ship crude to new markets, Ferguson said. The Canadian company is also part owner of a refinery in Borger, Texas.
“We are taking a portfolio approach to our transportation arrangements,” Cenovus’s CEO said. The company has already committed capacity to proposed pipeline expansions like Kinder Morgan’s Trans Mountain conduit and those planned by TransCanada and Enbridge to the Gulf and Pacific coasts because of significant expansion opportunities in the oil sands, he said.
Cenovus had operating cash flow from refining of C$344 million, an increase of C$22 million from the year-earlier quarter. The company is counting on new technology, hedging and higher production to help reduce costs of its oil-sands production in the coming years.
“In any commodity business, it’s the low-cost producer that is always the one that benefits whether there are high prices or low prices,” Ferguson said.
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