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Cost Cuts Restore Oil Sands Viability
Since hitting a low of $41.15 per barrel back on February 18, the price of crude oil has surged more than 42% over the last few months, recently crossing the $58 mark. While this may not be good news for motorists, it's great news for Canada's oil sands producers who were forced to cancel or delay more than $200 billion worth of spending as a result of last year's oil price free fall. Read on to find out why oil sands companies might be set to strike black gold once again.
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Sizable Declines in Operating and Capital Costs Improving Project Economics
Crude prices are poised to move even higher, and with labor and material costs now down significantly due to the recession, the economic pendulum has swung back far enough to make the revival of oil sands producers' mothballed projects a distinct possibility.
Over the last few months, major oil sands operators like Suncor (NYSE:SU) and Petro-Canada (NYSE:PCZ, TSX:PCA) have taken advantage of the slack construction business conditions to strong-arm contractors into rolling back costs. According to Suncor CEO Rick George in an April 1 Reuters release, that should help reduce operating costs this year by 10- 15% and capital investment costs by 20- 25%.
Per-Barrel Operating Costs Down to $33
Already there are signs that costs are coming down. Suncor's per-barrel operating cost declined to just over $33 per barrel during the first quarter of 2009, down considerably from the $41 per barrel cost reported during the last quarter of 2008. Other major oil sands producer Syncrude, a consortium operation which includes ConocoPhillips (NYSE:COP) among its owners, is also targeting a reduction in per-barrel operating costs to $33 this year. With these lower operating costs, Suncor estimates that it will still generate a double-digit return from its existing operations, even at crude prices in the high $40 to low $50 per barrel range.
Petro-Canada recently re-estimated the capital cost of its Fort Hills oil sands project and saw that number fall from C$14 billion to C$10 billion, a drop of about 30%. Husky Energy (OTC:HUSKF, TSX:HSE) also re-crunched the cost of its "sunrise" project and saw that estimate fall by nearly 50%, from $4.5 billion to $2.5 billion.
Incidentally, Suncor and Petro-Canada recently agreed to merge, in part to realize about $1.3 billion in savings from operating synergies. (Learn how to invest in companies before, during and after they join together in The Merger - What To Do When Companies Converge.)
New Project Breakeven Cost Now Estimated at Just $60 Per Barrel
As a result of these cost reductions, analysts have now revised their breakeven cost for new oil sands projects from $80 to $100 per barrel to something closer to $60 a barrel – just a hair shy of the current price.
Small wonder then that investment dealer Goldman Sachs recently did a major about-face on the oil sands producers, upgrading the shares of Suncor and Petro-Canada from "sell" to "buy" and raising its price targets on Nexen (NYSE:NXY) and Canadian Natural Resources (NYSE:CNQ), despite retaining a "neutral" opinion on the latter two companies.
The Bottom Line
Both Suncor and Petro-Canada have realized huge gains in the last three months, gaining 58% and 70% respectively. With oil still shy of the $60 a barrel price, what now looks like the trigger-point to revive of many of the stalled oil sands projects, share prices could be somewhat ahead of the fundamentals at this point. But if any pullback in the shares takes place, a second buying opportunity could present itself for an industry many had just recently written off as economically unviable. (Before jumping into this hot sector, learn how these companies make their money. See Oil And Gas Industry Primer.)
IN PICTURES: Top 7 Social Security Myths: Exposed
Sizable Declines in Operating and Capital Costs Improving Project Economics
Crude prices are poised to move even higher, and with labor and material costs now down significantly due to the recession, the economic pendulum has swung back far enough to make the revival of oil sands producers' mothballed projects a distinct possibility.
Over the last few months, major oil sands operators like Suncor (NYSE:SU) and Petro-Canada (NYSE:PCZ, TSX:PCA) have taken advantage of the slack construction business conditions to strong-arm contractors into rolling back costs. According to Suncor CEO Rick George in an April 1 Reuters release, that should help reduce operating costs this year by 10- 15% and capital investment costs by 20- 25%.
Per-Barrel Operating Costs Down to $33
Already there are signs that costs are coming down. Suncor's per-barrel operating cost declined to just over $33 per barrel during the first quarter of 2009, down considerably from the $41 per barrel cost reported during the last quarter of 2008. Other major oil sands producer Syncrude, a consortium operation which includes ConocoPhillips (NYSE:COP) among its owners, is also targeting a reduction in per-barrel operating costs to $33 this year. With these lower operating costs, Suncor estimates that it will still generate a double-digit return from its existing operations, even at crude prices in the high $40 to low $50 per barrel range.
Incidentally, Suncor and Petro-Canada recently agreed to merge, in part to realize about $1.3 billion in savings from operating synergies. (Learn how to invest in companies before, during and after they join together in The Merger - What To Do When Companies Converge.)
New Project Breakeven Cost Now Estimated at Just $60 Per Barrel
As a result of these cost reductions, analysts have now revised their breakeven cost for new oil sands projects from $80 to $100 per barrel to something closer to $60 a barrel – just a hair shy of the current price.
Small wonder then that investment dealer Goldman Sachs recently did a major about-face on the oil sands producers, upgrading the shares of Suncor and Petro-Canada from "sell" to "buy" and raising its price targets on Nexen (NYSE:NXY) and Canadian Natural Resources (NYSE:CNQ), despite retaining a "neutral" opinion on the latter two companies.
The Bottom Line
Both Suncor and Petro-Canada have realized huge gains in the last three months, gaining 58% and 70% respectively. With oil still shy of the $60 a barrel price, what now looks like the trigger-point to revive of many of the stalled oil sands projects, share prices could be somewhat ahead of the fundamentals at this point. But if any pullback in the shares takes place, a second buying opportunity could present itself for an industry many had just recently written off as economically unviable. (Before jumping into this hot sector, learn how these companies make their money. See Oil And Gas Industry Primer.)
by
Eugene Bukoveczky
Contributor - Investopedia Advisor
Eugene Bukoveczky is a freelance writer for Investopedia.com. He holds a Chartered Financial Analyst (CFA) designation and has broad experience in investment research and portfolio management. He has traveled extensively during his career, working in Toronto, New York, London and Dubai. He graduated from York University School of Business with an MBA.
Eugene Bukoveczky is a freelance writer for Investopedia.com. He holds a Chartered Financial Analyst (CFA) designation and has broad experience in investment research and portfolio management. He has traveled extensively during his career, working in Toronto, New York, London and Dubai. He graduated from York University School of Business with an MBA.
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