Costs are declining, but era of the megaproject is over
What was clear from the messaging coming from each of the three companies on the earnings calendar — Suncor, Cenovus and MEG — is that costs are coming down and the era of oilsands megaprojects is definitely over.
Notes of caution dominated the conversations surrounding the release of second-quarter results by oilsands players on Wednesday and Thursday.
What was clear from the messaging coming from each of the three companies on the earnings calendar — Suncor, Cenovus and MEG — is that costs are coming down and the era of oilsands megaprojects is definitely over.
“The biggest takeaway is the success companies have had in bringing down their costs,” said Mike Dunn, director, institutional research with FirstEnergy Capital Corp. pointing to Cenovus and MEG.
The drop in costs — from changes in operating practises — is allowing companies to put the dollars saved towards modest growth opportunities, with Dunn expecting as much as two-thirds of what has been reduced should remain in place when prices do start to recover.
Supporting the perspective the time of megaprojects is over is the fact it is more attractive from a valuation perspective to buy oilsands assets because they are cheap. Other reasons for not turning on the spending taps include low prices, uncertainty over the impact of federal climate change legislation and the lack of progress on achieving access to tidewater; progress on pipelines remains a critical factor to companies making investment decisions — even in a low price environment.
And that’s despite the fact the capital markets, for the most part, have been open for the “good” names in the oilpatch and allowed for more than $15 billion to be raised in both the debt and equity markets since the beginning of the year. Not only that, there are signs overseas and transborder investors — even with the concerns that may exist over environmental issues — are starting to buy up shares in oilsands companies. The reason behind the renewed interest in the sector seems to be stemming from a sentiment that shares have bottomed, the supply response looms and investors with longer time horizons are looking to position themselves for big gains over the next 12-18 months.
Look no further than a company like MEG, which, for better and worse, is highly levered to oil prices and trading below $6 per share. A sustained jump in crude prices could see their shares respond in short order — especially if prices can stick in the US$60 per barrel range. If they do reach that threshold, MEG will be in a position to fund its expansion plans from internal cash flow; if prices remain closer to the $50 mark, analysts are speculating MEG will be going to the market to raise equity, but this could be deferred if it sells its interest in the Access Pipeline. Devon sold its stake to Wolf Midstream earlier this month for $1.4 billion.
The good news from MEG, though it wasn’t the “knock your socks off” variety, was that it is expecting to spend $30 million of the $170-million capital budget on growth opportunities; previously, the entire amount was to have been allocated to sustaining capital. Also interesting was that Bill McCaffrey, the founder and chief executive officer, is no longer chairman of the company. He has been replaced in the chairman’s role by Jeff McCaig.
While this brings MEG into the modern age of corporate governance, it also sends a signal that the distance created by this move points to a greater possibility of a sale being considered if an offer comes forward.
Cenovus also had news of modest reinvestment plans, with the company in a position to capture the impact of achieving lower operating costs, and putting Phase G of Christina Lake back on the table after being shelved last year. The company is currently rebidding the project and between that and the operating efficiencies it says it has captured, Cenovus chief executive Brian Ferguson was clearly preparing the market that the company is looking to add to production. But slowly. Given the continued uncertainty in the markets — whether in terms of prices, access to tidewater or climate change policy — the comments made by Suncor CEO Steve Williams should not have been a big surprise.
Williams said the company is in discussions with the Alberta government to shut-in production in certain areas, which would result in the stranding of some assets in its portfolio. Let’s chew on that for a bit. The company said they would do this if the economics don’t work because prices are too low, or if the production at these sites would add to Suncor’s carbon emissions footprint.
It wouldn’t be the first time a company has shut-in production — though the fact it is in discussions with the province suggests it is a permanent move, because companies are granted permission to produce the entirety of reserves on Crown lands.
In other words, it’s a tad unusual on the part of the company. What usually happens is the shut-in reserves are brought back on-stream when commodity prices strengthen.
The fact it goes against current government policy also makes it a departure from the norm.
One has to wonder whether the carbon footprint factoring into the equation is a thinly disguised ploy to get the government to agree to Suncor’s request, because of the government’s focus on reducing carbon emissions.
That said, it would be incorrect to think Suncor would be shutting in its marquis producing assets.
Rather, the move would pertain to older wells, whose productivity has fallen but still require the same amount of steam to extract the bitumen; that’s not exactly efficient, cost-effective or carbon friendly.
Nor does it result in maximum utilization of its oil treatment facility.
There are valid economic reasons for a company to go down this route, especially in this capital-constrained world.
However, the fact the carbon emissions argument could function as the deciding factor that convinces the government to go against existing policy could see more companies follow suit.
However, industry and government choose to address this issue, it must be done thoughtfully and carefully because it would constitute a dramatic shift in policy direction; the last thing the industry needs is more uncertainty nor does the government want to be dealing with anything resembling unintended consequences.