A Not-So-Obvious Way to Play an Oil Rebound

Teck Resources Ltd. (TSX:TCK.B)(NYSE:TCK) has a major catalyst on the horizon that the market doesn’t give it much credit for these days: its significant upside exposure to oil prices. The reason the market is overlooking this potential is that Teck doesn’t produce a drop of oil at the moment. However, that is going to change by the end of next year when the Fort Hills oil sands mine comes online, enabling the company to capture the upside of higher oil prices in future years.

Counting down to first oil

Teck currently owns a 20% stake in Fort Hills, which is a project developed by Canadian oil sands giant Suncor Energy Inc. and French oil giant Total SA (ADR). Currently, that stake is somewhat of a liability because Teck must fund its share of the project’s capital costs, which total an estimated $2.94 billion, including $960 billion in spending this year. However, once Fort Hills comes online, it will shift from a cash consumer into a cash flow generator.

Construction, which started in late 2013, is scheduled to be complete by the fourth quarter of 2017. Once production ramps up to peak capacity, Teck’s share is expected to be 36,000 barrels of bitumen per day for the next 50 years. Given Fort Hills’s low operating and sustaining costs of less than $30 per barrel, it is expected produce gobs of cash flow for the company over the next five decades.

Drilling down into Teck’s oil upside

Thanks to those low operating costs, Teck’s energy business will be cash flow positive as long as oil is above $45 per barrel. Meanwhile, as oil prices rise, so does cash flow. For example, at $60 oil the company expects to generate $180 million in annual pre-tax cash flow, which is about a 6% yield on the nearly $3 billion of capital it poured into the project. That cash flow grows to roughly $290 million at $70 oil, or about a 10% yield on capital.

Cash flow continues to expand along with oil prices and could nearly double to $600 million should oil ever reclaim triple digits. Suffice it to say, if oil prices rise, Teck’s new oil business will benefit from those higher prices.

However, even at the low end, Fort Hills will supply Teck with a meaningful amount of cash flow. For perspective, the company generated roughly $1.6 billion in operating cash flow through the first nine months of this year, putting it on pace for more than $2 billion in cash flow. As such, Fort Hills could boost that number by about 10% at $60 oil.

Further, because the project will soon no longer be consuming cash; it will be an even more meaningful contributor to the company’s financial flexibility going forward. That is money the company can use to repay debt, make growth-related investments, or return to shareholders.

Investor takeaway

Teck Resources has tremendous upside to an oil price recovery thanks to its participation in Suncor Energy’s Fort Hills project. At the low end, that asset could boost its cash flow by 10%, while that number could soar if oil prices regain their former highs. Because of that, investors looking for a unique way to play an oil market recovery should take a look at Teck Resources.

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Fool contributor Matt DiLallo has no position in any stocks mentioned.

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