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Suncor Energy Inc.: Understanding the Inherent Advantages of Integrated Energy Producers

With the price of West Texas Intermediate Crude (WTIC) recently having established a firm foothold above the US$60 mark, and gasoline prices nearly 15% higher than where they say a year ago, it only makes sense to revisit a few of Canada’s largest integrated oil and gas producers.

Suncor Energy Inc. (TSX:SU)(NYSE:SU) and Imperial Oil Ltd. (TSX:IMO)(NYSE:IMO) are the two largest oil and gas producers listed on the Canadian exchanges.

Suncor entered Wednesday’s trading with a market capitalization of $75 billion, the fifth largest of all Canadian listed companies. Imperial Oil, meanwhile, clocked in at a market cap of $32.7 billion — about half the size of Suncor but still a very significant part of the Canadian financial ecosystem and the 19th-largest publicly traded Canadian company.

Both Suncor and Imperial Oil are “integrated producers,” meaning that both companies facilitate the extraction, transportation and refinement of energy products — essentially taking energy from beneath the earth’s surface all the way to your gasoline tank.

The process of extracting crude oil and natural gas from the ground is referred to as an integrated producer’s “upstream operations.”

The process of transporting those liquid and dry energy materials to refineries is referred to as “midstream operations,” and when that energy is finally converted into finished products to be consumed by end markets — gasoline, diesel, jet fuel, and certain chemical compounds — this is referred to as a company’s “downstream operations.”

But integrated producers like Suncor, Imperial Oil, and Cenovus Energy Inc. (TSX:CVE)(NYSE:CVE) have a distinct advantage over exploration and production (E&P) companies that are only engaged in upstream operations, like, for example, Crescent Point Energy Corp. (TSX:CPG)(NYSE:CPG) or Baytex Energy Corp. (TSX:BTE)(NYSE:BTE).

That’s because unlike companies engaged strictly in E&P operations, integrated producers get the added benefit of realizing cheaper input costs in their refining operations when crude prices are depressed relative to gasoline prices.

Essentially, when crude oil prices are low, E&Ps like Crescent Point and Baytex sell their product to refineries at a discount, and that’s the end of the story.

But in the case of the integrated producers, they sell the crude oil to themselves at a discount, which effectively lowers their input costs, or costs of goods sold, tied to refined products that are eventually sold to end markets.

So, the upstream profits are lower for the integrated producers just like the E&Ps, but these lower profits in upstream operations are often offset by improved profitability in the company’s downstream operations.

It’s as if the integrated producers have a built-in hedge — and it goes a long way to smoothing out these integrated producers financial performance relative to most E&P names.

Bottom line

While companies like Baytex and Crescent Point struggle to keep the lights on and maintain production at current levels, Canada’s integrated producers have been gaining strength.

Despite falling oil prices, Suncor has continued to increase its dividend over the past three years, and Cenovus recently executed a large acquisition to effectively double the company’s production.

Yet both Suncor and Cenovus have seen significant pullbacks in their respective share prices to begin 2018, making now the opportune time to initiate a position in the two blue-chip names or add to your current holdings.

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Fool contributor Jason Phillips owns shares of Cenovus Energy Inc.

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