Oil continues to gyrate wildly as energy markets react sharply to news both and good and bad relating to the outlook for crude. The latest developments, which have caused oil to dip significantly in recent weeks because of fears that OPEC and Russia will amend the historic agreement on production caps, has sent crude into a tailspin.
Since breaking through the psychologically important US$70-a-barrel barrier early last, month the North American benchmark West Texas Intermediate (WTI) has pulled back sharply, falling to just over US$65 per barrel. While this is bad short-term news, it shouldn’t deter investors from betting on higher oil. Among the best means of doing so is by investing in integrated energy major Suncor Energy Inc. (TSX:SU)(NYSE:SU), which has gained 9% since the start of 2018.
Suncor is the unquestionable king of the oil sands, deriving over 80% of its petroleum production from Canada’s prodigious oil sands. The company used the protracted slump in crude to make a variety of acquisitions that bolstered its oil sands operations and production, as it prepared to profit from the eventual rebound in crude. That includes buying Syncrude partner Canadian Oil Sands Ltd. in 2016 and then further bolstering its interest in the project in 2018 by acquiring Murphy Oil Corp.’s 5% ownership share, giving it a controlling 54% interest.
What makes Suncor a particularly attractive play on higher oil is that the company has low breakeven costs with analysts estimating that it needs WTI to be at US$37 per barrel. This makes it competitive against the vast majority of U.S. shale oil producers and highlights one of the advantages that oil sands has over shale oil: the long production life of the assets. That means once considerable upfront costs have been incurred on constructing the asset and bringing it to production, very little capital is required to sustain operations.
Shale oil wells typically have extremely high depletion rates, which have been estimated to be more than double conventional oil wells, forcing shale oil companies to invest considerable capital in exploration and well development so as to sustain production.
As a result, Suncor’s existing oil sands operations have low cash costs of around a mere US$21 per barrel produced, meaning that they will remain cash flow positive, even if WTI falls substantially in value. Those costs should continue to fall, further boosting profitability, because CEO Steve Williams is pushing to get operating costs below $20 a barrel compared to $26.85 for the first quarter 2018.
Suncor is also highly resilient to weaker oil prices because of the integrated nature of its operations, which allows it to use the oil produces in its own refineries, thereby boosting margins on its refined products.
The company has also been able to steadily improve its return on capital employed (ROCE) in recent years, reporting a ROCE of 6.5% for the first quarter, which was almost double the 3.5% recorded a year earlier.
While first-quarter production declined by 5% year over year primarily because of unexpected outages, including one related to weather, Suncor has a long history of growing production at a steady clip. This is an important attribute to possess in an operating environment where oil has firmed significantly from its 2016 lows.
Suncor may not be the most exciting oil stock, but it does offer investors a relatively less-risky means of playing higher oil and the increasingly positive outlook for crude. The integrated nature of its operations, low operating costs, diversified portfolio of quality assets, and solid balance sheet leave it well positioned to weather any further weakness in crude, while being capable of significantly profiting from even a moderate spike in the price of oil.