Trouble in the Oil Sands (SU, ECA)

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Yesterday’s New York Times carried a story about the commercial building boom in Calgary, Alberta. About 75% of Calgary’s office space is occupied by companies involved in extracting fossil fuels, and much of that is taken up by companies in the oil sands business.

Two of the largest players in the oil sands are Suncor Energy Inc. (NYSE:SU) and Encana Corporation (NYSE:ECA), and both are headquartered in Calgary. Encana has fully leased a 58-story office tower that is still under construction and that is finding it difficult to secure financing to complete the building.

Calgary’s troubles are well reflected by Suncor’s full year earningswhich the company released yesterday. Compared with 2007, net earningswere down about 28%, from C$2.983 billion to C$2.137 billion. EPS fellfrom C$3.23 to C$2.29. Excluding certain items, 2008 EPS wasC$3.23 compared with C$2.59 a year earlier. Cash flow from operationsincreased by nearly C$500 million.

Higher prices boosted Suncor’s earnings and cash flow in 2008,so even though the company produced less due to maintenance issues. Themissteps were covered up by high prices. Going into 2009, Suncor willnot have that cover, and shares took a beating yesterday, openingmore than $2 lower than Friday and falling more than $2before closing at $17.49.

For 2009, Suncor cut its projected capital spending budget by 50%, toC$3 billion, with one-third targeted for growth and the rest on "basebusiness operations." Two projects have been shuttered indefinitely.

The really bad news is that Suncor expects operating costs in 2009 tobe C$33-C$38/barrel. In the oil sands operations, fourthquarter 2008 total operating costs per barrel finished at C$49.10, upfrom C$34.05 in the fourth quarter of 2007. The company gives noexplanation of how it will reduce these costs other than to say thatSuncor will be "implementing reliability and operational efficiencyinitiatives which we expect to minimize unplanned maintenance in 2009."

That won’t do the trick if prices remain below about $60/barrel becauseSuncor’s synthetic crude in 2009 is expected to sell at a discount ofC$4.50-C$5.50/barrel to WTI crude. The unstated expectation is that theglobal economy will improve and that crude prices will rise. That iswishful thinking, not planning.

Paul Ausick
January 21, 2009