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Suncor's long-term value

Suncor is Canada's oil sands champion. It celebrates its hundredth anniversary this year

Suncor Energy's history and that of Canada's oil sands are virtually inseparable. Yet, as the company marks its 100th anniversary, it is redefining the pioneering spirit that transformed a former US underling into a world-class major producer.

Suncor's origins trace to 1917 when it was a subsidiary of Pennsylvania's Sun Oil (now Sunoco) originally formed to supply lubricating oils and kerosene for Canada's military in the First World War. Over the ensuing decades, it marketed refined products brought in by rail from Sun refineries in the US. That all changed in 1930 when it opened its first Sunoco-branded retail stations in Toronto, Montreal and Quebec City.

When the next war came, the company moved its headquarters to Toronto. Under pressure from the Canadian government to stop buying so much foreign oil, in the 1940s it built a 10,000-barrel-a-day refinery in Sarnia, Ontario and began upstream exploration after oil was discovered at Leduc, Alberta in 1948.

By then much of Alberta's exploration lands had been claimed by majors such as Shell and Imperial Oil, a subsidiary of Exxon. To find its own source of crude, Suncor looked to an unlikely resource—Athabasca's oil sands.

In 1923, barely five years after Sun incorporated in Canada, University of Alberta scientist Karl Clark developed a technique for separating oil from sand in his bathtub using nothing but hot water. It's the basis of the process still used today.

430,000 b/d - Suncor's oil sands output, Q4 2016

Commercialising the technique was a longer-term effort that would consume the better part of the next three decades, requiring intense research and development along with government prodding and subsidies. Given the sheer size of the bituminous resource, nothing happened quickly.

It began in earnest in 1949 when Canada's federal government commissioned a report that suggested the oil sands were commercially viable. Capitalising on those findings, in 1953 Sun incorporated the Great Canadian Oil Sands Company (GCOS) as a wholly owned subsidiary and began acquiring patents and leases around Fort McMurray, Alberta.

Separating bitumen from sand was just one part of the process. The other involved converting the raw bitumen into a refinery-ready crude via a process called upgrading. An upgrader is a specialised coker that yields a light synthetic oil comparable in quality to a standard West Texas Intermediate grade.

In 1962, the company received approvals from the Alberta government to build its first 45,000-b/d mine. It's still operating. Technical difficulties prevented construction from starting until 1965 and it was eventually completed at a cost of C$56m ($40.97m)—about C$450m in today's money—including a pipeline to Edmonton. First oil flowed on 30 September, 1967.

The modern era: independence

Suncor's road to independence was a long one. Following the startup of GCOS it essentially remained a branch plant of Sun Oil. The late 1970s and 1980s were a time of growing suspicion of foreign multinationals in Canada's oil patch, and especially the oil sands. The National Energy Program (NEP) of 1980 actively encouraged Canadian ownership, setting an open target of 51% in Canadian hands by 1990.

In response, Sun formed what is now called Suncor by merging its production—including GCOS—with its refining and retailing assets. The move was precipitated by the NEP's so-called "energy wars" between an activist Alberta government which bitterly opposed it, and the rest of Canada, which felt threatened by skyrocketing oil prices following the Arab oil embargo. In 1981 the government of Ontario took a 25% stake in GCOS to hedge its energy costs, transforming the oil sands into a national project.

It subsequently sold that interest in 1993 after oil prices crashed and the NEP was repealed. By then global oil prices had fallen to pre-1980 levels. Sun followed suit in 1995 and Suncor officially became a publicly traded company, listed on stock exchanges in New York and Toronto, although it retained the Sunoco brand in Canada. It had a market capitalisation of C$2.8bn. Today that figure has since risen to C$72bn.

Cost control: retrenchment and re-evaluation

Although Suncor's independence as a Canadian-owned entity was assured, it came at bad time. For the first time in its history, falling oil prices and higher costs threatened to derail the economic viability of the oil sands—a recurring theme that would come to define both the company and the oil sands itself in the modern era.

Even in the 1960s, oil sands were the marginal barrel. Though it was considered a technical success, Suncor's oil sands mine had never turned a profit after more than 20 years in operation. But oil prices had never fallen below the cost of production either.

Once it went public, new chief executive Rick George faced an arduous task of reorganising operations and reducing costs. George, a young engineer and graduate of the Colorado School of Mines, rose through the ranks of Sun Oil, rising to manager of Sun Oil Britain before being appointed Suncor's first chief executive in February, 1991.

After spiking to $25 a barrel in the wake of the first Gulf War the previous year, oil had fallen below $20/b by the time George took over, well below Suncor's cost of production. Investors balked at buying the company's newly issued shares.

George faced a stark choice: either wind down the mine or rebuild it. He opted for the latter, with a bold C$2bn bet—roughly the value of the company at the time—to replace the ageing draglines with the iconic trucks and shovels in use today. In doing so, he set the stage for the massive expansion of the oil sands as competitors adopted Suncor's new operational and business model.

The company doubled down again in 1999 with the addition of its new Millennium mine at a time when oil prices were below $12/b. The Economist magazine infamously predicted they would never again rise above $5/b, earning George a reputation as a contrarian and a gambler.

Buying growth through acquisition: Petro-Canada and Syncrude

George's bets on expansion proved successful, when oil prices closed in on $150/b in the summer of 2008. That all changed barely a year later after the financial crisis, when they fell below $33/b in less than six months, once again plunging below the cost of the company's production and throwing it into crisis mode.

In response, Suncor cancelled expansion projects, including a second $2bn upgrader, while it attempted to ride out the storm. But instead of retrenching, George once again rolled the dice with a C$19bn takeover of Petro-Canada in March of 2009.

Petro-Canada, Canada's state-owned oil company, had been formed at the height of the NEP in the 1980s as a bulwark against foreign acquisition. To win approval, the two companies appealed to economic nationalism, arguing the merger would create a combined C$43bn entity large enough to withstand foreign takeover.

At the same time, it also created the world's largest oil sands producer. Through the deal, Suncor acquired Petro-Canada's 23.9% stake in rival Syncrude and the undeveloped leases at Fort Hills, which will come into production later this year.

In 2016, Suncor increased its Syncrude stake to 54% with the acquisitions of Canadian Oil Sands and Murphy Oil. Including its base mine, the company produced 430,000 b/d of oil sands in the fourth quarter of last year. Fort Hills will add another 194,000 b/d when it is completed later this year. Also in the queue are the 160,000-b/d Joslyn project, in which it owns a 37% interest in partnership with French major Total. (Total shelved the project a couple of years ago.)

Creating economies of scale

The acquisitions added much needed economies of scale to reduce costs. It seems to be working. In its 2016 financials, Suncor reported combined oil sands costs of $24.95/b, down from $28/b the year before.

In its first-quarter results, new chief executive Steve Williams boasted that those costs had fallen to $17 in the first three months of the year. This will be necessary if oil sands are to be competitive in the global market.

The larger question is whether it will be enough, given the flight of majors such as Shell, ConocoPhillips and Chevron from the oil sands in recent months. Again, Williams suggested only tightly focused operators will be able to survive.

"This is a development that we foresaw several years ago, when we first recognised that resource could be more efficiently and effectively developed by companies whose core business was oil sands", he said. "The oil sands business needs focused operators with deep expertise. And we expect the transition to more concentrated oil sands leaders will drive the sector forward and its global competitiveness in the decades to come".

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