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Suncor doubles down with Canadian Oil Sands takeover

The company’s $4.5bn deal for Canadian Oil Sands makes it the undisputed champion of the oil sands. It’s a big bet on a recovery in prices

Capitulation and retreat: they aren’t kind words but they describe the situation facing Canadian oil sands producers in the face of sub-$30 oil prices. Now the strongest of the plays’ producers has pounced on a rival – and taken a big gamble that oil prices will eventually justify the move.

On 18 January, Canadian Oil Sands, the largest working-interest owner in the world’s largest oil sands mine, Syncrude Canada, finally gave up after a prolonged and acrimonious hostile takeover bid from one of its partners, Suncor. The defeat represented the first major piece of M&A activity in global oil this year, and probably won’t be the last.

After a bitter fight which saw Canadian Oil Sands take Suncor to securities regulators over terms, the two companies at last reached agreement in a now-friendly deal that gives Suncor the prize it was after - Canadian Oil Sands’ sole asset, the 37% interest in Syncrude.

An opportunistic move

Suncor is paying C$6.6bn (US$4.5bn) including C$2.4bn of debt to buy Canadian Oil Sands’ interest in the mine. It’s an opportunistic move that immediately swells Suncor’s reserves base by 3.7bn barrels of proved reserves, not including production. Including undeveloped leases adjacent to Suncor’s own operation, the figure climbs to a staggering 50bn barrels.

Syncrude Canada, with a nameplate capacity of 350,000 barrels a day of light synthetic crude, is a consortium of domestic and international producers, including Sinopec and ExxonMobil. Before the deal Suncor held 15% of Syncrude, a stake it inherited from its acquisition of Petro-Canada in 2009. With Canadian Oil Sands’ interest Suncor’s 49% will give it effective control of the operation.

Suncor also operates its own 300,000 b/d mine directly across the highway from Syncrude at Fort McMurray in northeast Alberta. Assuming the deal closes as planned in February, Suncor becomes Canada’s pre-eminent oil sands producer, with more than 0.5m b/d of mined and thermal production under its belt.

It will control five upgraders capable of converting ultra-heavy bitumen into light synthetic crude that fetches a premium to world prices - almost all of which is exported to the US. It also gains undeveloped leases that extend the life of its existing mine by more than half a century.

The risks are numerous

Suncor is also building the 220,000 b/d Fort Hills mine in partnership with Total, which is scheduled to come on stream in 2017. Once that operation is on line, the company will be an oil sands powerhouse.

That’s a huge, Alberta-sized gamble. As producers of some of the world’s highest-cost crude, oil sands players are limping through the market downturn. The oil sands also face new regulatory risks from parallel federal and provincial climate-change policies. In November 2015 the Alberta government vowed to limit CO2 emissions from the oil sands at 100 megatonnes per year by 2020. Although that allows for a rise of more than 40%, the effect will be to cap production growth at 1m b/d without a quantum leap in emissions-reduction technology.

Then there is the matter of plant reliability. Syncrude, commissioned in 1976, is nearly half a century old. Frequent fires and explosions have reduced output and threatened safety and the environment. Unplanned outages have contributed to Canadian Oil Sands’ poor financial health. According to Barclays, a bank, downtime has kept Syncrude at just 77% of capacity over the past five years. Extensive upgrades costing billions of dollars are required to bring it up to snuff.

Suncor says synergies with existing operations can reduce costs and increase efficiency. It will need to find something to help. Canadian Oil Sands said its operating costs would be $37.14 a barrel in 2016, well out of the money at present prices. Suncor’s operating costs are lower, at $27-30/b – about the same price as WTI in mid-January. But its numbers include un-upgraded bitumen, a lower-quality product that sells at 50% discounts to WTI. On 19 January, this raw bitumen was selling for just $15.67/b.

Long term perspective

So Suncor needs a price recovery to make the deal work. The acquisition looks better in the long term, a perspective that always gives oil sands producers more comfort. Canadian Oil Sands estimated before the deal that it could be profitable again at oil prices of $45/b. In any event, Suncor’s purchase at least allows it to outflank its main rival, Imperial Oil, which owns 25% of Syncrude, and operates it under a management contract with its parent, ExxonMobil.

It’s puzzling that ExxonMobil didn’t make its own white knight bid for Canadian Oil Sands, preferring to stay on the sidelines as it ramps up its own 150,000 b/d Kearl oil sands mine, commissioned in 2014. Certainly, sub-$30/b oil didn’t help. And the value of Suncor’s offer – when measured by how much it was paying for each barrel in the ground – effectively went up as oil prices fell. An added sweetener of 0.39 of a Suncor share was icing on the cake that convinced reluctant Canadian Oil Sands shareholders to accept to the offer.

As Canada’s oldest oil sands operator Suncor has ridden out many downturns since it commissioned its own mine in 1969. Time and the market will decide if its latest move is a bold gambit or a fool’s bet.

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