Canadians are a polite bunch. Albertans, in particular, are so polite that we have tolerated the following:
1. A major project (Transmountain pipeline), which was identified as being in the national interests of the country, was blocked by a neighbouring provincial government propped up by a coalition;
2. Foreign-funded groups have been allowed to systematically tarnish the industry’s reputation;
3. A major commodity, which contributes significantly to the national GDP, is sold at a massive spread to what other countries fetch for a similar product;
4. Our province, in the throes of the worst provincial recession in history, receives $0.00 in equalization payments, whereas another province will receive nearly $14 billion.
Now it’s important to highlight that we used the term “tolerated” loosely. People are fed up and have hit a breaking point. Protests have sprung up all over the province, and talks of an Alberta separation have intensified. In other words, the gloves are coming off.
We can (and should) be angry with Quebec for refusing to support Energy East. Under the current equalization structure, Quebec is getting a roughly 20% bump this year, taking them to nearly $14B. The hypocrisy is deafening. Quebec is fine accepting large handouts, they just don’t want to know where the money comes from.
We can (and should) be angry with Trudeau, as his policies have done little to help Alberta. After all, this is a Prime Minister who said oilsands need to be phased out. Not only is the recession in Alberta ostensibly being ignored at a federal level, Bills C-45 and C-69 have the potential to make the situation worse. Trudeau’s proclivity to make decisions at this level suggest he shares a similar sentiment to his father, leading us to believe blood is thicker than oil (not sure if that’s true in the literal sense, but we liked the poetic ring to it).
With neither BC or Quebec supportive of getting Alberta oil to tidewater, the Federal government appears to lack the political appetite in reminding the provinces who the big dog is in the Confederation. Perhaps it stems from the limited seats they expect to win in Alberta next fall. While it is not surprising for a political party to pander to the areas where they expect to have support, it’s a good reminder of what’s at stake in the next election.
Notwithstanding the political road blocks to economic recovery, it’s here where we venture off on a likely-to-be-unpopular tangent. It’s where we introduce the term Vertically Integrated Company. When referring to an oil company that is vertically integrated, it generally means they extract the oil, refine the oil and sell the oil (in the form of gasoline) to the end user.
Suncor, one of a few vertically integrated oil companies in Alberta, does exactly this. They extract crude bitumen from the oilsands, ship it to be refined (at refineries they own in Alberta, Quebec, Ontario, and Colorado), then sell it back to us via Petro Canada (the line of gas stations they also own). They also manage 1,700 km of pipeline. From this perspective, Suncor essentially controls the entire supply chain of oil.
With that in mind, we’re throwing out the idea that Suncor might actually prefer low oil prices.
Why would Suncor prefer lower oil prices?
First, oil companies pay royalties to the Alberta government. The royalty structure is on a sliding scale, so the lower the price of oil, the less royalty they pay.
Second, low oil prices makes it much more difficult for junior oil and gas companies to operate. Less competition is surely a benefit for any company. In fact there’s a history of Suncor supporting ideas which would potentially impact their competition. For example, Suncor publicly supported the provincial government when they introduced a carbon tax:
“We think a broad-based carbon price is the right answer.”
— Steve Williams, CEO of Suncor
Now we’re not going to argue the merits or wisdom of a carbon tax, but one of the ancillary effects of such a tax is that it makes oil production more expensive. This puts a further burden on the industry, particularly those that don’t have the luxury of being vertically integrated.
At the time, MP Michelle Rempel suggested this might allow larger companies, like Suncor, to potentially buy assets from future bankrupt companies at cheaper prices.
Conversely, when the provincial government recently introduced cuts in production, for the sole purpose of increasing oil prices, Suncor opposed it:
“Our position is that government intervention in the market sends the wrong signal.”
— Suncor spokesperson
The reduction in provincial production was implemented for the sole purpose of increasing oil prices, yet Suncor was against it.
In the current environment, low oil prices stifle other producers and limit market supply. Low oil prices also mean less royalties, a fact painfully being displayed by Alberta’s projected $8B deficit this year. Low oil prices are also less relevant to vertically integrated companies where the end goal is to refine it and sell it to the end user.
So how has this strategy played out for Suncor’s stock?
Here are a couple of quotes from recent financial statements / press releases:
“Strong operational performance was foundational to our success in the third quarter, resulting in over $3 billion in funds from operations“.
“Our downstream integration and favourable market access position continue to significantly mitigate the impact of wider crude differentials at Oil Sands. This helped generate significant discretionary free funds flow, which we returned to investors through close to $900 million in share repurchases“.
“Oil Sands operations achieved a new quarterly production record of 476,100 barrels per day (bbls/d)”
Let’s also look at a graph showing Suncor’s performance overlaid against the price of Western Canadian Select over the past five years:
The white line is Western Canadian Select and the red line is Suncor’s stock. It’s fairly clear that Suncor has performed reasonably well, while Western Canadian Select prices have plummeted (note the recent steep incline as a result of the production cuts).
To be fair, Suncor makes a large contribution to our provincial economy. They employee thousands of people, lease a considerable amount of commercial real estate, contribute significantly to the GDP and make meaningful investments in the community.
But they are also experiencing record production levels and profits, so it wouldn’t appear they are allies in the crusade for higher oil prices.
We’re sure living in interesting times. We have a product that contributes to global demand in the tune of 100 million barrels per day, but for confounding reasons the price we are getting in Alberta is being artificially depressed.
Perhaps we’ve just been too polite, for too long.
From the Government of Alberta:
“The ability for royalty rates to change based on the price of oil is sometimes referred to as a ‘sliding scale.’ The government has designed royalty rates to change based on the price of oil, so the risk and reward is shared between industry and government. When prices are high the royalty rates are higher, and when prices are low the royalty rates are lower.
Royalty rate is shown as either a gross royalty rate between 1-9% of gross revenues, or a net royalty rate between 25-40% of net revenues, depending on if the project is pre- or post-payout and the current WTI price in Canadian dollars”
Chad GriffithsPartner, SIOR, CCIM
Chad is a partner with NAI Commercial Real Estate and focuses on the Greater Edmonton area. Chad entered the industry in 2004 and has completed over 400 commercial transactions with clients ranging from small, local companies to large institutional owners. Chad has been a top 15 producer with NAI Canada-wide since 2013.
Ryan BrownPartner, BCom, SIOR
Ryan is a partner with NAI Commercial Real Estate in Edmonton and is currently ranked nationally as one of NAI's top advisors. Having executed in excess of $100 Million worth of sales transactions and over 2 Million square feet of lease transactions, Ryan has developed a firm understanding of asset evaluation and an aptitude for building design, functionality, and long-term practicality.
Darcie is a licensed Commercial Real Estate Agent in the Province of Alberta with a focus on the Edmonton market and its surrounding areas. Darcie accomplishes custom solutions for her clients through her personable nature and results driven attitude. Darcie can help if you are looking to invest in commercial real estate or are looking for representation for a sale or lease transactions.
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