Oil Giant Comparison: BP vs Suncor

This month in our comparison series, we look at a legacy European oil and gas company, BP (NYSE:BP), and a Canadian heavy oil producer, Suncor Energy, (NYSE:SU). These two companies have a similar stock price and dividend yield, giving potential investors a bit of a conundrum as they look for places to grow wealth. In this article, we will try and clarify the likely arc the stock price of the two companies will take if oil prices reverse their present course, and head back toward $100 bbl as the year closes out.

The true tightness of supply is lost in the wall of worries occupying the market presently. I think the stage is set for them to resume front and center status as the SPR releases wind down this fall.

First, we will look at BP and close out with SU.

BP

BP's stock has traded in a fairly tight range of $28-$32 per share for about a year now, despite briefly nudging $34 in June. The company is flush with cash and recently raised its dividend and announced a share buyback. As an investor, I am more interested in the dividend than the share buyback. With nearly 20 billion shares outstanding, it’s going to be a while before share buybacks have much of an impact. Although, it can be argued that with the company’s absurdly low cash flow multiple, the company is making a shrewd investment. It can also be argued, from the stock’s weak connection to upward oil price movements, that it is dead money.

Marketwatch

I have looked at the company through a fairly harsh lens in the last couple of years, calling them uninvestable due to their ESG messaging. For the purpose of this review, I am at least considering revising that stance for their income potential, but don't see them as a growth play. I will explain as we develop the thesis for the company. At a high level, significant growth has managed to elude the company for the entire year, leaving them about 15% above where they started out in 2022. Most of that occurred in the January spike to $32 and it's been range bound largely ever since. This week’s market action took them to the lower bound of that range.

2022 has been a time when the share prices of many E&P companies have doubled and tripled with rising oil prices. So clearly, I am not the only Doubting Thomas poking them with a stick for signs of life. One of the metrics I use to gauge the health of an oil company is its reserves. You can see that for the last three years it has fallen as capex has been restrained for new upstream development and diverted toward ESG friendlier sources. Wind, Solar, and Hydrogen have all absorbed big chunks of BP’s capex budget as the company sought to accelerate its move away from petroleum.

I expect this trend to continue for 2022, although we won't get a firm grip on that until next year when they publish their annual report.

Quarterly production of 2,198 mm BOEPD was down from the prior quarter of 2,252 mm BOEPD, and down still further from Q-4, 2021-2,332 BOEPD. So the trend is not their friend as regards production. This is in spite of splashing a couple of new projects in GoM this year - Herschel, and Mad Dog Phase II intended to deliver ~140K BOEPD.

But there is that tasty dividend which BP has forecast to grow 4% annually-at least. The question before us is, is it sustainable?

The thesis for BP

The company is a legacy oil and gas producer that has fallen down what I like to call “a green rabbit hole” in recent years. The company is planning to purposely produce less oil and gas in the coming years as they transition to clean energy. All of that said, they refer to their oil and gas production as "Resilient Hydrocarbons," perhaps meaning their oil and gas projects are so robust that they will have a long life cycle. EVP of Production for BP, Gordon Birrell commented on the BP webpage-

“So, we plan to reduce production by 40% by 2030 and create a resilient, lower cost and lower carbon oil, gas and refining portfolio that is smaller but of the highest quality, giving us the cashflow we need to help fund our transition to an integrated energy company.”

The bet the company is making is by 2030, they can replace the revenue and profitability that hydrocarbons have brought, with revenue from wind farms, solar farms, hydrogen production, and biofuels. This is all untried territory for the company and investors can be forgiven for being wary. Bernard Looney, CEO noted that they planned to deliver $2 billion in EBITDA from these sources by 2030, leveraging their 20000+ retail sites.

“Here, we aim to deliver around $2 billion of EBITDA by 2030, focusing on fleets and focusing on fast charging to on-the-go customers.”

For the time, BP is generating massive amounts of cash quarterly. Gas and Low Carbon Energy contributed $6.1 billion toward the $12.1 billion total for the quarter. They don’t break out current revenues from Low Carbon Energy. This is the cash they are using to pay down debt, fund a share buyback scheme, increase dividends, and invest in energy transition projects and at the very least, Resilient Hydrocarbons.

It should be noted that BP is a heavy hitter in natural gas and the company views natty as part of the energy transition. BP has made some major investments in LNG, notably in West Africa with its buy-in of the Greater Ahmeyim Tortue project offshore Senegal and Mauritania. Phase I is forecast to produce 70K BOEPD, with potential (now FID review) for Phase II. It should be noted that it's not all sunshine and daffodils on this project. The recent typhoon-Muifa, tore the Gimi FLNG vessel loose from its moorings. Details are sketchy at this point, but if this vessel has sustained significant damage, the project will be further delayed.

BP is also divesting its stake in the Sunrise oil sands project, wanting to disassociate itself from this resource as it does fit into its clean energy profile. This is a cash and exchange deal with Cenovus Energy, (NYSE:CVE), with BP taking on the Bay du Nord project offshore, Eastern Canada.

In summary, BP's Resilient Hydrocarbons business certainly has staying power, subject to oil prices to support the initiatives we've discussed above. There are some risks and caveats that we will cover when we wrap up and make a recommendation.

Suncor Energy

In Suncor Energy, (SU) we have another company producing low decline heavy oil in the Canadian Western Canada Sedimentary Basin-WCSB. It has grown EBITDA from 1.1 billion in Q-4, 2020 to $5.9 billion in Q-2, 2022. Production has declined slightly over the same period, due to sharp capex reductions in the depths of 2020 shutdowns from 767K BOPD to 720K BOPD. Management has guided toward YE 2022 exit production rates of 760-795K BOPD, a boost of about 9-10% from current levels.

In contrast to BP, Suncor has a primary focus on oil production from its key production areas discussed in the slide below. It also produces significant amounts of oil from its offshore interests in the East Coast Canadian field and a couple of North Sea fields. It has definite plans for growing its petroleum output as world oil prices allow. One offshore field, Oda in Norway is set for divestiture later this year, $400 mm. It has a small footprint in Wind in three projects across southeastern Alberta province, but in April listed these for sale. It plans to invest proceeds in hydrogen and renewable fuels projects. I am going to reserve commentary about this directional shift, the core thesis for SU lies in its heavy oil production.

Note- prices for SU are in Canadian dollars unless noted.

The Thesis for Suncor

The case for heavy oil has been made countless times, but we will touch on it just for grounding. U.S. refineries now standing were built to process in the 1970s to process the heavy crude that came largely from Mexico and Venezuela. Note their concentration on the Texas-Louisiana Gulf Coast. Circumstances in these countries have changed in the intervening time but the limitations of these refineries have not. There are several reasons Canada is our top import country-they have what we need, and pipeline access infrastructure is robust from Canada's oilfields to the Midwest and Gulf Coast.

Shale oil is light, generally high 40's API gravity and above. To run efficiently our Gulf Coast refineries need that heavy crude that the Canadian oil sands provides.

A point we've made many times in conjunction with oil sands and syncrude discussions is the low decline aspect of these fields. Typical output isn't what we expect from shale wells, but the decline curve is much lower, leading to lower well costs and high capital efficiencies. This is particularly true with the Steam Assisted Gravity Drainage-SAGD reservoirs in the Firebag and McKay River fields. In Mining, the big capital costs have largely been written off in prior years, providing another boost to capital efficiency. The slide below compares this output against production from other fields.

Something I harp on constantly is the value of installed infrastructure. You can't build anything - exaggerating here, but just a teensy bit - in America any longer. Permitting of even the simplest dirt-moving project takes years, and the outcome is delayed by endless lawsuits from the environmental and anti-development crowd. Just recently a U.S. Senator “sold his soul”, as noted by the linked article, to get the Mountain Valley Pipeline through the permitting process. The odds are against this going through, which will leave Senator Manchin between a rock and a hard place with respect to his constituents. The Wall Street Journal commented-

“The bill makes no substantive changes to the National Environmental Policy Act, Clean Water Act, Clean Air Act, and Endangered Species Act that let opponents delay projects for years. Mr. Manchin had political leverage, but the bill shows he traded his vote on the cheap.”

WSJ

That means that infrastructure that's already in the ground has value in that light. You can see Suncor has significant processing, transfer, and refining capacity in North America. It could not be built today. 

Q-2, 2022

Suncor's total upstream production was 720,200 barrels of oil equivalent per day (boe/d) in the second quarter of 2022, compared to 699,700 BOEPD in the prior year's quarter. Production was aided by a ~50K BOEPD increase that offset lower output at oil sands from turnaround activity.

Adjusted funds from operations increased to $5.345 billion ($3.80 per common share) in the second quarter of 2022, compared to $2.362 billion ($1.57 per common share) in the prior-year quarter. This was the highest in the company's history. For the past year the company has generated ~$10.5 in AFF, paid down ~$1 billion in LT debt, and bought back 88 mm of its common shares, at about $40 per share and reducing the share count by about 8%. It paid $657 mm in dividends at $0.47 per share, an increase of $0.11 CAD from the prior quarter.

Capex runs about $1.2 a quarter, slightly higher due to inflationary pressures, but is still covered, along with dividends and share buybacks by AFF.

A potential catalyst

The sale of PetroCanada's 1800 fueling stations, could lead to a nice investor payday down the road. The article notes that the sale of this asset would yield a windfall of between $5 and 8 billion. SU has picked up an activist investor-Elliot Management, which is looking to drive change in the company and boost shareholder value. The company has forced a change in management at the top with former CEO Mark Little being replaced by another long-time SU insider, Kris Smith on an interim basis. This is an open question right now, so we will just note the possibility and wrap up.

Your takeaway

BP is trading at about 2X EV/OCF on a one-year run rate basis, an absurdly low valuation, and one that you would think would push the company higher. I have no good explanation for this lack of growth, other than the ESG messaging of the company. Which is essentially they are going to diminish production of the primary source of their revenue and profits, to enter a new business for which they have no demonstrated proficiency. The resistance to the upward pressure the oil price has put on energy stocks writ large is telling us something. Perhaps we should continue listening. 

On the plus side, there is little risk in BP shares at current prices, absent a complete collapse of oil and gas. Dividends are not guaranteed as they are authorized every quarter, and when oil prices decline oil companies are notorious-with a few exceptions, like Chevron, (NYSE:CVX), and ExxonMobil, (NYSE:XOM), for cutting them. This was the case with BP in Q-1, of 2022 where the company cut the dividend by 50%. The point here is, as I have noted I don’t think dividends alone constitute an investment thesis. You need for your capital position to grow, and as we have discussed BP has stayed in a tight range. Even with their ridiculously low cash flow multiple, I can’t think of a catalyst now on the table for that to expand, providing capital appreciation in addition to dividends.

A couple of recent events may also prove to be a drag on BP’s shares. The previously mentioned, but unknown impact of any damage to the Gimi FLNG, scheduled to begin operations next year is a billion-dollar question mark. Until more is known it will be hard for shares to do much. Then there is the sale of BP’s Husky Refinery in Toledo, Ohio. A fire last week killed two people working there. The refinery is shut down and an investigation is underway as to the cause. At the very least there will be a direct impact on earnings. There is also the potential for bad PR. BP has a history of refinery trouble and has paid big fines and enormous settlements in the past. The sale could also be jeopardized, although that’s an unlikely outcome as it was to their JV partner Cenovus. On to Suncor now.

Suncor on the other hand has also drunk from the ESG cup with its move into wind farms (now pivoting toward biofuels and hydrogen). What is a substantial difference between the two companies is SU’s commitment to growing production in their core operating areas. They are doing it as we've discussed above. I've often said that companies should figure out what they do well and then ask for my money. In my opinion, SU is doing that.

SU is trading at just under 5X OCF, so not as good as BP on that score, but still in a competitive range for its class. What tips the scale to SU is the ability it’s shown to respond to the trend of rising to higher multiples with the oil price. Suncor at its current price has a dividend yield of nearly 6%, a third better than BP.

SU is lowering break-even forecasts through 2025. Currently, at around $30 a barrel, which is already slightly below industry standards, they are targeting further declines toward the middle $20s in a few years. This is critical as WCS differentials (shipping costs essentially) can vary from $10-$20 per barrel. Keeping those lifting costs down can make the difference between making and losing money.

The risk for SU is that 5X multiple being compressed still further with the weakness in oil prices, or the WCS differential. If continued adverse price movement in oil continues, investors might consider an entry point slightly below the current range, subject to their own risk profile.

Bottom line, SU has demonstrated the ability to rise with oil prices and offers an excellent yield on cost at current prices. The company is aggressively buying back shares, and at current rates (which we hope will be pursued at current prices), the company could go private in a dozen years. With its long-lived assets (approx 30 years), that's 18 years of cash flow for the price of 12. That is a very attractive prospect that could deliver huge returns a few years hence. With 20 billion shares outstanding, BP investors have no prospect of ever seeing a return of that caliber.

If oil prices resume climbing as the year closes which many pundits predict based on supply constraints, SU stock should rerate higher. In June the company was commanding a multiple near 6X, and it doesn't seem like stretch for it to return to that level. For reference, competitor Canadian Natural Resources, (NYSE:CNQ) is trading 4.2X OCF. In June it touched 6.6X, meaning that SU’s multiple is quite reasonable as are prospects for its uplift if my thinking about oil prices pans out.