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Suncor Weighing Spending Cuts on Oil Discount: Corporate

Suncor Energy Inc. (SU) is considering making an C$11.6 billion ($11.8 billion) oil-sands project the first major spending reduction among Alberta energy producers as the region’s crude prices sink to the lowest in the world.

The oil-sands benchmark, West Canada Select, traded at a record $42.50 a barrel less than U.S. crude on Dec. 14. Canadian companies are forgoing about C$2.5 billion a month because of the lower prices, according to an estimate by Houston-based investment bank PPHB Securities LP. The discount has helped erode Canadian oil profits and hurt companies’ shares.

Lowering production costs is one of the few options available for producers facing shrinking commodity prices, said Barry Munro, Canada oil and gas leader at Ernst & Young LLP in Calgary.

“This year will challenge oil-sands companies,” Munro said in a Jan. 3 telephone interview. “Most executives are coming back to work focused on how to manage a margin that has been severely depressed. That means better cost management.”

Canadian heavy oil is being discounted because of a lack of pipeline capacity to ship increasing volumes of crude to higher- paying markets. The decline has been exacerbated by surging U.S. production from reserves such as the Bakken field in North Dakota and falling demand as vehicles become more fuel efficient.

Steam Tar

Companies have already begun to decrease investment. Suncor, Canada’s largest energy producer by market value, last month reduced its annual capital spending plan to C$7.3 billion for 2013 from an estimate of C$7.5 billion on Nov. 1. Cenovus Energy Inc. (CVE) said on Dec. 12 that cash flow this year will be as low as C$3.1 billion, compared with 2012 guidance of C$3.7 billion, because of lower prices, while Canadian Natural Resources Ltd. (CNQ) expects to reduce spending on its thermal-sands production, a process that warms up bitumen underground.

Canadian Natural, Suncor, Cenovus and Imperial Oil Ltd. (IMO) are among the largest companies that scrape and steam tar-like bitumen from the sub-Arctic reaches of northern Canada. The oil- sands bitumen is then put through machines called upgraders to separate out the sand.

Suncor has said it plans to decide the fate of the Voyageur upgrader project, a joint venture with France’s Total SA that would process 269,000 barrels a day of bitumen, by the end of March. The company is also reviewing its Fort Hills and Joslyn oil-sands projects, Suncor Chief Executive Officer Steve Williams said on a conference call on Nov. 1.

Suncor Options

“It is possible for them to go either together as part of a sequence or for them to be split apart and for one to go and one not to go. All of those options are possible,” Williams said.

Sneh Seetal, a Suncor spokeswoman, didn’t immediately respond to calls seeking comment. Alishia Paradis, a spokeswoman for Canadian Natural, declined to comment. Pius Rolheiser, an Imperial Oil spokesman, declined to comment ahead of the company’s 2012 earnings report.

Suncor’s adjusted per-share earnings fell 9.4 percent in 2012 to C$3.27 and will remain little changed this year, according to the average of 19 analysts’ estimates compiled by Bloomberg. Canadian Natural may report adjusted profit of C$1.62 a share for 2012, a 30 percent decline from 2011, according to the average of 20 estimates.

‘Train Wreck’

“I can’t envision somebody shutting down existing operations in the oil sands,” said Allen Brooks, managing director at PPHB Securities LP. “Might the trucks go a little slower? Maybe. Might they not complete a few wells, that’s the kind of thing. It’s more at the margin.”

Shares of Canadian oil producers shrank last year. The S&P/TSX Energy Index (SPTSX) fell 3.6 percent compared with a gain of 4 percent on the broader S&P/TSX Composite Index in 2012. Canadian Natural fell 25 percent while Suncor bucked the trend, rising 11 percent last year.

Suncor fell 0.3 percent to C$33.83 at the close in Toronto, while Canadian Natural dropped 1.2 percent to C$28.74.

“The revolution in domestic production in the U.S. is obviously a train wreck for most Canadian producers, compounded by the gridlock in pipeline approval,” Chris Damas, an investment adviser at BCMI Research in Barrie, Ontario, said in an e-mail. “I don’t think this has sunk in for most retail, and many institutional investors.”

Pipeline Opposition

Canadian producers are encouraging the construction of new pipelines to reach coastal refineries and overseas markets and relieve a glut of supply that has constrained prices. TransCanada Corp. (TRP)’s Keystone XL pipeline to the the U.S. Gulf Coast and Enbridge Inc.’s (ENB) Northern Gateway project to the Pacific Coast have faced delays because of environmental opposition.

The main U.S. oil grade is also trading lower than global benchmark Brent, due to record production in the country and a lack of pipeline capacity to the coasts. That discount is poised to remain “for years,” keeping a lid on oil prices in Canada that track New York-traded West Texas Intermediate, and encouraging Calgary-based producers to lower spending, said Robert Mark, director and equities analyst at MacDougall, MacDougall & MacTier Inc. in Toronto, which has C$2.5 billion under management.

Brent oil ended the session at $110.61 a barrel today, West Texas Intermediate closed at $94.24, while West Canada Select was at $57.36.

Capital Allocation

“The big companies, when they’re looking at their capital spending for the next number of years, they’re realizing this WTI-Brent discount is not going away and they have to be conscientious with their investors about how they allocate their capital,” Mark said.

Companies with international operations may shift spending to operations that fetch global crude prices, such as Exxon Mobil Corp.’s decision on Jan. 4 to proceed with developing the $14 billion Hebron oil project off the coast of Newfoundland and Labrador, Mark said.

Canadian heavy crude’s discount will affect some companies, including Canadian Natural and Baytex Energy Corp. (BTE), “quite substantially,” said John Stephenson, who helps manage C$2.7 billion at First Asset Investment Management Inc. in Toronto.

“The nitty-gritty is it’s going to impact quite a few producers in the quarter and through the second quarter,” Stephenson, who owns shares of both companies, said by phone. “It’s a huge buying opportunity. These names are dirt cheap and this is going to be one of those great themes for energy in 2013 is just how much that gap closes from its historically high ratio.”

Narrowing Gap

Canada exported C$68.3 billion worth of oil products in 2011, more than the nation’s other main products including vehicles, logs and metals.

Upgrades that will allow the biggest refinery in the U.S. Midwest, BP Plc’s facility in Whiting, Indiana, to take Canadian heavy crude are soon scheduled to be complete and new pipeline capacity to the U.S. Gulf Coast is being added, Stephenson said, predicting the gap between Canadian crude and the U.S. benchmark is set to start narrowing.

Canada’s heavy oil will probably face even steeper discounts in the first half of the year before the differential narrows, PPHB’s Brooks said.

“What you’ve got is this confluence of a weak economy here in the U.S. and continued production growth putting a squeeze on the U.S. market,” Brooks said. “Canada becomes, to some degree, the odd man out.”

To contact the reporters on this story: Jeremy van Loon in Calgary at jvanloon@bloomberg.net; Rebecca Penty in Calgary at rpenty@bloomberg.net

To contact the editor responsible for this story: David Scanlan at dscanlan@bloomberg.net

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