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Richard George of Suncor Energy: Floating on a sea of sand

Richard George of Suncor Energy: Floating on a sea of sand Despite almost doubling profits in 2002, Suncor is not a "punter's stock," says its CEO.

With growing prospects for war in Iraq and disruptions in the oil supply from Venezuela, the price of benchmark West Texas intermediate crude oil, or WTI, topped $37 per barrel in mid-February, up more than 90 percent from $19.40 in January 2002.

For Calgary-based Suncor Energy, times couldn't be better. Since 1967 it has been developing the vast oil-sand deposits in northern Alberta. The province boasts a staggering 2.6 trillion barrels' worth of oil-soaked sand. More than 300 billion barrels -- far exceeding the proven reserves of Saudi Arabia -- are recoverable using current technology. Suncor owns rights to 13 billion barrels of these reserves. Its only -- and slightly larger -- rival, Syncrude Canada, is a consortium of nine companies.

Still, when Sun Oil Co. (now Sunoco) sent Richard George north as chief executive of Suncor in 1991 after four years as head of Sun Oil Britain, it didn't seem like a promotion. "There was a lot of trepidation," George admits. "It was a huge turnaround task."

With no exploration, separating oil from sand is essentially a manufacturing process -- but the costs at the time were uneconomically high. The tarlike oil, called bitumen, must be extracted, then purified, to produce a light crude oil. In 1992, after years of losing money in Canada, Philadelphia-based Sun, which owned 75 percent of the operation, decided to bail out. It spun off its Canadian company, which aside from the oil extraction business included a marginal natural-gas operation and a retail network of gasoline stations. Sun and the province of Ontario, which owned the other 25 percent, sold their shares to the public, exiting completely in 1995.

These days, however, George, 52, has reason to smile. This year Suncor hopes to lower the cost of extracting a barrel of oil to C$10 ($6.50), competitive with the exploration and extraction costs of drilling. It has just completed a C$3.4 billion expansion project that will yield 225,000 barrels a day and is engaged in new expansion projects that will double production by 2012. Every dollar increase in oil prices now goes straight to the bottom line. As a result, net income almost doubled in 2002, to C$761 million, or C$1.64 per share, from the record of C$388 million in 2001. Suncor's Toronto and New York Stock Exchange­traded stock price is up 12-fold since 1992 (up 10 percent the past year in a market down almost 30 percent), to more than $17. Its market capitalization of $7.8 billion is more than triple the $2.4 billion of its erstwhile U.S. parent.

Originally from Brush, Colorado, George became a Canadian citizen in 1996. He has a BS in engineering from Colorado State University and took the midcareer program for management development at Harvard Business School. George discussed Suncor's prospects with Institutional Investor Assistant Managing Editor Subrata N. Chakravarty.

Institutional Investor: It seems Sunoco did Suncor a favor by cutting you loose.

George: Sometimes it's the second owner of the golf club that makes the money. We've taken Suncor from, in Canadian dollars, a $1 billion company to a $12 billion company in market cap. It's actually had a track record way above even Exxon or BP.

Why the big difference in performance?

Suncor's strategy is less like an oil company -- although we are an oil company -- and more like a manufacturing company, where we use technology to increase production and reduce cost. Canada has a huge reserve base. There's more oil in the oil sands in Alberta than there is in all of Saudi Arabia. The issue is that it is heavy oil. On the other hand, we're close to the largest market in the world. By direct pipeline we ship to south of Chicago as well as the Rocky Mountain region. Right now there are two oil-sands operations: Syncrude, which has nine owners, and Suncor, which owns 100 percent of its operation. Shell just put about C$6 billion into a project that'll start producing this year. This is getting to a size and scale that's important for the U.S., with no finding costs and no decline rates. You know, the conventional oil-gas player, the first year that he puts a field on stream is his best year; after that he fights decline rates.

How do you cut production costs?

Technology. Every time we invest we look at new technology to reduce cost. In the original mine we used bucket wheels that sat at the mine base and rotated. In 1993­'94 we switched to truck and shovel. We used to convey all this ore from the mine face to the processing plant by conveyor belt. Today that's all done by hydro-transportation, where you dump it in a warm-water slurry and pump it over. So this is actually the low-cost supply of crude oil in North America -- if you look at the total cost of Gulf of Mexico oil, on exploration, development, production -- because we have no exploration costs.

But the costs in the Middle East are still lower?

If you look at production costs around the world and put them on a curve, there's an S-type curve. Saudi Arabia, Iran, Iraq are all about $2.50. We're currently sitting at about $8.00. What you're doing every day is trying to get down that curve to widen your margin. We're far enough down this curve that even during that price collapse that we saw in 1997­'98, our earnings and cash flow held up very well. And because we're not out exploring, I think we're actually able to withstand downturns better than a conventional player.

How is oil extracted from oil sands?

In very simplistic terms, oil seeped into the sand many millennia ago. Around each sand molecule there is a thin layer of water. In the void-spaces between sand grains is oil. We dig it out, add steam and hot water, and the whole thing starts to break apart. We put it into the settling tank. The crude oil floats on the top; we have a warm-water layer and then a clean sand that looks like a beach sand. We take that very heavy oil, called bitumen, and upgrade it.

Your stock has performed very well, but it's still selling at a low multiple of earnings. Why do you think that is?

Well, we just finished a major expansion. I think that the market's saying, "We want to see these guys really get these assets running." And they are running well. Last month we averaged 225,000 barrels a day, which was the designed capacity. But Suncor is not the kind of stock that you should be a punter on. We do a lot of hedging. We have ten years of construction projects ahead of us to go from now at 225,000 to more than 550,000 barrels a day. What we want is very steady, growing earnings and cash flow to afford this construction to continue to grow.

Oil companies have been chasing reserves for years. Are you concerned that someone could acquire you for reserves?

Listen, it's always on the radar screen. I don't lose a lot of sleep over it because I can't control that. Our job is to make that process, if it ever were to happen, as painful a process as possible. The challenge to our organization is to continue to perform in the way that we have.

What about future technology?

Right now we are about 30 percent done on construction of the first stage of what we call "firebag," an in situ technology. We put in two long horizontal wells that go out more than a kilometer in length. One is right at the base of the oil formation, and the other is about six to eight meters above it. We inject steam in the top and take heavy oil out at the bottom. So we'll do this without the open pit mining system. Our current estimate is that we can do this up to C$1 cheaper than open pit mining.

Will production keep increasing?

By the beginning of the next decade, you'll see well over a million barrels, close to 2 million barrels a day.

Talk about your hedging policy.

Largely, in the past two years, what we've used is costless collars. We lock in a floor at roughly $21 or $22 WTI and then share some of the upside. We put some on recently at a floor of $22 WTI, and the ceiling was about $27 or $28. If it's anywhere in there, it doesn't cost us anything and it doesn't cost the person on the other side of the transaction. When a crude oil goes below $22, we get a $22 price; when it goes above $28, that person gets the upside. If you think about it, a $22 WTI is about C$35 a barrel. Our operating costs last quarter were C$12 a barrel, and we're hoping to take it to C$10. That still leaves you with more than a C$20 margin. What product in this world can you produce with a C$20 margin? So it allows you to get out of the cycles. I'm not trying to tell you that it hasn't cost us money, because it has, but I think about it in terms of building a company as opposed to taking the swings. Again, it's not a punter stock.

©Copyright 2003 Institutional Investor, Inc.

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