Suncor Energy: It Is Not The Right Time To Buy

Suncor Energy (NYSE:SU) is a prominent energy company operating in Canada and the United States. Their operations include oil sands development, production and upgrading, offshore oil and gas, and petroleum refining. In line with its commitment to developing sustainable energy resources, the company is investing in power, renewable fuels, and hydrogen to transition towards a low-emissions future. The company has been able to improve its upstream and downstream operations in the past few quarters, and based on its planned maintenance & increasing upstream and downstream capital expenditures, the company’s capacity for higher oil sands production and higher refining and processing volumes may increase significantly in the following quarters. However, based on the current crude oil prices, and current gasoline and diesel crack spreads, representing a significantly weaker energy market compared with a year ago, Suncor’s developments seem to be ignored by investors. We cannot expect crude oil prices to jump to their levels a year ago, and it is not wise to decide on buying SU’s stock just based on crude oil prices. But the fact is that with the current economic outlook that prevents oil price increases, Suncor’s financial results may not be attractive to investors. With Brent crude oil prices of about $85 per barrel, Suncor Energy can show the market how its recent upstream and downstream developments can affect its operating earnings. However, with the current crude oil prices, the company’s operating earnings won’t be attractive enough to gain the attraction of investors in our view.

Suncor financial outlook

As we are all aware, the oil industry is notoriously volatile, with revenues and profits fluctuating frequently. Therefore, it is crucial to consider shareholder return strategies for companies in this sector. Suncor Energy has consistently increased its investors' returns through share repurchases and dividend payments. Over the past year, they have raised their dividend payments every quarter from $0.42 per share in 1Q 2022 to $0.52 per share in the latest quarter, except for the first quarter of 2023 compared to the end of 2022. This has resulted in a dividend yield of 5% in TTM, which is appropriate (see Figure 1).

Figure 1 – SU’s shareholders returns

Suncor's 1Q 2023 results were weaker than in 1Q 2022, primarily due to lower prices of oil. Despite this, the company was able to provide significant value to shareholders, totaling $1.6 billion. This value was driven by $874 million in share repurchases and $960 million in dividends. It is important to note that Suncor's management prioritizes share buybacks as a key strategy for delivering profits to investors. Additionally, they are focused on strengthening their balance sheet by improving their leverage conditions, as evidenced by their efforts to decrease net debt from $12.3 billion in 1Q 2022 to $11.6 billion at the end of the prior quarter. In the current global economic climate, characterized by the aftermath of the pandemic and rising interest rates to counter inflation, it is imperative to focus on companies with strong balance sheets. To ensure investor returns and mitigate future risks, the management team has established a minimum debt target of $9 billion. Once this threshold is achieved, all excess capital will be directed toward shareholder returns. As long as their debt levels remain within the range of $12-$15 billion, they will allocate 50% of any additional capital towards share buybacks and the remaining 50% towards deleveraging efforts.

The market outlook

As a result of low economic growth in the past year, which meant lower crude oil demand, oil prices decreased. According to Figure 2, Brent crude oil prices decreased by 35% in the past year to $76 per barrel. OPEC+ tried to support oil prices through various announcements of production cuts. Most recently, Saudi Arabia announced it will cut oil production by 1 million barrels per day in July 2023. Also, other OPEC+ oil producers agreed to extend earlier production cuts within the next 18 months.

However, it seems that the shadow of economic fears, high interest rates, and potential financial instabilities in Western countries, combined with a higher global supply of oil due to higher production levels in North America, may not let oil prices increase significantly. A few months ago, after the sudden reopening of China, there were predictions about higher crude oil prices. However, it seems that the reopening of China only prevents crude oil prices to decrease to below $70 per barrel. In its June 2023 report, The World Bank increased its China growth forecast to 5.6%, up by 1.3 percentage points from its January forecast. Also, The World Bank increased its forecasts for the United States, Euro area countries, and Japan’s 2023 real GDP growth rates (see Figure 3).

Overall, The World Bank increased its projection of the 2023 global real GDP growth of 1.7% in the January report to 2.1% in the June report. However, The World Bank revised down its projection of the 2024 real GDP growth from 2.7% in the January report to 2.4% in the June report. Even China’s real GDP growth in 2024 is not expected to be as high as it was projected in The World Bank’s previous report. However, overall, the world’s real GPP growth in 2024 is still expected to be higher than in 2023 and is expected to increase further in 2025. It means that the demand for crude oil in the second half of 2023 is still expected to be higher than in the first half, and is still expected to increase further in 2024 and 2025; however, not as high as was expected 6 months ago. The reason is that the tight monetary policies of monetary authorities to combat inflation are continuing, and even might get tighter, resulting in tighter credit conditions. In its short-term energy outlook, the EIA forecasts the average Brent crude oil price to be $79 per barrel in 2H 2023, then increase to $82 per barrel in 1H 2024.

Figure 2 – Brent crude oil prices

Figure 3 – World real GDP growth projection

Segment results and outlook

According to Figure 4, in the first quarter of 2023, Suncor produced 675.1 million barrels of oil sands per day ((mbbls/d)), compared with 685.7 mbbls/d in 1Q 2022. As oil prices dropped from 1Q 2022 to 1Q 2023, Suncor’s oil sands price realized price decreased from $110.27 per barrel in 1Q 2022 to $86.71 per barrel in 1Q 2023. Moreover, due to decreased energy prices, the company’s refinery utilization decreased from 94% in 1Q 2022 to 79% in 1Q 2023, resulting in significantly lower refinery crude oil processed in the first quarter of 2023. Suncor’s refinery crude oil processed decreased by 16% to 367.7 mbbls/d in 1Q 2023.

In 2Q 2023, crude oil prices were lower than in 1Q 2023, and are not expected to increase by the end of the year. Also, it is important to know that as in 2Q 2022, crude oil prices reached very high levels, crude oil prices in 2Q 2023 might be 30% lower than in 2Q 2022. Also, on average, refiner prices in 2Q 2023 were lower than in 1Q 2022, and are expected to decrease further.

In 1Q 2023, the company’s oil sands segment and refining and marketing segment’s operating earnings accounted for 87% of the company’s total operating earnings. Figure 5 shows a bridge analysis of adjusted operating earnings of Suncor’s oil sands segment (up), and refining and marketing segment (down). Despite slightly higher sales volume (in spite of lower production volume), Suncor’s oil sands segment’s operating earnings decreased by 34% YoY to $1490 million in 1Q 2023, driven by significantly lower price realization. In 2Q 2023, the company’s oil sands price realization may be lower than in 1Q 2023 and is expected to be considerably lower than in 2Q 2022.

Thus, the company’s oil sands segment’s operating earnings in 2Q 2023 may be lower than in 1Q 2023 and is expected to be far lower than in 2Q 2022. However, it is important to know that due to recent acquisitions and developments, such as the acquisition of an additional 14.65% working interest in Fort Hills and the completion of turnaround activities at Syncrude, Suncor’s oil sands production and sales volumes in 2Q 2023 may be higher than in 1Q 2023 and 2Q 2022. But I estimate the negative effect of lower crude oil prices entirely offset the positive effect of higher production and sales volumes by the end of the year.

Also, driven by lower refinery production, and lower FIFO inventory valuation and commodity risk management, partially offset by higher refining and marketing margin, SU’s refining and marketing segment’s operating earnings in 1Q 2023 were 28% lower than in 1Q 2022. Due to the company’s recent developments, its refinery production in 2Q 2023 may be higher than in 1Q 2023 and 2Q 2022. Also, I expect Suncor’s refining and marketing margins in 2Q 2023 to be higher than in 1Q 2023. The company’s significantly higher refining and marketing margins in 1Q 2023 were linked to higher gasoline and distillate benchmark crack spreads, reflecting a tight supply-demand balance. Figure 6, shows motor gasoline crack spread in the second quarter of 2023 was higher than in the first quarter. However, we can see that the motor gasoline crack spread in the second quarter of 2023 was significantly lower than in the second quarter of 2022.

Figure 4 – Suncor’s production and processing volumes

Figure 5 – Bridge analysis of adjusted operating earnings of Suncor’s oil sands segment (up), and refining and marketing segment (down)

Figure 6 – Motor gasoline crack spread

End note

Suncor Energy’s recent developments and planned maintenance mean that the company’s production, refining, and processing capacities are improving. With higher crude oil prices, Suncor Energy may be able to report strong financial results that can be beyond investors’ expectations. However, with the current crude oil prices, that are not expected to increase soon, SU is a hold.