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Junior fights above its weight class Tenacious UTS Energy faces tough scrap as Fort Hills oil sands project development costs soar 50-60 percent in uncertain times Gary Park For Petroleum News
UTS Energy is a pint-sized company with no cash flow to feed its considerable ambitions and, now, not much support from the investment community to keep its dreams alive.
But it has been down and counted out before.
More than 10 years after Koch Industries, the privately-held energy giant, took its huge war chest to northern Alberta, with plans to spend C$1 billion to produce 60,000-90,000 barrels per day of bitumen by 2004, the Fort Hills project has run the full gamut of oil sands emotions and experiences.
Through a series of ownership changes over the decade, Fort Hills has remained alive, largely through the 2005 decision by Petro-Canada to take a 60 percent operator’s role, and the inclusion of Teck Cominco, the world’s largest zinc miner, later that same year as a 20 percent partner, with UTS clinging to the remaining 20 percent.
For UTS, 2004 and 2005 were turnaround years.
By then Koch, through its TrueNorth Energy unit, called a halt to Fort Hills, with costs rising to C$3.5 billion and concerns about the ramifications of the Kyoto Protocol building.
Given market uncertainties and a risk analysis, TrueNorth effectively bailed out.
Buying out senior partner But UTS saw no reason to quit, with its market capitalization soaring from C$24 million in January 2003 to C$704 million in April 2005 and C$2.27 billion in September 2005. In addition, it hired a new management team with impressive credentials, led by president and chief executive officer Will Roach, whose major project experience included Husky Energy’s White Rose oil project offshore Newfoundland and two projects in the Gulf of Mexico for British-Borneo Petroleum.
Roach was recruited just as UTS pulled off a deal many thought impossible, buying Koch’s 78 percent for C$125 million, plus 7 million warrants.
It also obtained regulatory approval to scale back Fort Hills, add an upgrader to turn 2.8 billion barrels of bitumen into synthetic crude and extend the completion date to 2009. To all intents the venture was firmly on track.
UTS and Teck were so enthusiastic about the oil sands that they embarked earlier this year on planning two new mines costing C$12 billion or more to build, with Roach claiming UTS controlled sufficient resources to produce 150,000-200,000 bpd net to his company.
“If you look at a company of the size and valuation of what I’m talking about, it’s a C$30 billion company in 15 years. It’s exactly what Suncor Energy has done, gone step by step by step, with cash flow supporting each later step,” he said.
But Roach may have overstepped himself. UTS now carries a market value of under C$800 million, and Roach is begging for understanding as the Fort Hills partners grapple with ways to overcome runaway costs.
In mid-2007 they estimated the planned mine and extraction plant in northeastern Alberta and an upgrader near Edmonton would cost C$14.1 billion.
Inflation far outstrips expectations Now the Fort Hills partners figure the first phase, designed to produce 140,000 bpd of synthetic crude within about three years, doubling to 280,000 bpd by 2015, will run to C$23.8 billion and the final costs have yet to be calculated.
The increase stunned analysts, who fully expected a rise, but not on the order of 50-60 percent.
And the fallout has put UTS in the takeover category now that the company is expected to need C$4 billion of financing, double the previous estimate, to retain its place in Fort Hills.
UBS Investment Research analyst Andrew Potter, after factoring in the impact of the cost increase and equity dilution, lowered his 12-month UTS target price to C$4 from C$9.
“Although there is good return potential in UTS relative to current share prices, it is clearly not for the faint of heart – there is little in the way of short-term catalysts other than the potential for a hostile bid,” Potter said.
CIBC World Markets and RBC Capital Markets have both downgraded UTS because of the possibility it won’t be able to finance its part of Fort Hills.
With credit woes turning global financial markets on their heads, the struggles facing junior oil sands players, who rely on capital and equity markets to offset their lack of cash flow, have been compounded.
Tough times for small independents Adam Waterous, president of Calgary-based Scotia Waterous, said independent, small-cap producers will have a tough time keeping their independent status as the credit crisis increases the pressure on small companies to consolidate.
Michael Tims, chairman of investment dealer Peters & Co., told the Calgary Herald that oil sands developers will be forced to look at financing alternatives as investors weigh project costs against commodity prices, the cost of equity and the cost of debt.
Michael Borrell, president of Total E&P Canada, the Canadian unit of France’s Total, shared the sentiment that the oil sands will increasingly be dominated by major companies.
“My own view, and you can look at the Petro-Canada numbers, is that the oil sands is a game for larger, solidly-based organizations and that will likely be the case going forward,” he told the Financial Post.
“These are large, complex projects with huge investment levels, and you need a certain size to be able to carry those investments,” Borrell said.
He said there has already been a degree of consolidation in the sector, with a number of international companies, including Total, entering the oil sands through acquisition.
“Total is convinced there is value in the oil sands, and it is the sort of opportunity that is attractive to a company like ours,” Borrell said.
The updated Fort Hills numbers translate into a capital cost of C$181,000 per flowing barrel, according to UBS. That’s greater than Roach’s estimate of C$160,000-C$170,000, which he said would yield a netback within five years of oil prices averaging about $100 per barrel and within 10 years with oil at $80 per barrel, assuring UTS of free cash flow for 30-40 years.
Potter said new mining projects need oil selling for more than US$100 to turn a decent profit.
“Producers will have to defer projects to get a handle (on rising costs),” he said. “You’ll probably also see more joint ventures with U.S. refiners because that is probably still a cheaper alternative to building an upgrader in Alberta. You may see more bitumen-only projects go ahead and you will see some corporate consolidation.”
Costs could trigger deferrals National Bank Financial Senior Vice President Peter Ogden said in a recent report the capital costs of new oil sands mining operations are C$125,000-C$160,000 per flowing barrel. He said the break-even price is now US$85 per barrel, assuming an 8 percent rate of return, capital costs of C$120,000 per flowing barrel and operating costs of C$27 per barrel. While not expecting immediate project cancellations, he said a drop in oil prices could cause the deferral of marginal projects.
FirstEnergy Capital analyst William Lacey said the U.S. banking crisis will make it tougher over the near term for developers to raise the C$170 billion worth of capital needed to keep projects on track over the next decade.
In making a rare public plea for market understanding, Roach said prospective lenders should base their decisions on project longevity rather than the current price of oil.
“If you look only at today’s oil prices, you go nuts,” he said.
He argued that the intrinsic attraction of oil sands assets is why major companies are still taking positions in the resource.
But that appetite will not sway UTS to sell its estimated contingent resources of 1.4 billion to 1.7 billion barrels – with 300 million-600 million barrels at Fort Hills and the rest at its joint Equinox and Frontier leases with Teck Cominco.
Divesting any part of Fort Hills “is not on the table – we want the right project at the right cost, so selling now is probably the wrong thing to do.”
The next few months, leading up to a final corporate investment decision on Fort Hills – which could see a deferral of the planned upgrader, now budgeted at C$9.9 billion – will tell whether UTS can succeed or become a footnote in oil sands history.
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