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Cenovus Gives Safest Oil Sands Returns on Low-Cost Growth

08 May 2012

Cenovus Energy Inc. (CVE) had the best risk- adjusted returns among Canadian oil sands producers since it started trading 29 months ago, as the company controlled costs while expanding crude production.

The BLOOMBERG RISKLESS RETURN RANKING shows Cenovus, the fifth-largest oil-sands producer, returned 1 percent when factoring in price swings since the company was spun off from Encana Corp. on Dec. 3, 2009. That’s the highest among peers including Suncor Energy Inc. (SU), the largest producer. The Calgary- based company also beat Western Canada Select, the crude derived from Alberta bitumen that trades near a record discount to the U.S. benchmark.

Cenovus uses steam generated by burning natural gas to melt the tar-like bitumen for easier extraction, a cheaper, less labor-intensive method than traditional processes, making it the most profitable in the industry. The stock may continue to reward investors looking to minimize risk in their portfolios while taking advantage of potential for growth from Canada’s oil sands producers, said John Stephenson, who helps manage C$2.7 billion ($2.73 billion) at First Asset Investment Management Inc. in Toronto and holds Cenovus shares.

“They’re well-prepared for the next few years because they can supply their own natural gas and they have one of the best reservoirs in the business,” Stephenson said in an interview.

Beating Imperial, MEG

Imperial Oil Ltd., Canada’s second-largest oil producer by market value, came in second place with a risk-adjusted return of 0.6 percent. MEG Energy Corp. (MEG), at one-third Cenovus’s market value, ranked third among major Canadian oil producers with a return of 0.4 percent.

Cenovus provided higher total returns than Western Canada Select while remaining a third less volatile than the benchmark crude, which fluctuated between $45.80 and $98.18 during the period.

“Cenovus’s oil-sands asset base is among the lowest cost, so the value of the asset just doesn’t swing as much with oil prices or oil-price expectations,” said Randy Ollenberger, an oil and gas analyst at BMO Capital Markets in Calgary.

The most expensive part of the method used by Cenovus, known as steam-assisted gravity drainage, or SAGD, is natural gas, which has been trading near 10-year lows since the beginning of the year. That contrasts with mines owned by Suncor, Canadian Natural Resources Ltd. (CNQ) and Imperial, where labor is the biggest cost.

Highest Gross Margin

Cenovus’s cost-control strategy results in the highest gross margin in the industry, at 91.8 percent compared with 40.5 percent at Suncor and 16.4 percent at Exxon. That means Cenovus turns C$100 of sales into C$92 in profit.

“They’re taking $2 gas and converting it into $100 dollar oil,” said fund manager Stephenson. “That’s a pretty good deal.”

Canada has the world’s third-largest recoverable crude reserves after Saudi Arabia and Venezuela, and the commodity is the nation’s most valuable export worth about C$52 billion in 2010, according to the most recent figures available by Statistics Canada, the government statistics department.

This year through May 3, Cenovus produced a total return of 1 percent while being 15 percent less volatile than the average of the largest oil sands producers, placing it fifth by risk- adjusted return. Nexen Inc. (NXY), more volatile than the average but with the best returns, is the best performer. Nexen’s shares sank 29 percent in 2011.

Refining Hedge

Cenovus’s heavy-oil processing partnership with U.S. refiner Phillips 66 (PSX) also gives the company a hedge against swings in the price difference between heavy oil-sands crudes and lighter varieties, said BMO Capital’s Ollenberger.

The Canadian company is part owner of the Wood River, Illinois, and Borger, Texas, refineries, which turn bitumen into jet fuel, gasoline and chemicals. By pairing production with refining, Cenovus effectively hedges itself against some of the risk of crude-price fluctuations, said First Asset’s Stephenson.

“We’re able to handle about 235,000 barrels a day of Canadian heavy crude through the Wood River refinery,” Brian Ferguson, chief executive officer of Cenovus, said in an interview yesterday. “It really reduces the volatility in our cash flow and our earnings performance.”

The gap between heavy Canadian oils and other crudes in the first quarter might have hurt the company’s profit had it not been for the refinery venture’s ability to make more money by buying low-priced crude, he said.

Crude Price Gap

“They’re capturing the full value chain and avoiding the problems that some competitors have,” with discounted prices for sellers of Western Canada Select, Stephenson said. The difference between the Canadian crude and West Texas Intermediate reached a record gap of $36 on March 7.

Imperial, 70-percent owned by Exxon Mobil Corp. (XOM), is currently spending about C$9 billion to build a bitumen mine, where the hydrocarbon-saturated sand is scraped from near the surface, transported in some of the largest trucks on earth and boiled in giant tanks to separate the oil. Imperial also operates a chain of gas stations in Canada.

Oil-sands miners, which have the best recovery rates from their reserves, face volatile labor costs in Alberta’s tight market. The province of 3.7 million people is looking for ways to stimulate immigration, Premier Alison Redford has said.