Image source: Getty Images.
Continue Reading Below
As tough as the market has been for oil and gas producers over the past couple of years, Suncor Energy (NYSE: SU) stock has remained relatively resilient. Part of that has to do with the company's integrated business model, but management has also been opportunistic during this downturn, gobbling up assets from weaker companies. It has set the company up rather well as we see a rebound in the oil and gas market.
That being said, there are reasons to think the decline in Suncor's stock could get worse. Here are three reasons investors should consider when looking at Suncor Energy, because they could certainly send shares plummeting.
We just saw one big risk exposed...
In Suncor's most recent quarterly earnings report, daily production rates declined by 52% compared to the first quarter of 2016. The reason, of course, was the wildfires that forced the evacuation of Fort McMurray, Alberta, as well as shut down the operations at most of its oil sands operations in the region.
This particular event is a one-off disaster for the region and the company. According to management, it has been able to mostly get its facilities back up and running and should have things 100% back to normal by the fourth quarter of this year. The greater risk this exposed, though, is how concentrated Suncor's production is in one particular geographic region.By having so much of the company's success concentrated in one place, the risk to the company in the event that something goes wrong in that particular region is much greater.
Continue Reading Below
Wildfires are just one example of the natural disasters that could take a larger-than-average bite out of Suncor's results, but it isn't the only one. Pipeline takeaway capacity from the Athabasca oil sands region is limited, and any disruptions in the event of a leak or rupture would likely lead to both a reduction in sales as well as lower realized prices as producers try to push product through limited channels.
If anything were to happen in this part of Canada again, it would likely have a huge impact on overall production. With so much of the company's future riding on the Athabasca oil sands region, that is something Suncor Energy can ill afford.
Over-reliance in oil production will make earnings more volatile
One thing that makes Suncor a more attractive investment than other energy companies is its vertically integrated business model. Having assets in production, refining, and retail helps to smooth out the volatility that typically comes with producing and selling a commodity like oil and gas. In the first half of 2016, Suncor's refining and retail business segment accounted for 80% of the overall company's operating cash flows. This goes to show how having a balance of assets in all parts of the value chain can help keep the overall business afloat when one of them is suffering.
The one concern here is that Suncor's business is becoming more and more tied to the upstream production side of the business every day. In 2016, the company plans to spend $6.0 billion to $6.5 billion for capital expenditures. Of that spending program, only $700 million to $800 million is dedicated to refining and marketing, and 95% of that is maintenance capital.
With that little amount of money going into refining and retail growth, and so much new production coming online in the coming years, Suncor's earnings and cash flows will become much more volatile and will tend to follow the swings in commodity prices. That could make it harder for the company to reasonably raise dividend rates in the future without the risk of them being cut in the event of a sustained lull in oil prices
Lack of end-market diversification could suppress oil prices
Today, oil sands production essentially serves two markets: The domestic Canadian market and the U.S. market. The reason for that is there is very little in terms of pipeline infrastructure that can deliver oil sands to the east or west coast for export. Today, the only pipeline connecting Alberta crude oil to the West Coast is Kinder Morgan's Trans Mountain pipeline, and the only East Coast access is via Enbridge's mainline system, which mostly feeds to the U.S. Midwest and Gulf Coast.
There are several proposals for new pipelines that would connect oil sands producers to the two coasts for export, but all of them have met heavy resistance from provincial governments. Keeping the market so constrained to just domestic and U.S. consumption has an adverse impact on market prices for that crude oil. That is, in part, why Western Canadian Select oil has typically sold at a double-digit discount to West Texas Intermediate for years.
While Suncor has dealt with a lower realized price for a while, it's something that holds the company's stock back compared to other oil producers. If, in the event that these proposed pipelines were to be shot down, it would really put a bottleneck on oil sands' takeaway capacity as more and more production tries to find a home.
What a Fool believes
While these things could certainly put a damper on Suncor's stock price, they are manageable issues. Restricted pipeline access is typically a situation that will correct itself over time as pipeline companies build more capacity, and more and more U.S. refineries gear their facilities to run higher percentages of Canadian heavy crude. Also, as this recent wildfire incident shows, it's something the company can repair within a few quarters.
A big question going forward, though, will be whether Suncor continues to dedicate an outsized portion of its capital spending to production and production alone. Any investor concerned about a stable dividend check will likely want to see the company balance out its portfolio with some more assets on this side of the business. Since so many investors have been attracted to Suncor's stability, anything that could make it a little more volatile might have investors looking elsewhere.
A secret billion-dollar stock opportunity
The world's biggest tech company forgot to show you something, but a few Wall Street analysts and the Fool didn't miss a beat: There's a small company that's powering their brand-new gadgets and the coming revolution in technology. And we think its stock price has nearly unlimited room to run for early, in-the-know investors! To be one of them, just click here.
The Motley Fool owns shares of and recommends Kinder Morgan. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.