Unfortunately, as sometimes happens with a purchase based on bad news, that bad news is followed by more bad news. Yesterday, Canadian Natural announced that their 110,000 barrel a day upgrading plant would be down until mid- to late March to fix a fractionator unit, or 2-3 weeks longer than initial expectations.
The extended shutdown has force Canadian Natural to cut its 2012 production target for Horizon to 93,000-103,000 barrels a day from the previous forecast of 105,000-115,000 bpd.
Now, as this was a value buy for me, let’s look if the market’s reaction to these announcements make any sense. The Closing price on February 6th, before the announcement of Horizon downtime, was $40.50. This would give Canadian Natural a market cap of around $44.34 billion. At market close on February 14th at $36.36, the market cap had decreased to $39.81 billion, a loss of almost $4.5 billion or 10.3%.
Over this period, the S&P/TSX capped energy index dropped nearly 3%, so let’s first include that into our calculation as accounting for around $1.3 billion of the market cap loss. That leaves $3.2 billion in projected loss to be accounted for by the 5-7 week outage. Let’s be overly pessimistic and use 8 weeks of outages for our calculations.
8 weeks, or 56 days of downtime on a 110,000 boed facility = 6,160,000 barrels of production.
In Canadian Natural’s May, 2011 Horizon presentation, Canadian Natural shows that their best quarterly operating costs in 2010 were $32.27 per barrel with an average of $36.36. Their full production expectations are a cost of $25-35 per barrel, and I am going to use $30 / barrel for my calculations, which I feel is very conservative.
Light synthetic crude for March delivery was quoted at $2-$3.50 a barrel under benchmark West Texas Intermediate on February 14th afternoon, the smallest discount in more than a month, compared with $18.50 a barrel under WTI a day earlier.
Since this price differential mainly decreased due to the Horizon outage, and the February 6th market cap would have assumed a continuation of the differential for sometime, let’s use a $15 differential in our calculations. In reality, the decreased differential will help Canadian Natural once output resumes, as the glut in supply of Synthetic crude should be removed as both Syncrude and Horizon are down for maintenance and refiners will use up their high supplies.
Now, the simple calculation of short-term loss to Canadian Natural is the $100 WTI minus the $15 Differential for Synthetic = $85/barrel, minus the $30 per barrel operating cost = a loss of $55 per barrel. $55 / barrel multiplied by 6,160,000 barrels of production is a loss of around $339 million. Of course, in reality, this is just deferred production, but given the long-life of the project there is not much point in doing an NPV calculation and we will just assume a $340 million loss.
Therefore, from a valuation perspective, we’re looking at the markets taking $3.2 billion off the market cap of the company for what will likely amount to less than a $340 million loss in production. I would imagine the actual loss to be in the $200-300 million range, since I used overly pessimistic criteria in my forecast. Now, consider the $18.50 increase in the price of SCO relative to WTI (which I believe was also a knee-jerk reaction and will probably move down to a $12-15 differential) and you can see that the expected loss will be even less since Canadian Natural will likely command a higher price for their SCO once production resumes.
Of course, this unexpected downtime leads to an increased risk that the Horizon project will prove to be unreliable in the future and that there are design issues that may lead to further downtime in the future so one must price in additional risk for that…but $3 billion worth!?!? I don’t think so. Also remember that this downtime may allow for other maintenance activities to proceed which will shorten future downtime for planned maintenance, reducing the actual number of days of loss in the longer term.
To me, the company is even more oversold than when I made my last post and this represents an even greater opportunity to accumulate stock than I expected, notwithstanding the potential for the overall market to go into a small correction in the short-term. I will continue accumulating small increases to my position over the coming weeks as more news comes out and the overall market picture becomes more clear. The major risks continue to be a correction in the market as a whole, and more bad news. I believe the energy sector is a good sector to be in even if the market does correct, and the effect of further bad news being limited given the extent of selling that has already occurred.
