EUR 850.00 For Business Accounts Only

Morningstar | The Market Continues to Underestimate Imperial’s SA SAGD Prospects

After taking a fresh look at no-moat Imperial Oil’s fourth-quarter earnings, we are lowering our fair value estimate slightly to $34 (CAD 45) from $35 (CAD 46) driven by our lower near-term price realization forecasts. Despite the lower fair value, we still see 25% upside in the 4-star stock. We think the market is underestimating the application of Imperial's solvent-assisted technology to its resources and is placing too much emphasis on the company's near-term exposure to the heavy oil discount due to lack of pipeline commitments.

Imperial has been at the forefront of the solvent revolution and has spent the most resources developing and testing these technologies. We estimate that Imperial can lower its project break-evens to $45 per barrel of West Texas Intermediate on Aspen, putting it at the head of the class. Further supporting our position, Imperial sanctioned its Aspen expansion project, the first announced expansion to use solvents. We see it as unlikely that any future expansion phases will revert to the more primitive forms of in situ extraction.

Imperial is working to extend its market access and lower its exposure to the heavy oil discount. The company intends to use its entire 210 mbbl/d rail loading facility in the near term while it awaits pipeline expansions, in which it holds long-term commitments. We expect the use of rail; the Line 3 expansion in 2020; and the TMX and KXL expansions to ease the heavy oil discount. As such, we expect the expanded market access coupled with Imperial's SA SAGD economics to generate lower bitumen price realization differentials than the market is expecting, even with the negative impact of IMO 2020.

As a reminder, Imperial's fourth-quarter upstream operations were hit hard by the widening of the heavy oil discount. Bitumen realizations fell almost 70% from the third quarter despite only a 40% decline in average Western Canadian Select pricing. Crude by rail shipments didn't have the positive impact that many expected during the quarter. However, the expected industrywide ramp-up of rail shipments during the first quarter of 2019 has already increased heavy oil pricing, which we expect to have a positive impact on Imperial's first-quarter results. During January, the heavy oil discount averaged $10 per barrel, down significantly from the fourth-quarter average of $34/bbl.

Imperial reported fourth-quarter production of 431,000 barrels of oil equivalent a day, up 8% sequentially and above our expectations. Higher production was driven by improved reliability at Kearl and Syncrude coupled with a faster-than-expected ramp-up at Normal Wells.

Imperial's downstream business benefited from the low pricing environment and helped offset the depressed upstream cash flows. Downstream earnings were CAD 1.1 billion in the fourth quarter, up 120% sequentially and above our expectations.

The company also continued its share buybacks. During the quarter, Imperial repurchased another 10 million shares, totaling CAD 410 million. For the full year, Imperial purchased approximately 49 million shares for CAD 2 billion. Imperial also announced its first-quarter dividend of CAD 0.19 per share, which equates to a 2.1% yield at current levels.

For a detailed look into Canadian crude market and pipeline trends, please refer to our January Energy Observer, "Pipelines Are Canada’s Lifelines.”