Synenco Energy Inc. SYN CN
March 13, 2007 - 12:00pm EST by
2007 2008
Price: 10.50 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 528 P/FCF
Net Debt (in $M): 0 EBIT 0 0

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Synenco currently trades at nearly a 60% discount to it closest peer based on an EV/barrel basis as well as a 50+% discount to its NAV. Shares are currently down 63% from their 52-week high of C$28.74.  If you believe that established global oil reserves are declining and that the US, as a matter of national policy, will continue to diversify its oil supply, then Synenco represents an extremely compelling opportunity to invest in a scarce and valuable asset that is trading at an unwarranted discount to its peers and its intrinsic value.  Even if you are not a long-term energy bull, this still represents an enormously undervalued and overlooked asset with huge upside optionality and very limited downside risk.
We believe Synenco should trade closer to its conservative Net Asset Value of C$20.93, implying 95+% upside from current levels.  This NAV assumption is based on a long-term oil price of just $50 (more than 15% below current levels).  If oil prices were instead to remain at the levels anticipated by the market (December 2012 futures are currently at $65) or by the Street (Goldman Sachs’ 2008 oil price forecast is $68), then there is potential upside of 200% - 225% in Synenco shares.
As the only public oil sands company to have not ceded operating control of the project to a larger integrated player, we believe Synenco is a unique asset that would make a highly attractive acquisition candidate for a global energy company looking to enter or expand its presence in a low risk proven reserve basin.  In our conversations with management, they have echoed our belief that the company could be sold at any time to a strategic player for a significant premium. 
Finally, we believe Synenco’s stock provides an attractive return even if Synenco decides to delay developing its project due to rising project costs.  Over the next four years, a long list of competing Canadian oil sands projects are slated to begin and finish construction.  After 2011, this capital spending is expected to drop dramatically.  Lehman Brothers estimates that building costs for future projects started after 2011 will subside by over 25%.  As a result, even if Synenco were to delay the project by 4 years in order to lower its total project costs by 25%, the Company’s NAV would remain virtually unchanged at C$20.31.  We believe this optionality is also another compelling reason why these assets would be particularly attractive to a strategic acquirer with a long-term focus.
Synenco Energy Inc. (SYN CN) is a Calgary-based oil sands development company whose primary asset is its 60% interest in the Northern Lights Project located in the Athabasca oil sands of northern Alberta.  The remaining 40% interest is held by the Sinopec Group, which is the 4th largest global refiner and is owned by the government of China.  The Northern Lights oil sands leases contain discovered resources of 1.7 billion barrels, which are expected to produce 100,000 barrels per day (bbls/d) of light, sweet synthetic crude oil (SCO) for 30+ years.  To put that figure in perspective, at today’s oil prices, that level of production would equate to US$2.2b in annual project revenues, just shy of Canadian Oil Sands Trust’s (COS-U CN) 2006 revenues – a company with an enterprise value of C$14.5b or more than 50 times that of Synenco.
The oils sands in the Northern Lights Project are at a shallow depth and can be recovered using surface mining technology (more cost effective than other methods).  Synenco and Sinopec split all profits and capital costs associated with the Northern Lights Project 60%/40%.  The project is estimated to have a total capital cost of C$8.5 billion and production is estimated to begin in 2011.
In addition to the Northern Lights Project, Synenco owns 100% of the rights to another lease of 22,775 acres in the Athabasca oil sands region.  To date, the Company has explored just 25% of the land, but has not discovered significant bitumen resources.
The Alberta oil sands are the largest global oil reserves after Saudi Arabia, encompassing 140,000 square kilometers and are estimated to contain over 175 billion barrels of recoverable resources.  Oil sands are essentially a mixture of sand, clay, water and bitumen (hydrocarbons).  Each grain of sand is covered by a film of water, which in turn is covered by heavy oil.  The two most common methods for recovery are open pit mining techniques where resources are close to the surface and in situ production methods for deposits buried too deep for mining to be economical (typically more than 75 meters).  Some advantages that mining projects, such as Synenco’s Northern Lights Project, have over in situ projects are their proven technologies, higher recovery rates and lower energy usage.
After the oil sands of a project have been mined, the material is sent via conveyor belt to an extraction plant which separates the sand from the bitumen.  It typically takes processing two tons of sand to produce a single barrel of oil.  The collected bitumen is then sent to an upgrader for converting the bitumen into synthetic crude oil (SCO), a more refined and valuable product.  The synthetic crude oil is then transported via pipelines to oil refineries in the US and Canada for final processing into end product petrochemicals – gasoline, diesel, heating oil, etc.
We have used 3 different methodologies to arrive at our price target of C$20.93 (implying 99% upside):
-Net asset value (NAV)
-Comparable oil sands valuations
-Recent precedent oil sands M&A transactions
1)  Net Asset Value
Due to the long production life of the Northern Lights Project, we believe that determining the NAV is the most appropriate method for assessing Synenco’s valuation. 
Synenco’s Northern Lights NAV is C$20.93 or 99% above today’s share price.
Key Assumptions for valuing Northern Lights:
Total Discovered Reserves = 1.673 billion bbls (independent assessment)
Total Recoverable Reserves = 1.3 billion bbls (using an 80% recovery factor)
Daily Synthetic Crude Oil Production (bbls/d) = 100,000
Production Commences in 2011
2011 Cash Operating Costs ($/bbl) = C$21
West Texas Intermediate Oil Price 2009 = $50
2.0% Cost Escalator Post 2009
Total Project Cost = C$8.5 billion*
% of Cost that Synenco is Responsible for = 60%
% Financed through Debt = 50%
Share Price of Future Equity Issuance = C$15.00 (discussed below)
Discount Rate = 8.5% (12% cost of equity and 5% after-tax cost of debt)
* C$8.5 billion project cost estimate based on C$4.4 billion upstream cost estimate from Company and C$4.1 billion upgrader cost estimate from Wall Street research analysts.  While we have included all-in costs for both projects, management could decide to forego building the upgrader and instead choose to partner with an established oil refinery player – similar to EnCana’s oils sands partnership with ConocoPhillips announced in October 2006.
NAV Sensitivities
This analysis conservatively assumes a long-term oil price of just $50 beginning in 2009 (15% below today’s spot rate), however, if we assume something closer to the $65 long-term price implied by the market (using December 2012 futures contracts), our NAV increases to C$31.73 implying 202% appreciation to today’s stock price.  Using Goldman Sachs’ 2008 oil price forecast of $68/bbl results in 226% stock price appreciation.
NAV Sensitivity Analysis
West Texas Intermediate (WTI) Oil Prices
 $   8.5
 $   9.0
 $ 10.0
 % Share Increase Based on NAV Analysis Above
West Texas Intermediate (WTI) Oil Prices
 $   8.5
 $   9.0
 $ 10.0

The NAV analysis also assumes an equity issuance price of $15.00.  With oil prices at their current levels, management indicated that the share price would need to be ‘significantly greater’ than today before they would seriously consider an equity offering.  In multiple conversations, management has firmly indicated that rather than issue equity at today’s share prices they believe shareholder value would be maximized by an outright sale of the company to a strategic acquirer. 
Further, management also has the option of deciding to only build the mining project ($4.4 billion capital cost) and forgo building an upgrader ($4.1 billion capital cost).  Instead, Synenco could choose to partner with an established refining company to upgrade their bitumen production, significantly decreasing the need to issue equity.
For illustrative purposes, we have included NAV sensitivities to issuing equity at different share prices, assuming the Company decides to raise $8.5 billion in total capital (of which Synenco is responsible for 60%) to develop both the mine and an upgrader.
NAV Sensitivity Analysis
West Texas Intermediate (WTI) Oil Prices
% Share Increase Based on NAV Analysis Above
West Texas Intermediate (WTI) Oil Prices

2) Comparable Valuations of Pure Play Oil Sands Producers
Oil Sands Producer
EV (C$ mm)
Est. Reserves (mm barrels)
EV / Barrel
Western Oil Sands
Canadian Oil Sands
OPTI Canada
UTS Energy
Synenco Energy
* 1,673 million discovered barrels x 80% recovery rate x 60% Synenco Ownership = 803 million barrels
To be clear, we do not believe the first three companies in the table above (WTO, COS-U, OPC) are fair comparisons to Synenco.  These oil sands companies are either currently producing bitumen or are close to reaching actual production.  Rather, we believe these companies are illustrative of the potential upside valuation for Synenco once it becomes fully operational, estimated to be in 2011.
Currently, UTS Energy (UTS CN) is the purest comparable to Synenco.  UTS is an oil sands development company in the Athabasca region of Alberta that owns a 30% financial interest (with no operating role) in the Fort Hills oils sands project.  The remaining 70% interest is owned by Petro-Canada (PCA CN) and Teck Cominco (TCK/B CN).  The project is estimated to have 4.7 billion barrels of recoverable bitumen, with production expected to begin in 2011 (the same timeline as Synenco).  Fort Hill just recently received approval for their upstream mining application, putting them about 12 months ahead of Synenco (approval is expected later this year).  In addition to Fort Hills, UTS also owns 100% of Lease 14 – a project estimated to have 243-400 million barrels of recoverable bitumen (although no permit has been filed on this project).  Finally, UTS owns a few other leases that, similar to the Synenco Lease, have not yet been fully tested for potential resources.
Currently, UTS trades at an EV/bbl basis of C$0.66.  Despite a similar profile, Synenco trades at a 59% discount, with an EV/bbl valuation of just C$0.27.  Trading at UTS’EV/bbl multiple implies a Synenco stock price of C$16.45 or 57% above current levels.
To be clear, we like the UTS story and believe that it is also an undervalued stock that trades at a 30-40% discount to its intrinsic value (and well below its peers).  In essence, we are not only arguing that Synenco deserves at least the same valuation as UTS, but that they actually both deserve significantly more.  Given the valuations, we obviously prefer the greater upside potential in Synenco and believe that their majority stake and lead project operating role make the Company the more attractive acquisition candidate.

Possible Explanations for the Valuation Discrepancy between SYN and UTS:
Upside to the UTS Asset Base
UTS currently only reports 1,410 bbl of recoverable bitumen, which represents its 30% share of the 4,700 million bbls of the Fort Hills project.  Based on this recoverable resource estimate, UTS trades on an EV/bbl basis of C$0.75.  However, the Company is quite bullish that the preliminary core drillings on Lease 14 have shown promising initial results not yet included in their reserve calculations.  If we include the full upside from Lease 14 (based on very preliminary estimates), UTS trades at C$0.58 of EV/bbls.  For our comparative valuation analysis, we have used an average of these two ranges (C$0.66).  However, even if we compare Synenco to UTS’ aggressive upside scenario of C$0.58 (the lowest per barrel valuation), Synenco still trades at a 53% discount to UTS’ multiple, implying significant upside potential.
Established Canadian Oil Sands Operators
Some of the valuation discrepancy might be attributed to UTS having more established Canadian oil sands operators as partners with Petro-Canada and Teck Cominco.  While these two players are clearly more established within the local oil sands region, we would point out that Sinopec Group is an enormous global energy company with an established reputation of successfully completing large energy projects.  For instance, one of its subsidiaries, China Petroleum & Chemical Corporation (SNP), has a $90 billion market cap and over $200 billion of annual revenues, with a focus on domestic exploration and development in China.
We believe that the market is applying far too significant of a “non-local discount” to the Synenco/Sinopec partnership and giving no credit for the obvious upside – Sinopec’s large balance sheet will allow Synenco to raise the capital necessary for completion of the project.  Furthermore, Sinopec has a history of successfully partnering with major oil companies for energy projects domestically (Exxon, BP) as well as internationally (ENI, Petrobas).

3) Recent M&A Activity Supports Higher Valuation
The table below contains the listed acquisition multiples of recent oil sands development projects, which we believe provide significant valuation support for Synenco.  With the exception of Deer Creek Energy and BlackRock, all of these projects were pre-construction projects.  At the time of its acquisition, Deer Creek Energy was just 30% through its construction plans to develop its first commercial 40,000 b/d in-situ project; the mining projects did not yet have regulatory approval and only were targeted to begin production in 2011.  BlackRock is primarily a SAGD in-situ project with a small amount of actual production at the time of the sale.  The project is not expected to reach full commercial production until 2010.
M&A Oil Sands Comp Table
Korean National Oil Corp.
Teck Cominco
Newmont Mining - Black Gold
UTS & Petro-Canada
Deer Creek Energy
MEG Energy
75% mining
% Acquired
Est. Reserves
(million barrels)
C$/bbl (EV)
** Published reports list the BlackRock reserves at 604 million barrels; however, Shell claims the reserves are significantly higher.
BlackGold In-situ Oil Sands Project
On August 16, 2006, Newmont Mining sold its 100% ownership of the Black Gold oil sands project to Korean National Oil Corporation for C$310 million in cash.  The Black Gold project was an early-stage in-situ development initiative with an estimated 305 million barrels of recoverable bitumen and planned production of 35,000 bbls by 2010 (roughly one-third the expected production of the Synenco project).  This transaction represents an EV/bbl valuation of C$1.02, a 277% premium to Synenco’s current EV/bbl valuation of C$0.27, despite the fact that both projects are in the same relative stage of development, that the Black Gold project relies on riskier in situ technology and that many consider 500 million recoverable barrels as the minimum size to support a stand-alone oil sands project. 
The recent Black Gold transaction implies a value for Synenco of at least $C21.85 per share or 108% upside from current levels.

Unique Ownership and Control Position Attractive to Potential Strategic Acquirers
We believe the ability to maintain operational control combined with Sinopec’s strong balance sheet and successful partnership history will be viewed as significant positives by potential strategic acquirers.  Synenco is the only oil sands developer to have secured a large integrated oil company as a partner while maintaining a majority stake in the oil sands project. 
Low Production Risk
Unlike traditional E&P initiatives, oil sands projects hold considerably less risk around the variability of recoverable resources.  Upon completion of a drilling program to determine recoverable barrels, the oil sands project can be expected to eventually produce an amount very close to this estimate.  This unique level of certainty helps to eliminate a large risk associated with conventional E&P projects, effectively increasing the value to shareholders.  Norwest Company, a leading independent geological engineering firm, completed an extensive winter drilling program on the Northern Lights lease and announced a best estimate of bitumen in place of 1.673 billion barrels.  Applying a conservative 80% recovery factor, Synenco estimates that 1.3 billion barrels are recoverable.
Flexibility to Delay the Project
Synenco currently has no long-term debt and C$339 million of cash on its balance sheet (C$7 per share).  As a result, Synenco has the flexibility to either delay its fundraising process if the capital markets are less than ideal or to strategically delay certain capital expenditures if inflationary cost pressures warrant it.  As described earlier, a four year delay to achieve a 25% reduction in total capital costs would have little effect on Synenco’s NAV.  While such a delay is a possibility, our conversations with management lead us to believe that they would be more inclined to monetize the project assets at that point, creating tremendous and immediate upside for shareholders based on recent similar transactions.
Free Option on the Synenco Lease
We are currently assigning zero value to the additional 100% owned Synenco lease, which falls outside of the Northern Lights partnership with Sinopec.  Only 25% of this 36 square mile property has been explored and any successful bitumen find could provide significant upside to our valuation.  While management does not make any forecasts as to their expectations for recoverable bitumen, they do point out that they initially bought this lease because their preliminary seismic tests on the property indicated a positive environment for bitumen deposits.
Large, Experienced Financial Partner
Synenco benefits not only from Sinopec’s financial strength but also from its extensive engineering, construction and mega project management expertise.  Sinopec also provides Synenco with access to a low-cost and non-traditional source of vendors, fabricators and suppliers outside of Canada.  These relationships will allow a great amount of the pre-fabrication of the equipment to be completed in Asia and away from the tremendous inflationary cost pressures currently affecting the Alberta region.  While new to the oil sands region, Sinopec has deep experience in building oil refineries in a modular fashion and then exporting these units to their eventual destinations.
Lower Cost Development Strategy
Synenco plans to build all of the mining and upgrading components in Asia on a modular basis.  Management estimates that this process will save the company 25% versus building the project completely on-site in Alberta.  This modular strategy should help the Company to mitigate some of the cost pressures and potential delays caused by labor and equipment shortages currently facing the Alberta region.
Upside from Utilizing Gasification Technologies
Synenco is currently planning to build a gasification unit as part of its upgrader project.  Management wants to take advantage of the opportunity to capture and monetize some of the byproducts of the upgrading process (excess gases such as CO2 and hydrogen).  They believe that the sale of these products could yield an additional C$2-3 per barrel, which in turn adds another C$2-3 to our NAV.  We are currently not assigning any value at all to this potential revenue stream, but view it as further potential upside.
Strong Operating Partners
Synenco has selected Jacobs Canada, Colt and AMEC to provide engineering and construction services for designing and building the Northern Lights Project.  These partners have deep expertise in developing oil sands projects and strongly complement the current skills and background of the Synenco management team.

Oil Prices
This is clearly an investment that is leveraged to the long-term price of crude oil.  To the extent that oil prices fall below $45 (25% below current spot rates) and the market believes this to be somewhat permanent, Synenco may have difficulty in raising the necessary financing for its projects – in which case management would attempt to monetize the asset through a sale.  However, it must be noted that under such a scenario, recent inflationary pressures within the Alberta region would reverse, allowing for much lower production costs and thereby creating a lower break-even rate for oil production.  As a result, we believe that even at significantly lower oil prices than we currently have today, the intrinsic value of Synenco’s assets provide a considerable floor value.
CapEx Requirements
Cost inflation has been a well-documented issue within the Alberta area.  Labor costs continue to rise as demand outstrips the available local labor supply.  If costs continued to sky-rocket, many new oil sands projects, including Synenco, may need to be delayed until the situation improved (thereby easing the inflationary pressures).  Synenco’s strategy of building modular components in Asia should greatly help to mitigate these cost pressures.  Synenco also has the option of foregoing the build-out of an upgrader and instead partnering with an established oil refinery, such as EnCana’s partnership with ConocoPhillips, greatly reducing its capital requirements.
Dilutive Equity Offering
Half of the $2.6-5.1 billion in required financing (Synenco’s 60% share of the $4.4-$8.5 billion total project cost) is expected to come from the issuance of equity.  Management has assured us that if Synenco’s stock remains at today’s depressed levels by the time the financing is required, they would instead seek a sale of the Company (or at least of the primary asset). 
Regulatory Risk
Having filed its upstream application to the Alberta Energy and Utilities Board (EUB) in June 2006, Synenco expects to receive approval no later than Q4 2007.   While the risk of a delay is always possible, our understanding is that there has not been a single instance of an application being denied by the EUB and that the regulatory process is basically a formality.  After speaking with various oil sands consultants and research analysts, we do not have any reason to expect a different outcome in Synenco’s case.
Political Risk
The Alberta government currently collects a royalty on all oil sands projects.  While the recent run-up in oil prices may have spurred some populist calls for changes to these royalty agreements, we believe the equal run-up in production costs has mitigated the risk of any material alterations actually being made.


1. M&A activity within the western Canadian oil sands region, which will further highlight the significant undervaluation of Synenco.

2. Announcement of positive results from the winter drilling program on the remaining 75% of the Synenco lease – expected in Q3 2007.

3. Regulatory approval of the Northern Lights Project in Q4 2007.

4. Stabilization of oil prices at current spot levels.
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