TomCo Energy - Oil sands opportunity is alluring
TomCo (LON:TOM) is an oil & gas exploration and production company which operates in the Uinta Basin in Utah. In June 2020 the company announced the formation of a joint venture (JV) called Greenfield Energy LLC to unlock the potential for oil sands development within the area using an innovative new production technology. This project took a further step forward in September 2020 with the release of a pre-FEED (front end engineering design) study detailing the economics of a production plant based on the new system. In this report, we examine the implications of the pre-FEED report.
The Uinta Basin and adjacent formations hold some of North America’s largest deposits of oils sands with potential to yield some 10 billion barrels of oil. The Greenfield JV was formed to examine a scalable modular production plant that could be used to extract oil from the sands with cost efficiency and low environmental impact. The proposed technology offers the following benefits among others:
- Limited environmental impact, with a modest water requirement, and no “dirty” sand to remediate at the end of the process
- A scalable modular system with limited capital expenditure (capex) requirement
- An output product that needs no further refining
The output product is an important part of the business case. We base our financial modelling (p8-10) on an output product of low sulphur fuel oil that can be sold directly into the market place as bunker fuel for shipping. The processing system offers considerable flexibility in being capable of producing various end products. We examine these on p6-7. All of the potential options sell at a premium to crude oil and have shown greater price stability than WTI )West Texas Intermediate) crude.
Oil-sands technology making progress
The Greenfield venture is a 50/50 JV between TomCo and a global engineering procurement, construction and installation (EPCI) company called Valkor LLC. Currently, Greenfield is performing upgrade work on a test plant capable of producing 500 bpd (barrels per day) at Asphalt Ridge in Utah. Results from this plant will serve as validation for the separation technology, which will form the basis for a proposed 10,000 bpd plant that would serve as the first commercial oil sand processing facility for Greenfield.
During the fourth quarter (Q4) of 2020 there are several key milestones for the project:
- Production commencing at the test facility, expected November 2020
- Completion of the full FEED study
- Selection of a location for oil-sand ore extraction
The pre-FEED study indicates attractive economics for the project. The study estimates that US$185mln of investment would be required to establish a 10,000 bpd production facility. This would produce revenue of about US$160mln per year and underlying earnings (EBITDA) of US$50mln per year by our calculation, at the current price of low-sulphur fuel oil. We examine the financial and valuation implications in detail on p8-10.
Next stages, and financial outlook
Low capex requirement and a clean production process
Globally oil sands are already being exploited on a large scale, but the system being examined by TomCo will use a new processing technology that differs from the systems used by the larger-scale operations that are well-established in Canada. The new process offers modest initial capex, flexible scalability, and eliminates the expensive disposal of ‘dirty’ sand at the end of the process.
Output is ready-to-use fuel, enhancing the economics of the project
Perhaps most importantly, the process under development would produce ready-to-use output product, rather than producing crude oil which requires refining.
The pre-FEED study published September 16, 2020 outlines the design of the proposed 10,000 bpd oil sands plant, and its costs in terms of capex and operating expenditure (opex). The following summarises:
Economic highlights based on pre-FEED study and Proactive Research estimates
Source: Proactive Research
Objectives and timeframe
The oil sands project began in December 2019 with an agreement between TomCo and Valkor to examine the processing technology. Since that agreement, the project has taken significant steps forward. The following table summarises the timeline of recent events, together with our own expectation for further project milestones.
Timeline of events, recent and near future
Source: Proactive Research
We expect significant project milestones to be met during Q4 2020
From this point, we believe that the development pathway offers a rapid potential transition to commercial production. This is contingent on various significant factors which are still under negotiation, including:
- Completion of the full FEED study.
- Securing a location in the Uinta Basin for oil-sands ore extraction.
- Financing the production of the full-scale facility — we consider this on p10.
During the next few months, we expect TomCo to disclose further progress on these issues, which could provide a catalyst for the share price.
Oil sands / tar sands
Tar-sands, also known as oil sands are sands that are saturated with bitumen, which is a highly viscous form of oil. Extraction of oil from oil sands already represents a large scale commercial undertaking globally, especially in the Athabasca region of Alberta, Canada. The following map shows major known oil sands deposits in the world, with the size of dot being illustrative of the relative size of the resource.
Biggest oil sands resources are in Canada, Venezuela, and Russia
Utah is at the top of tier-2
Major global oil sands resources
Source: Proactive Research
The dot in the middle of the USA represents the Green River formation, which includes the Uinta Basin. The following table summarises the biggest oil sands deposits identified:
Three major deposits: Asphalt Ridge, Sunnyside, and PR Springs
Oil sands deposits in the Uinta Basin
Source: Utah Geological Survey
The following map shows the location of these oil sands deposits within the Uinta Basin:
Oil sands deposits within the Uinta Basin
Source: Utah Geological Survey 1996
The fuel oil market
As a base case for our financial analysis, we assume that the Greenfield plant will produce low sulphur fuel oil for the marine market. We consider some alternatives on p6-7.
Regulations introduced by the International Maritime Organisation, which took effect in January 2020, demand that sulphur content in marine fuels be reduced from 3.5% to 0.5%. This has led to a shift in demand within the marine fuel market, illustrated by the following chart.
A major shift from high sulphur marine fuel to low sulphur
Demand for marine fuel oil by category
Source: OPEC World Oil Report 2019
The increase in demand for low sulphur fuel oil (LSFO) provides a degree of price support for these products. During the recent period of very high volatility in the energy market, the price of LSFO has retained its premium to crude oil (or to higher sulphur fuel oil). The following chart shows the recent price action in LSFO (global average price).
Low sulphur fuel oil stayed above US$40 per barrel through the oil market volatility during 2020
Price of Low Sulphur Fuel Oil
Source: Ship and Bunker
These are weekly figures. The absolute daily low point for LSFO in recent months was US$35 a barrel. We believe that even at that low point, it is possible that the TomCo oil sands operation would be able to run at a profit.
Flexibility in targeting the final end market
We have highlighted marine bunker fuel as an end market for Greenfield’s product.; however, this is not the only possibility. The final stage of the separation process is a back-end emulsion process that produces a water/oil emulsion that can be used as a direct substitute for existing fuels in various applications:
- A dual output of diesel and asphalt, both of which trade at a premium to WTI Crude
- Marine bunker fuel
- Medium/low-speed diesel reciprocating engines, typically used for industrial power generation
- Fuel oil for heating or for water-boiling power generation
We expect that the FEED report will provide a basis for TomCo to decide which application to target in its first commercial-scale production facility. Any additional future facilities could be configured to target a different end product or multiple end products.
The in-built flexibility in terms of product applications allows an additional level of revenue optimisation and risk mitigation.
Current technologies for separating oil sands have significant limitations
The TomCo oil-sands project
Currently, oil is separated from oil sands by a number of operators globally, using a process with large gravity separation tanks to produce diluted bitumen, which can then be sent for refining. Issues with this method of separation include 1) large capex requirement, 2) very large requirement for water, 3) dirty (oiled) sand to be disposed of, and 4) bitumen output that contains high levels of sulphur.
The Greenfield project aims to use an innovative separation technology that gets around some problems with the “traditional” process.
In December 2019 TomCo signed an MoU (memorandum of understanding) with Valkor, a global engineering procurement, construction and installation specialist, to work on the development of a new process for oil sands separation.
Valkor will bring expertise from its experience working with Petroteq Energy, an oil sands specialist also based in Utah, which uses its own proprietary separation process. Valkor holds a licence to use the Petroteq process within the USA. Under the Greenfield JV TomCo and Valkor will apply this technology to establish a 10,000 bpd production facility once the technology has been fully validated and a suitable location for oil sands extraction has been identified.
Advantages of the new system being evaluated by TomCo
This process has a number of advantages over conventional oil sands separation techniques:
- A modular, scalable extraction plant.
- Lower start-up capex.
- Lower water requirement.
- By-product of clean sand, requiring no expensive remediation.
- Output product that can be sold directly into the market with no further refining.
The following diagram illustrates the process which is being developed. This is from the September 2020 pre-FEED study.
Oil sands separation system
Source: TomCo pre-FEED study
The economics of this methodology are attractive, particularly for an operation that will start out at a relatively small scale when compared with some existing oil sands industry projects.
Economics of the new separation system
The pre-FEED study includes detailed estimates of the operating cost for a 10,000 bpd plant based on the new technology. The following chart illustrates these costs. These are pure opex costs, not including financing expense or taxes. In this sense, the differential between the operating cost and the oil price is a good proxy for EBITDA per barrel.
Profit per barrel US$15 based on conservative cost estimates
Production costs for the new system, compared with current LSFO price
Source: Proactive Research, based on TomCo pre-FEED study
We note that, at the time of writing, the actual price of LSFO is around US$50/bbl. We are applying a price of US$45 to allow a discount for the location in Utah rather than a major marine fuel hub.
The pre-FEED study also contains capex estimates for constructing the facility, coming to US$185mln including a 15% buffer for contingencies. The following chart summarises.
Capex of US$185mln to establish a plant converting 10,000 bpd
CapEx costs - US$185mln
Source: Proactive Research, based on TomCo pre-FEED study
Based on these figures, we are able to arrive at a discounted cash flow (DCF) valuation model to calculate the net present value (NPV) of the project. This is based on an annual net cash profit of US43.2mln, after charging 21% tax. There is no annual capex to be deducted, as we have already counted maintenance capex within operating costs as per the chart on the previous page. Any working capital requirements would depend on the nature of any off-take agreements, but we assume that any working capital requirements would give rise to only a small decrease in NPV.
DCF implies a NPV of US173mln, for 100% of the Greenfield venture, unleveraged
This is the NPV of the whole Greenfield venture (100%), on an unleveraged basis. The value to TomCo will depend on financing factors. We consider these issues in our conclusions section below.
This valuation is based on a single plant producing an output of 10,000 bpd. Assuming this project is successful, we would expect the capacity to be expanded, giving rise to further value creation.
Finally, we consider the sensitivity of this DCF to two factors — discount rate and selling price for low sulphur fuel oil. The following table summarises the sensitivity.
DCF sensitivity
Source: Proactive Research
Various financing options for the project
Current market cap leaves considerable upside
Conclusions
It is not possible to precisely quantify the financial upside potential for TomCo at this stage. In particular, the issue of financing the project remains an open question. We note that much of the equipment required for the plant is off-the-shelf industrial equipment, which implies a possible route for asset-based financing. Also, there is a possibility of resource-based financing once all the elements of the project are in place.
We argue that almost any reasonable financing structure would leave significant value for TomCo shareholders relative to the current market cap of the company.
This value proposition is supported by the unique characteristics of the new separation process:
- An output product which requires no further refining
- A modular production system with low capex requirement
- Modest water requirement, and no “dirty” sand to be remediated at the end of the process.