Suncor Energy Inc (SU) 2004 Q1 法說會逐字稿

Good morning ladies and gentlemen and welcome to the Suncor Energy first quarter results conference call. I would now like to turn the meeting over to Mr. John Rogers, Vice President, Investor Relations. Please go ahead, Mr. Rogers.

Good morning everyone and thanks for listening in to our conference call. By now you should have received the quarterly release which went out, I believe, at four o'clock in the morning Calgary time. So hopefully you have that and had a chance to have a good look at it.

Today is a pretty big day for us. Not only are we releasing our first quarter earnings, but we're also having our annual meeting here in Edmonton. So it will be a pretty busy day.

As usual I have in the room with me Rick George, our President and CEO, and Ken Alley, our CFO. At our last conference call I was a bit remiss in not mentioning that Gordon James, our long-standing Corporate Controller, had retired. So Gordon, if you're out there sitting somewhere in a lawn chair listening to the conference call, thank you for everything you've done in the past, and we will certainly miss you around here.

I am very happy to introduce our new Corporate Controller. Brenda Charis (ph) is our Vice President and Corporate Controller. And with her is Murray Harris (ph), our Assistant Controller. So I am sure we will look forward to working with the two if you in our conference calls as we go forward.

We're going to follow the usual format -- I will turn it over to Rick; he will give you a bit of a summary in terms of the quarter; Ken will give you a bit of a detail in terms of financial results; I will give you a few modeling points; and then we will open it up for questions. So Rick, why don't I turn it over to you?

Thanks John, and I'm absolutely delighted to be here this morning. And we're obviously talking about the end of the first quarter.

I would describe this quarter as solid, if unspectacular. That happens to Suncor a lot in the first quarter. As you know, we face a lot of challenges, particularly in our Oil Sands operation January to March period of time. And typically this year, as in many years, starting off a little slower than we might have wanted in terms of cash flow and earnings. But I have to say that my outlook for the rest of the year remains extremely optimistic and solid in terms of where we're going.

After we got through the first quarter, we also have some maintenance in the Oil Sands business in April. So April will not be quite up to snuff. But after that we should be kind of all bores ahead in terms of meeting our goal. And our annual target of 225 to 230,000 barrels a day is still our target and still very doable. Our cash costs in the range of 1075 to 1175 again remains intact, and in our opinion very doable as we go forward in the year.

The other one to note is Firebag, and we averaged just under 6000 barrels a day in the quarter. And obviously every month production rates are moving up. And so our commitment there in terms of having Firebag in that 35,000 barrel a day range in 2005 again remains right on schedule and on plan or at least within the realm of plan. We have had obviously start-up issues there as well, but everything is kind of moving along very well.

So from a foundation kind of viewpoint, the company is exactly where we should be. The year is going, I think, very good as far as the go forward look, and so we will not be concerned at all about the first quarter, although I know out there in the investment world the quarters are all important. Remember, Suncor is more about division in the future than it is about any individual quarter.

There's a couple things that I want to mention that I'm extremely proud of, and some of the things you will see will make a difference in our company going forward. One area that I haven't talked a lot about is the natural gas group really making some very solid progress. We have had some very good results over the last -- particularly the last 12 months, but also forming up to that over the last couple of years. Production, you'll notice, is already ahead of schedule this year. We have had some great results in the foothills in terms of some wells and also gas production, but also a planned kind of drilling program that goes forward over the next couple of years. So we feel very confident about that group, where it's going in terms of both reserves and production and our natural hedge very firmly in place, not just for this year but on a go forward basis. So we're feeling great about that.

The other one I want to mention is our capital projects. We're, I think, making huge strides. I know there will be a lot of concern out there as are these Oil Sands projects all going to run over budget and over schedule. And I just want to kind of talk about that just a moment in the sense that Firebag Stage One $600 million project on schedule and on budget. The Millennium Vacuum unit which is our next project, its 45 percent complete on construction. Again, on time and on budget. Firebag Stage Two is actually 15 percent complete on construction. Again, on time and on budget. It's a little bit early days; it's still only 15 percent complete. And then the next project in the queue here is our Millennium coker (ph) unit project. That again we've got approvals in terms of the regulatory approvals to proceed with that. Engineering is pretty far advanced. We will kind of break ground on that later this year. And so again, very solid progress. I think our overall tactic here of having the in-house impounds control over the engineering, procurement and construction of these projects is starting to pay off big time.

The other one I would say is that our ability to optimize on these projects and to build only what is required to kind of optimize around a return on capital number rather than having to build everything from scratch you're going to continue see as a competitive advantage for Suncor on a go forward basis. Certainly through the vacuum tower, the vacuum project we're currently putting in, the MCU, and then projects beyond that which we refer to as Voyager. So we're charging ahead with our plans to achieve production of 330,000 barrels a day by a late 2007 or early 2008. I don't really see anything that should in any way deter that.

Obviously one of the things in the quarter is the government's decision around the classification and the (indiscernible) of our Firebag project. And obviously we are disappointed with that decision. The 1996 generic royalty regime as designed by both the federal and provincial governments was visionary and has done exactly what it was intended to do, and that is stimulate investment. From Suncor's viewpoint it does seem to us that the rules have been changed midstream. We fully accept and have always accepted that Suncor has a responsibility to pay its fair share of royalties, but the impact of this (indiscernible) just means that we will be paying royalties a little bit earlier than we would have been. Of course part of that is also the impact of very high crude oil prices.

So what I would say is that although not happy about this, our future plans are intact. We have lots of options on how we design future growth, how it's delivered and where it's delivered. And we will be, obviously, as we have always done, continue reassessing how we implement that growth in the future. So it's not about if; it's about how and where we actually kind of commit to in terms of these options around future growth. Our goal, being 500 to 550,000 barrels a day in the 2010-2012 time frame, remains unchanged.

One final point around the quarter, and I know this will come as no surprise because we've been talking about this for the last several quarters, and that is hedging. And I'm talking now about our major selling forward program on crude oil. And we have used that through the project millennium when we were a much smaller company, undertaking that $3.4 billion project to protect our balance sheet. Now we're actually in a different circumstance -- we're a much bigger company; we have a very strong balance sheet; we also have the flexibility to adjust capital expenditures to match cash flow, which we didn't have in those prior periods. So with those things and with our Board's endorsement yesterday basically our current intent here is barring unusual circumstances -- you never want to say never, but barring anything unusual happening here -- our intent is not to hedge beyond our current position. We haven't put on new hedges for something like around a year or better. So any way that is a big change. I want to make sure that everybody was aware of it. So it does mean probably a little bit more risk, a little bit more volatility depending on what crude oil prices do in the future. But I think we're well prepared. In fact, some of our growth plans will kind of taper around to make sure that we've got that kind of flexibility.

So that, John, is my comments. I think I am going to turn it over to Ken Alley, our Chief Financial Officer, who will carry on here.

Thanks Rick and good morning everyone.

Rick talked about the solid operating performance in the quarter, and that's reflected in very solid first quarter earnings and cash flow -- earnings of $227 million; cash flow $422 million. I was just going to take a couple of minutes and take you through the major factors that impacted the quarter.

And when we think first quarter this year over first quarter last year we had higher natural gas production, higher Oil Sands production and higher benchmark crude oil prices. But that was more than offset by the significant shift in the currency rate -- the US-Canadian currency -- where we moved from a 66 cent dollar last year to 76 cents this year. Just to give you some idea how that impacts us, we estimate that it would have an impact, that shift in currency, of about $75 million after-tax on our first quarter earnings. So significant impact in the quarter and I think really the largest story in the quarter.

Rick talked about the government's decision on the royalty treatment for Firebag, and we have reflected that position in our first quarter earnings. We've accrued $62 million pre-tax for royalty expense in the first quarter, about $40 million after-tax. And just to give you some idea, we estimate that based on first quarter actual crude prices and forward curve prices for the balance of the year of about $32.50 WTI, and with a 75 cents assumed exchange rate, that the royalties would be in the $230 million range for the year. That is the estimate.

There was also a change in the Alberta government tax rate, a reduction that did have a positive impact on earnings, so it's a revaluation of future income taxes -- non-cash onetime adjustment of $53 million positively earnings. On a go forward basis you should continue to expect the effective tax rate to be in the 35 to 36 percent range.

Before I pass it on to John I just wanted to speak for a minute on the balance sheet. Capital expenditures for the quarter were about $346 million. With that, net debt was relatively flat. We did redeem the preferred securities in March. We refinanced that with lower cost debt. So overall debt is still around the $2.6 billion range that we had in the quarter.

So with that, John, I will pass it back to you.

Thanks Rick and Ken. I am going to do my best to try to ward off any modeling questions that we might get after this. Hopefully, we will be able to keep the questions to the strategic level. So hopefully you have your pen in hand because I'm going to give you some numbers.

First of all, as Rick mentioned, the outlook does not contain any changes. We're not anticipating making any changes. Certainly the goals we set for ourselves clearly look very doable, and we're continuing to work towards that. So no changes there.

Crude oil hedging -- loss for the quarter was on 85,000 barrels. After-tax loss was approximately $63 million and about 100 million in cash.

Page five of the press release actually, if you haven't seen it, shows you the variances from the first quarter of 2003 to the first quarter 2004. I suggest you look at that and it should help you reconcile your models in terms of the earnings from one-quarter to the next.

Turning to this quarter, Suncor did adopt a new asset retirement obligation standard. I can hardly say that. You'll notice an account called accretion on our income statement, and really what that is is a buildup of the provision over the next few quarters and next few years as we go forward and provides for the asset retirement. You should probably expect somewhere in the neighborhood of about $5 million per quarter for that. So it in your models if you want to include that, that would probably be good.

Capitalized interest for the quarter this quarter was $10 million. It will build during the year as we continue on our capital projects. And you can expect full year that we will be in the neighborhood of 70 the $75 million in capitalized interest.

DD&A at Oil Sands, it is a little higher than we had originally expected. You can probably expect going forward we will be somewhere in the neighborhood of about $6. Part of the reason for that is the amortization of last year's turnaround. The capital costs were higher than the previous turnarounds have been, so there was a bump up in terms of DD&A. The actual DD&A charge this quarter was higher because of the low production volumes also.

You'll notice corporate charges are running also a little higher at about $37 million. You can expect that to be a good run rate for the rest of the year. We are expensing some of the projects we're doing at the corporate office and throughout the company through that. So use that as a good run rate going forward.

And I guess the last piece is the start-up on Firebag. This will be the last quarter that we will actually be separating Firebag as a start-up, and in the future it will be included with the regular Oil Sands numbers.

So Lisa, with that I think we're finished our formal remarks and we will certainly open it up to questions.

(OPERATOR INSTRUCTIONS) Peter Best (ph), BSFB (ph).

I just had a question about Denver, just a few points on the refining. And they are what do think it would take to turn that asset around; what are your CapEx plans; do you have any plans to do like what Fitcher Canada (ph) has done with their Edmonton refinery to reconfigure it; and finally, are there any other sort of downstream assets you're looking at adding to your portfolio?

First of all, when we bought the Denver refining and other Colorado assets we fully understood that it is a cycling business. We've been talking about that since the purchases, that we expect very weak fourth and first quarters, very strong second and third quarters. It is just the nature of the business there and also relates to diesel sales and a bunch of things. Among other things, in the US the trucking routes are different in the winter than they are in the summer. In other words, they head further south to avoid weather. So we always knew that and assumed that.

Actually the business has performed very well. And if you look the total amount of cash flow and earnings from when we closed the purchase on August 1st, we're right on our targets. And we fully expect that 10 percent return on capital kind of number to be achieved.

So it was a weak first quarter. One of the reasons for that also is we had a turnaround in the first ten days of April there. And as you kind of go into that, into those turnarounds for these refineries here, down to kind of last legs on catalysts and also on some of the compressors and pumps. So that was maybe a little bit unusual in terms of a low-volume quarter, but not overly so I guess.

We do see very strong margins, both refining and retail, in the Denver area. Currently we're kind of back up at full rates, and we would expect a relatively good second and third quarter here and meet our annual targets in terms of cash flow and earnings. So kind of nothing unusual there. You have just got to get used to the fact that it's a cyclic kind of business, unlike our refining and marketing assets in Toronto, which is a little bit more of the steady business.

I think the same thing to do is on capital. We're spending over US$200 million to get to low sulfur diesel specs, and so we're adding high nutrine (ph) there. That project is proceeding very well. Engineering is pretty far along. We're just getting the final permits to get that started. We have made -- when we did this turnaround we've made some of the tie-ins to make that possible. We've done some site clearance. So everything is kind of on schedule for that. Again, we've got to have that up and running kind of mid-2006. And with that we will be running more of our sour product through that refinery than we currently are able to do. So it's kind of all part of the game plan overall in terms of that refinery. Ultimately, what we would like to do is over time here run more and more of the crude straight out of our Oil Sands operation in that refinery. And this investment, in addition to meeting sulfur specs, will allow us to do that.

I guess the other one was if there are any other assets similar to that that you can identify. Or do you think that will be the capability to add more?

Yes absolutely. We continue to look at the refineries where we can reach direct by (indiscernible) from our Oil Sands business and look at the integrated properties of those so that can we drive value that others cannot by purchasing the refinery. So absolutely. We continue to look at that. I don't have anything on the screen right now that should raise any alarms.

One of the things that I wanted to do is to make sure also that we got the experience of buying a refinery, which we did in Denver, manage it very well, prove that we can get the kind of results that we said we were going to get and then we will move on to another target potentially. Nothing on the radar screen right now.

Thanks very much.

William Lacey, First Energy Capital.

Just a couple of quick questions; one to follow up on the downstream. What was the impact of the turnaround in Denver in Q1? Do you have a rough number on that?

It probably would have had a marginal impact, but probably not significant. I think it's probably performing up to expectations, as Rick just mentioned. It would have had an impact, but it would have been minimal.

On Firebag, could you give some sort of outlook as far as for the year what you think your average production from this facility will be because obviously production has come on a little bit earlier than expected at 6000 barrels for the first quarter? Just wondering for the year what you would be looking for.

We haven't really committed to that publicly at all. We have the ramp up curve here through the year, getting to 35,000 barrels of oil today really a year from today in the first quarter of next year. We've modeled this thing very carefully. All the reactions of the reservoir and everything else, we're right on our targets. I don't want to get into -- number one, we also may do some maintenance, so as you would normally expect and as you've seen on some of these other projects, we may even have to take it down for a couple weeks here and correct some things that either were not done properly during construction. So it's not going to be a straight line up, but there's no question about the reservoir performing according to all of the design criteria and our modeling of that reservoir. So everything is really right on track. But what we don't want to do is get into kind of monthly projections on that. We're still kind of in a start-up mode overall.

Petro-Canada in their conference call talked about McKay River and some of the issues they're continue to have on the water handling. How is the performance at your asset going right now?

It's going very well. If we have one problem it is the final treatment of water before we run it through the steam gen. So we're having some difficulty getting to the quality of water to run through those. And so the final filter there is not really quite operating according to what the design is. We're working with the manufacturer of that filtering system, and that's probably the biggest hurdle we have. Everything else has really operated extremely well up there.

Last question, I guess the one I'd really like to hear about, talks about your strategy going forward. When you said that you were looking at you may need to reassess the choices on how to deliver on your growth strategy, what sort of choices do you have out there, Rick? Maybe you could speak to that a little more.

You're obviously always going to produce the bitumen in Alberta. That you don't have options around. But to the extent that you -- as brought up earlier in this phone call, to the extent that you buy a refining assets in the US or other places in Canada, that will mean less upgrading capital being spent in the north. And you have got to remember, we have two refining assets we can also add other assets onto. So the point is obviously you're going to produce the bitumen up north; how much to the other investment is there versus other places -- by the way, that's not new; that's been kind of the downstream integration model Suncor has been pursuing. Obviously this change will mean we will take even a harder look at it as we go forward.

Thank you very much.

Will Gobert, Peters & Co.

The one modeling thing variance in the quarter, I think at least for us and probably a number of estimates, is that in the Oil Sands the sales were 214,000 barrels a day versus production of 220. I haven't gone back into previous Q1s versus Q2s to figure this out, but was there something strategic issue-wise or is this just normal course? And as a result which quarter would we expect to see sales exceed production?

I would say it's very much in the normal course. It really isn't necessarily seasonal. I think if you look back over history you will see times when there is a difference between sales and production, and it's really just movements in inventory. So we did have higher sales in the fourth quarter. We did draw down some inventory. We replenished that in the first quarter. So really nothing structural.

Second is on the crude oil hedging strategy. There's probably no good time to make that decision, but it does seem just a little bit counterintuitive with oil near the highest level it's been to stop hedging at this point in time. I'm wondering about sort of the timing of the decision.

That's a great question. In fact, I even had the remark yesterday from one of my Board members, "does that mean we're right at the peak of oil prices?" That's kind of one that I'm not necessarily going to be able to answer until down the road.

But I think a couple of things. I'm quite sincere about the fact that we did hedging for the right reasons. Those reasons have now changed in my mind. And we're dealing in a lot more uncertain worlds than we were dealing in in some ways five or six years ago. And I think as this company continues to grow and mature as a company and our strategy, I think we can take that additional risk.

And so I know it is a change and that's why we're trying to signal to the marketplace. And I agree with you. In fact, I'm a little bit worried about exactly what you raised in terms of just when you actually end it will be right at the peak where you should have been hedging. But that's kind a f second-guess issue. There's not much I can do about it. Again, I would pull you back to it's not about this quarter or this year; this company is about the long-term vision and I have been on that track for about ten years and you are going to see that over the next and as we go forward as well.

I agree with those points. I think it's the right decision. Congratulations.

Paul Cheng, Lehman.

First of all, I want to concur that I think that to get rid of the hedging is actually a very good idea. I don't think that over the long haul anyone had the crystal ball to say where's the oil price going to be, so there is a net zero or maybe net loss gain going forward.

We have certainly proved that.

I actually appreciate that you get rid of that.

Rick, several questions. First, you mentioned about your natural gas business -- but maybe I have written it wrong -- but at the end of last year you're proven reserves is 456 Bcf versus back at the year-end 2001 is 545 Bcf. So you're down about 16 percent on your proven reserves while you're production from 2001 to current level is up about 11 percent. That as a result strained your reserve money (ph) to about 6.3 years (ph) from 8.4. Is that a bit of the dangerous as you're increasing your production while see your reserve drop? Do we need, say, to keep one and the other moving in tandem?

I will answer that. No we're not concerned about it. I think that's normal range reserve revisions and production. I think as you know this is a relatively small natural gas business that we're building. We're quite comfortable that we can continue to grow at that three to five percent range that we have targeted, and we've seen that increase in production. And we would expect as we go forward to see the reserves match that as we move forward. So we're not concerned about that.

So can you expect that over the next several years you're going to have more than 100 percent reserve replacement?

We would expect the reserve base to grow in line grow with the production expectations.

And Ken since that you're here maybe you can tell me what is as percent of the revenue what is the royalty rate now for your Oil Sand business?

The way to think about that, Paul, is the royalty structure is really when you're in pay-out; it is revenue minus cost royalty. So it's 25 percent essentially of net profits. You recover your operating costs as well as your capital cost.

Rule of thumb proxy here if you want to convert it to a revenue royalty, it is just a proxy -- it's an estimate -- it will vary with crude price. So it is sensitive to crude price. It is somewhere in that 8 to 12 percent range, depending on crude price. And (multiple speakers) 12 percent, if you use 12 percent that would be a conservative estimate of the royalties going forward.

You're saying that between 8 to 12 percent depends on the oil price; what oil price will be reflected an 8 percent and what oil price at 12 percent?

At the 8 percent range we're probably thinking the 24 to $25 range, and then when you move up north of $30 you get to 32 to 34, I think, in terms of 12 percent.

Secondly, Rick, on the share buy-back, any thoughts on that? It looked like you're in great shape a balance sheet-wise and your cash flow, even assuming commodity price comes down, should be pretty strong. Are you going to return some of the cash through the share buy-back?

You did notice that we did give a dividend increase, and so that is one method to do that. I guess unlike a lot of companies in this industry we're actually still opportunity long. In other words, these projects that we have outlined here between now and 2012 -- even beyond that -- if anything we're still capital constrained. That's not a bad thing. What that does is force you to optimize and to look at that.

But unlike other companies, this is not about reserves and it's about how fast we bring on these stages of production. So our intent here is we're going to kind of match cash flow -- capital programs to cash flow. There may be some variation in that, and there will be periods where we pay down debt; there will be periods where we add debt. Basically we're going to try to match that as we go forward into this program, and that will mean that we can kind of adjust also when this capital is being spent. That kind of flexibility is what I was really talking about. I don't anticipate near-term any share buy backs. Now we end up in a 35 to $40 crude oil world forever, then you never say never. But that certainly is not currently on our screen.

So Rick, if that means that -- this year you are probably talking about 1.7 billion in your CapEx into the next several years that we may see the CapEx higher than that?

Yes. Again, we've got flexibility, so some of that will we will be dependent on our cash flow. So if we see higher cash flows then we certainly have the projects and opportunities to invest in those. Right now we're actually kind of going back in a complete rework of our forward-looking plan overall. And so you may see periods where we go over $2 billion on capital investment on an annualized basis, but I still think that kind of proxy that we've been giving, that we will be in that 1.5 to 2 range is a good range for planning. There may be years we will be above it and years below it, but so we have got that kind of flexibility.

Finally, in Denver (indiscernible) invest the 200 million to upgrade for the Tier 2 (ph), would that change the facility gasoline yield?

Gasoline yield change?

Yes. Are we going to produce more gasoline from that unit or that is really not going to change the product mix?

It will change a little bit, but not significantly.

It's mostly about the feedstock into the upgraders.

Very good. Thank you.

Jay Saunders, Deutsche Bank.

Just two questions on the cost -- on the cash cost, the first quarter 1215. Is there anything else to say about that, other than the high natural gas prices, what was behind that number?

It was actually two things -- it was high natural gas prices and it was volumes.

Just an update on the marketing. Have you guys -- is there anything else to say in terms of potential regions or areas that you can expand in the future on the marketing front -- the West Coast, Asia? Are you still running test cargoes in those areas?

There is a small amount of crude -- not necessarily our crude -- that does end up off the West Coast. As you're probably well aware, Terezin (ph) is talking about moving or expanding that line into Vancouver and Anacorda (ph). Not necessarily Suncor crudes because you know we have both long-term customers and internal demands. But you'll see more Canadian crudes head that direction.

You are also aware there is at least one project in terms of looking at a pipeline direct west out of Edmonton/Fort McMurray area to Prince Rupert. I do not think it is a secret either that there is look at reversing pipeline from Chicago area down to as far as the Gulf Coast.

So the way I would look at this, there are still a number of options on the drawing board in terms of expansion of the pipeline capacity out of Canada into the US. How that unfolds is really an industry issue, which we obviously will be looking at hard, studying and placing our bets on. But I don't really have anything more than that right now in terms of where we're going to place those bets.

It's really not impactive on our industry in my estimation until about 2008. But that doesn't mean that you'll be making a decision on that in the next 12 to 24 months in terms of making the picks on which one of those expansions the industry will be backing. So it is worth a watch. There's no question about there is opportunity there to expand the market. And I think that will happen in kind of a natural sense.

Thank you.

Leslie Lesabe (ph), Ontario Teachers Plan.

There was a comment in your MD&A, I think it was, in the quarter release that CapEx had not changed materially versus that laid out earlier this year. Is there a change in the budget, and if so what is it?

No, there's not a material change in this year's budget at all. Is there a chance that as the year unfolds we add another $100 million or something? Yes that is possible. But not a material change off of what we have released.

Okay. Can you give me a sense -- the 8 to 12 percent royalty rate that you noted on the Oil Sands projects, could you give me a sense of what that royalty rate would look like at a WTI price below $24, God forbid?

This is a rule of thumb proxy here. So I would use the 8 percent as the low range and 12 percent as the top range. It's hard to be more precise because there are a lot of moving parts to the estimate.

Even if the oil price was down at say 20, $21 you still think it's roughly an 8 percent rate?

As Ken is saying, there are so many pieces. Part of it is the costs that are allowed; part of it is the maintenance; part of it is the US dollar. So all we're really trying to do is -- a rule of thumb is only that -- it's a rule of thumb. So use something like eight percent and you probably won't go too far wrong in that.

Thank you.

Andrew Fairbanks, Merrill Lynch.

I wanted to explore the potential for optimizing the marketing of the Oil Sands products going forward. As you guys look out at all potential projects that are moving forward, likely to move forward in the Oil Sands, is there something you can do with the particular slate of Suncor products coming out that might be able to put you in a market niche that the other products may not likely serve or something else you can do to really optimize your overall realizations?

That's a good question. We already feel like we're kind of in an unusual position in the sense that if you look at Suncor we are pioneering company. And last year, by the way, we were the largest producer. We produced more than Syncrude did last year. And you remember we have a very different strategy than other players in this industry. We actually produce and market about eight different products as opposed to -- not to overuse the Syncrude as an example, but they produce one product in the marketplace. So we feel like we already have that. And you saw the announcement with PetroCan in terms of them becoming a major customer and also an input of bitumen into this whole operation.

We will continue to look those kinds of opportunities -- there's absolutely no question about that -- as well as this downstream integration and looking at the other refineries in the sense of can we buy upgrading hydrotreating and even cooking capacity cheaper than we can build it up north. That puts us in a different category than other players in the sense that we're looking at this on a very broad market basis, and also have those kinds of options and opportunities that not many players are looking at currently. So I think if I look at this, the one thing I would kind of leave you impression is that we feel like we have a front running position and our intent fully here is to continue the race to make sure that we stay in that front running position and that we have more flexibility and more options than anyone else in this industry. And I'm thinking of that in the broad North American context.

That's great. Thanks. Just another question on the capital programs going forward. Do you have any thoughts on what the impact in higher steel prices may have on the overall capital budgets of the bigger elements going forward? Should we kind of stay at the levels we've risen up to?

Yes. On materials -- you have got to remember, materials are probably -- I would have to get Kevin to give you a rough rule of thumb, but it's probably 30 percent or less of these project costs. But you could see up to 5, 10 percent inflation on that particular sector. That doesn't deal anything with labor or engineering or the other costs involved in that.

One of the things getting a slight feeling is that we probably kind of peaked on this thing in terms of where we are seeing (ph) some of these other commodity prices going. I think the market probably over-reacted and now on the stuff that we bought, for example, for the Millennium vacuum unit, for Firebag Stages One and Two, most all that equipment was ordered kind of before this last run-up in steel and other commodity prices. My own bet on that is that you'll see that kind of inflationary pressure come back down here over the next 12 months. I could be wrong about that as well, but that's kind of my intuitive feel here.

That's great. Thanks Rick.

(OPERATOR INSTRUCTIONS) Gordon Gee, RBC Capital Markets.

Just a question on the Firebag royalty. Can you have you exhausted all your avenues in terms of appeals or just discussion with the government. Or should we assume this is now a closed situation, that there's no kind of room for any change in the future on that royalty situation?

And my other question just relates to your upstream exploration. I noticed that your exploration expenses were $20 million in Q1 compared to lower numbers in other quarters. Is that just an anomaly or is that something on go forward basis?

On the first question, you never say never. You never say it is ever over. We have a continuing dialogue with the government of Alberta, and I would fully expect that to continue on more than one front. So I don't look at this as over. I think what we're trying to paint for you is this is the kind of worst-case kind of scenario. I want to make sure that that is fully disclosed, that is in the marketplace. Where we go from here, there will be continuing dialogue probably for the next fifty years. So I don't think there's a lot that's going to change there in the sense that I know that Suncor is a very important company to the government of Alberta and they are an important partnership with us. This kind of dialogue will be going on for a long period of time.

On the exploration expenses, there was 4 to $5 million of seismic charges in there and a couple of dry holes. It's just a reality with the kind of capital spending that we're going have in our exploration division that we're going to have some dry holes and certainly we expense all seismic. So 20 million is probably high, so I wouldn't count on that every quarter. But really it's all dependent on the drill bits.

Thanks.

Brian Dutton, UBS.

Rick, just wondering if you could explain some of the commentary that's in the quarterly release talking about the special-purpose entity that could be created. It's under the section of the analysis of financial condition and liquidity. You talk about unwinding some transactions there and they would be reported in the second quarter.

I can answer that. This has been disclosed in previous quarters and annuals. It really is a sale lease-back transaction of inventory, and so it is going to be unwound or redeemed this year. And we had hedged a repurchase of inventory. Basically we have sold it and leased it back for use in the operations. We had hedged the repurchase, but that hedge could not qualify for hedge accounting treatment so we had been marking to market the position really since 1999 when we entered into the transaction. So we have had small quarterly and annual upward revisions in the mark to market. But when we actually do unwind the transaction, repurchased the inventory and we locked in the purchase price of $20. So the difference between the market price on the $20 will go through as a non-cash charge to earnings.

That will be in the second quarter?

Second quarter.

Great. Thank you.

Robert Plexman, CIBC World Markets.

I have two questions. The first one is you mentioned Firebag Two is about 15 percent complete. And tell us as far as the timing when you're planning start-up of Firebag Two? But what I really wanted to ask, Rick, is that you mentioned some of the options you have for dealing with the Alberta decision, but one thing you didn't mention was the option you have to increase mining production and less expansion at Firebag. I'm just wondering if you could talk about that and give us an idea maybe of the scope of how much production you could ultimately get out of the existing or modest expansions at the mine rather than the Firebag stages expanding.

That's a great question. First of all, on Firebag Stage Two, so what we're planning to do is to have steam in the ground kind of third quarter next year, third quarter 2005. As you know, it takes a year, a year and a half, to get that up to full rates. Again, it's another 35,000 barrels per day. So you would see that at the tail end of '06. That kind of tapers in to make sure that we get the production available for the MCU -- to feed into the MCU. Remember, also part of the feed into the MCU deals with the PetroCan deal. This is just all about business (indiscernible).

And you're absolutely right. Steve Williams and his team up there are working hard on the options around the mining side in terms of expansion of seat bank (ph) and the Millennium mines. There are very inexpensive kind of expansion options there that they're looking at and also working extremely hard on technology. And so again, I have talked about this a lot and we will be out talking more in the future. One of the big keys for us in the (indiscernible) in the interim, in this kind of five to ten year period is technology movements both on (indiscernible) open pit mining. And the team is working very hard there on things like -- this is not -- we haven't got this work completely yet, so don't build it into your models, but things like can we do the crushing right at the shovels as opposed to having trucks run it over to the crusher system; can we do some de-sanding right at the mine base. So we have got lots of those technology that we're looking at as we can afford it. And part of that is an expansion of these two existing mines, which are some of the cheapest bitumen supply options that we have on our table.

Again, one of the things about the optionality is that because we're the only company certainly currently in operation that is pursuing both sets of technologies -- and in fact in a funny way -- and both of those reported into Steve Williams, and we are kind of setting up a bit of horse race here in terms of who can do it not only in terms of increasing production cheap, but also operating costs and also reduced environmental impact. So I think you're going to have some of that optionality that we have talked about.

I know there are extensive reserves at the Oil Sands mine, so are you talking basically about maybe accelerating the production of those reserves rather than expanding the reserves base or is there elements of both?

I think there's elements of both in there as well. Again, we haven't really locked and loaded on exactly what that looks like, but there's elements of both.

Thank you.

Andrew Fairbanks, Merrill Lynch.

This does border on a modeling question, so I apologize. But in looking at exploration of the drilling program for the Oil Sands itself, would the kind of level we saw in the first quarter be indicative of a run rate going forward or was it a bit of a high quarter?

It was a bit of a high quarter. We always do a fair amount of core drilling in the first quarter. And if you look at last year, if you look at the profile, it was exactly that. So we do a fair amount in the first quarter. It really tapers of for the rest of the year.

Do you think something in line with where we were last year would be reasonable?

Yes.

Thanks.

There are no further questions registered at this time. I would now like to turn the meeting back over to Mr. Rogers.

Thanks Lisa and thanks everyone for being very attentive and great questions.

As I mentioned, we do have our annual meeting today. Those of you who are luck enough to be up here in Edmonton, it is here at the Hotel McDonald at 10.30. For those of you who aren't, you can check in at our website. It is being webcast and we suggest to check and maybe a few minutes before just to make sure you get in.

Other than that, Brenda Charis (ph) and Murray Harris (ph) and I will be around to answer any of your detailed questions. Just give me a call; you know my number. Other than that, have a great day and we will talk to everybody soon. Thanks. Bye.

Thank you Me. Rogers. The conference has now ended. Please disconnect your lines at this time. Thank you for your participation and have a great day.