5 Oil & Gas Firms Facing New Headwinds: Which Are Buys?

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The drop in crude oil futures has been attributed to the European debt crisis and a slowing world economy. Another threat to crude prices is the United States' growing independence from OPEC's oil supply.

This is bad news for oil and gas companies with high development costs, since it will be hard for them to compete on price. Since reserves do not last forever, these firms must find and buy new development projects as part of their ongoing business. In this article, I will specifically discuss five firms: Exxon Mobil (NYSE: XOM), Occidental Petroleum (NYSE: OXY), Apache (NYSE: APA), Anadarko Petroleum (NYSE: APC), and BP (NYSE: BP).

Exxon Mobil and Occidental Petroleum have made news based on increasing costs of production and the perception that they are hungry for new drilling programs. Are these and other oil and gas companies to benefit from this situation?

Occidental Profits Down

For the third quarter, Occidental Petroleum posted a 22% drop. Though sales dropped one percent and net income fell to about $1.4 billion, the profit per share exceeded analysts' average estimate by seven percent. This drop in net income can be attributed the company's increased operational costs and reduced prices of natural gas.

How is the firm responding? Occidental CEO Stephen Chazen favors dividends or share buy backs if stock prices don't improve in comparison with its peers. Though operational costs in California have doubled, Mr. Chazen hopes to reduce costs by reducing the drilling programs there and in Texas. Better development projects are hoped from New Mexico. According to Chazen, "The costs are how I intend to make the performance of the stock do better. The tool is bringing the costs under control and improving the profitability."

Though Occidental was able to sell crude oil at higher prices and increase its United States production, its natural gas results negatively affected profits. Natural gas accounted for 39% of total production, and its prices plunged 41% year-over-year. In the future Occidental may be forced to review its natural gas production in this new regime of lower prices and higher supply.

OPEC sees falling crude prices

With a bleak economy and an increasing reliance on alternative fuels like shale oil and natural gas, the demand for OPEC's crude oil probably will see a 1.4 million barrel decline from this year to 2016. The 2015 estimate of 1.6 million barrels is lower than what was forecasted for 2015 last year. OPEC foresees having 5 million barrels a day of spare capacity as soon as next year, and it is expected to increase production by 5 million barrels a day by 2016.

Global demand forecasts have been shifted downward for 2035 to 107.3 million barrels a day due to higher prices and increasing efficiency in the use of fuel. OPEC's share of oil is expected to remain constant through 2035. Price assumptions of the basket of crudes have been revised upwards to $100 a barrel.

Supplies from countries other than those belonging to OPEC will also increase, driven by the production of shale oil in the US, oil sands in Canada, and crude oil from Brazil and the Caspian Sea.

The Rise of Russian Oil

OAO Rosneft is set to buy a stake in the TNK-BP oil company in a deal that will see it match the production of Exxon Mobil. The company control's more than 40% of the crude output in Russia. This deal, worth about $55 billion, comes in third in the list of biggest acquisitions after Exxon-Mobil ($80 billion) and BP-Amoco ($56 billion). Rosneft will buy half of BP's stake and acquire $28 billion worth of the other half owned by a group of billionaires. BP will get two seats on Rosneft's Board. Chief Executive Officer of BP Bob Dudley said, "BP looks forward to being able to contribute to Rosneft's success and add value through our participation on the board."

Cass Business School finance lecturer Andrey Golubov noted that about 50% of the Russian government's revenues come from the oil and gas industry. According to Andrey, "This deal is in line with the Russian government's strategy of reversing the privatization of oil and gas resources that took place in the 1990s."

Exxon Oilfields

Exxon Mobil may have to find and develop new oilfields to maintain its status as the top-volume oil producer. In comparison to its competitors, Exxon has been falling behind on growth and it is set to face stiff competition from OAO Rosneft after its acquisition of BP. There is speculation that Exxon is looking to partner or acquire Anadarko Petroleum or EOG Resources to boost its sales but spokespersons from the two oil companies declined to comment on speculation. Another alluring option is Houston-based Apache for Exxon, and analysts estimate that the 21% revenues boost it would prompt falls in third after EOG and Anadarko.

Ariel Investments Analyst Anthony Walker feels that Exxon has room to increase its production and should not feel threatened by Rosneft's acquisition. According to Anthony, "I would be a little bit concerned if they felt that they needed to respond to what their competitors are doing because it probably signals that they would be going after lower-return opportunities."

Regardless of speculation, Exxon is forward-thinking and will most likely obtain large tracts of undeveloped acreage rather than projects that currently produce large volumes of gas or crude oil.


Let's consider the valuations of the stocks of these oil and gas firms against two attractively-priced tech companies:

<table> <tbody> <tr> <td> <p><strong>Ticker</strong></p> </td> <td> <p><strong>Company</strong></p> </td> <td> <p><strong>Country</strong></p> </td> <td> <p><strong>P/E</strong></p> </td> <td> <p><strong>P/S</strong></p> </td> <td> <p><strong>P/B</strong></p> </td> <td> <p><strong>P/FCF</strong></p> </td> </tr> <tr> <td> <p>APA</p> </td> <td> <p>Apache</p> </td> <td> <p>USA</p> </td> <td> <p>12.57</p> </td> <td> <p>1.81</p> </td> <td> <p>1</p> </td> <td> <p>NA</p> </td> </tr> <tr> <td> <p>APC</p> </td> <td> <p>Anadarko Petroleum</p> </td> <td> <p>USA</p> </td> <td> <p>19.54</p> </td> <td> <p>2.55</p> </td> <td> <p>1.73</p> </td> <td> <p>NA</p> </td> </tr> <tr> <td> <p>EOG</p> </td> <td> <p>EOG Resources</p> </td> <td> <p>USA</p> </td> <td> <p>25.96</p> </td> <td> <p>2.72</p> </td> <td> <p>2.25</p> </td> <td> <p>NA</p> </td> </tr> <tr> <td> <p>OXY</p> </td> <td> <p>Occidental Petroleum</p> </td> <td> <p>USA</p> </td> <td> <p>10.51</p> </td> <td> <p>2.57</p> </td> <td> <p>1.53</p> </td> <td> <p>NA</p> </td> </tr> <tr> <td> <p>XOM</p> </td> <td> <p>Exxon Mobil</p> </td> <td> <p>USA</p> </td> <td> <p>9.22</p> </td> <td> <p>0.81</p> </td> <td> <p>2.39</p> </td> <td> <p>35.86</p> </td> </tr> <tr> <td> <p><em>AAPL</em></p> </td> <td> <p><em>Apple</em></p> </td> <td> <p><em>USA</em></p> </td> <td> <p><em>12.29</em></p> </td> <td> <p><em>3.26</em></p> </td> <td> <p><em>4.31</em></p> </td> <td> <p><em>12.32</em></p> </td> </tr> <tr> <td> <p><em>INTC</em></p> </td> <td> <p><em>Intel</em></p> </td> <td> <p><em>USA</em></p> </td> <td> <p><em>9.07</em></p> </td> <td> <p><em>1.92</em></p> </td> <td> <p><em>2.1</em></p> </td> <td> <p><em>31.74</em></p> </td> </tr> </tbody> </table>

Note: Comparison across separate industries only intended to show valuation differences

It is better to buy shares of a potential target company than a potential acquirer. With this in mind, we would require ridiculous discounts in valuation to purchase shares of Occidental or Exxon. Though they are cheap, they are not that cheap. These commodity producers are not a cheap as Intel, a semiconductor company. Its products are protected by intellectual property, and are thus shielded from price competition; commodities are not differentiated and are not proprietary.

The potential acquisition firms EOG, Apache, and Anadarko are somewhat more expensive. Notice that they are more expensive than Apple on a price-to-earnings basis. This is unacceptable for a commodity-producing stock. Go with a company with a differentiated product with cheaper earnings multiples and cash inflows.

BillEdson11 has no positions in the stocks mentioned above. The Motley Fool owns shares of Apache and ExxonMobil. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.

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