Oil & Gas Investing From A Supply Side Angle

Bill is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

The one thing that environmentalists and commodity bulls agree on is that fossil fuels are running out fast. They envision an apocalyptic future of $100 gallons of gas within our lifetimes. Fortunately, this is one thing that they both get wrong.

There are many sources of fossil fuels that we have not tapped on Earth. Arguably we should not tap them because of global warming, global dimming, ocean acidification, rising sea levels, and any impact it may have on changing climate. Unfortunately, the “running out” scenario gets thrown into these reasons, despite the fact that it will not be relevant for some time.

Investors should be aware that oil and gas resources are plentiful, and that prevailing energy prices have provided incentive for investment in more oil projects. This is boosting supply, which should make investors weary of energy companies despite the “running out” mantra. Investors should be picky and select only oil and gas stocks that trade at low valuations.

Turkey Boosting Production

Turkey is coming into its own as an energy-producing region. In 2012, Turkey surpassed Norway in drilling exploration. Turkey fielded a total of 34 rigs, according to its Energy Ministry officials.  The country wants to ease reliance on imports for its energy needs. With the economy forecasted to grow by 3.5% this year and an average 4.4% annual increase until 2017, Turkey’s energy imports will increase the current account deficit, fuel domestic inflation, and threaten to restrain its economic growth.

Spending for oil exploration increased fourteen times to $610 million for 2012 from $42 million ten years ago.  State-owned Turkish Petroleum, known locally as TPAO, has tapped Royal Dutch Shell (NYSE: RDS-A) and Exxon Mobil (NYSE: XOM) as partners, after Israel and Cyprus found major gas fields in the past three years.  TPAO aims to boost domestic output with a target to be self-sufficient by 2023.  It had proved 307 million barrels of oil and gas reserves in 2010, but the country consumed 258 million barrels for 2011 alone.  Turkey imported about 92% and 98% of its oil and natural gas, respectively, for 2011, according to the EIA (U.S. Energy Information Administration).

In a move to increase exploration activity and avoid speculation, a draft Petroleum Law calling for changes to “ensure speedy, continuous and efficient search of carbon resources” and requiring companies to pledge 2% of their projects as collateral to qualify for license extension, was submitted to the Parliament on Dec. 21.  Energy Minister Taner Yildiz said, “Our aim is to make Turkey one of the 10 largest economies in the world by 2023.” He also stated that energy projects would “enable Turkey to achieve its goal.”

TPAO was exclusively tasked with searching and drilling for oil and gas in the country. Chamber of Petroleum Engineers Head of Energy Studies Group Necdet Pamir said, “Foreign companies are complaining that working conditions in Turkey are not favorable for them since they have to play with rules of the TPAO, which holds exclusively all offshore licenses. Chevron (NYSE: CVX), for example, decided to pull out after drilling the first of two wells at its own cost in the Black Sea and paid a penalty under its agreement with TPAO.”  The draft law changes that and treats TPAO like any other company.

TPAO, along with Shell, Exxon, and smaller explorers like Anatolia Energy and Transatlantic Petroleum, are investing and contributing to the drilling boom.  The state-owned firm is planning to continue the Black Sea drilling abandoned by Chevron in Kuskayasi field by 2014.  In partnership with Shell, TPAO also plans to start drilling in the Mediterranean off the coast of Antalya in 2015. Due to its geology, energy officials are guessing that the Black Sea and the Mediterranean regions are more likely to hold gas, while the southern part will have oil.

Turkey, the world’s 18th largest economy, currently depends on secure energy supplies from other countries. Energy imports for 2012 mainly come from Iran, Libya, Saudi Arabia, and Russia, with Iran accounting for about 50% if its energy needs. Due to international sanctions against Iran, Yildiz said it will go down to the 35%-40% range with the difference to come from other sources.

U.S. Oil Production Surges

For four consecutive years improvements in drilling techniques boosted oil exploration across the United States. Peak oil theory has been challenged by recent production. Domestic oil production has surpassed 7 million barrels a day, the first time since March 1993 that this production level has been achieved.

The current trend of oil production reinforces the shift of the United States towards energy independence, as the country met 83% of its energy needs during the first three quarters of 2012. Also, according to the Department of Energy, oil inventories have risen to over 360 million barrels last week. The DOE also stated that in the week of Jan. 4, the weekly average output rose to 7,002 million barrels a day. This meant an increase of over 1 million barrels a day when compared to the same week last year. Andy Lipow, President of Lipow Oil Associates LLC, said "I don’t think anyone expected the magnitude of the change in just one year. It’s extraordinary.”

This increase in production is currently the fastest pace of growth in U.S. history, with a boost in production of 40% last year through October. A couple of examples of this are Texas raising its production by 23%, while Utah increased it by 11%. Also, there are forecasts of it further accelerating as combined techniques such as horizontal drilling and hydraulic fracturing ,or "fracking," are further perfected. The combination of these techniques has given access to crude trapped in formations where it was previously unavailable, such as in North Dakota's Bakken shale.

According to forecasts from the International Energy Agency, the US should have an oil production average of around 7 million barrels a day during 2013, and almost 8 million barrels a day in 2014. If those numbers continue growing at that rate, U.S. oil production is on track to exceed Saudi Arabia's by 2020.

Finding Cheap Energy Companies

Consider the following price multiples:

<table> <tbody> <tr> <td> <p><strong>Ticker</strong></p> </td> <td> <p><strong>Company</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><span>(XOM)</span></p> </td> <td> <p><span>Exxon Mobil</span></p> </td> <td> <p><span>9.45</span></p> </td> <td> <p><span>0.84</span></p> </td> <td> <p><span>2.45</span></p> </td> <td> <p><span>36.77</span></p> </td> </tr> <tr> <td> <p><span>(CVX)</span></p> </td> <td> <p><span>Chevron</span></p> </td> <td> <p><span>9.31</span></p> </td> <td> <p><span>0.92</span></p> </td> <td> <p><span>1.67</span></p> </td> <td> <p><span>342.63</span></p> </td> </tr> <tr> <td> <p><span>(CHK)</span></p> </td> <td> <p><span>Chesapeake Energy</span></p> </td> <td> <p><span>NA</span></p> </td> <td> <p><span>1</span></p> </td> <td> <p><span>0.75</span></p> </td> <td> <p><span>NA</span></p> </td> </tr> <tr> <td> <p><span>(COP)</span></p> </td> <td> <p><span>ConocoPhillips</span></p> </td> <td> <p><span>10.62</span></p> </td> <td> <p><span>1.13</span></p> </td> <td> <p><span>1.51</span></p> </td> <td> <p><span>NA</span></p> </td> </tr> <tr> <td> <p><span>(EPD)</span></p> </td> <td> <p><span>Enterprise Products Partners</span></p> </td> <td> <p><span>19.07</span></p> </td> <td> <p><span>1.14</span></p> </td> <td> <p><span>3.8</span></p> </td> <td> <p><span>NA</span></p> </td> </tr> <tr> <td> <p><span>(SU)</span></p> </td> <td> <p><span>Suncor Energy</span></p> </td> <td> <p><span>11.11</span></p> </td> <td> <p><span>1.32</span></p> </td> <td> <p><span>1.31</span></p> </td> <td> <p><span>16.36</span></p> </td> </tr> <tr> <td> <p><span>(TLM)</span></p> </td> <td> <p><span>Talisman Energy</span></p> </td> <td> <p><span>NA</span></p> </td> <td> <p><span>1.61</span></p> </td> <td> <p><span>0.48</span></p> </td> <td> <p><span>NA</span></p> </td> </tr> <tr> <td> <p><span>(APA)</span></p> </td> <td> <p><span>Apache</span></p> </td> <td> <p><span>12.86</span></p> </td> <td> <p><span>1.85</span></p> </td> <td> <p><span>1.02</span></p> </td> <td> <p><span>515.72</span></p> </td> </tr> <tr> <td> <p><span>(NXY)</span></p> </td> <td> <p><span>Nexen</span></p> </td> <td> <p><span>37.4</span></p> </td> <td> <p><span>2.09</span></p> </td> <td> <p><span>1.59</span></p> </td> <td> <p><span>NA</span></p> </td> </tr> <tr> <td> <p><span>(CNQ)</span></p> </td> <td> <p><span>Canadian Natural Resources</span></p> </td> <td> <p><span>13.51</span></p> </td> <td> <p><span>2.1</span></p> </td> <td> <p><span>1.33</span></p> </td> <td> <p><span>123.08</span></p> </td> </tr> <tr> <td> <p><span>(DVN)</span></p> </td> <td> <p><span>Devon Energy</span></p> </td> <td> <p><span>31.02</span></p> </td> <td> <p><span>2.29</span></p> </td> <td> <p><span>1</span></p> </td> <td> <p><span>NA</span></p> </td> </tr> <tr> <td> <p><span>(ECA)</span></p> </td> <td> <p><span>Encana</span></p> </td> <td> <p><span>NA</span></p> </td> <td> <p><span>2.38</span></p> </td> <td> <p><span>2.6</span></p> </td> <td> <p><span>NA</span></p> </td> </tr> <tr> <td> <p><span>(OXY)</span></p> </td> <td> <p><span>Occidental Petroleum</span></p> </td> <td> <p><span>11.33</span></p> </td> <td> <p><span>2.77</span></p> </td> <td> <p><span>1.65</span></p> </td> <td> <p><span>NA</span></p> </td> </tr> <tr> <td> <p><span>(APC)</span></p> </td> <td> <p><span>Anadarko Petroleum</span></p> </td> <td> <p><span>21.57</span></p> </td> <td> <p><span>2.82</span></p> </td> <td> <p><span>1.91</span></p> </td> <td> <p><span>NA</span></p> </td> </tr> <tr> <td> <p><span>(EOG)</span></p> </td> <td> <p><span>EOG Resources</span></p> </td> <td> <p><span>28.3</span></p> </td> <td> <p><span>2.96</span></p> </td> <td> <p><span>2.46</span></p> </td> <td> <p><span>NA</span></p> </td> </tr> <tr> <td> <p><span>(SWN)</span></p> </td> <td> <p><span>Southwestern Energy</span></p> </td> <td> <p><span>NA</span></p> </td> <td> <p><span>4.32</span></p> </td> <td> <p><span>3.57</span></p> </td> <td> <p><span>NA</span></p> </td> </tr> <tr> <td> <p><span>(PXD)</span></p> </td> <td> <p><span>Pioneer Natural Resources</span></p> </td> <td> <p><span>51.56</span></p> </td> <td> <p><span>4.45</span></p> </td> <td> <p><span>2.43</span></p> </td> <td> <p><span>NA</span></p> </td> </tr> <tr> <td> <p><span>(NBL)</span></p> </td> <td> <p><span>Noble Energy</span></p> </td> <td> <p><span>49.21</span></p> </td> <td> <p><span>4.63</span></p> </td> <td> <p><span>2.35</span></p> </td> <td> <p><span>NA</span></p> </td> </tr> <tr> <td> <p><span>(CLR)</span></p> </td> <td> <p><span>Continental Resources</span></p> </td> <td> <p><span>35.96</span></p> </td> <td> <p><span>7.53</span></p> </td> <td> <p><span>5.14</span></p> </td> <td> <p><span>NA</span></p> </td> </tr> <tr> <td> <p><span>(RRC)</span></p> </td> <td> <p><span>Range Resources</span></p> </td> <td> <p><span>NA</span></p> </td> <td> <p><span>7.82</span></p> </td> <td> <p><span>4.7</span></p> </td> <td> <p><span>NA</span></p> </td> </tr> <tr> <td> <p><span>(COG)</span></p> </td> <td> <p><span>Cabot Oil & Gas</span></p> </td> <td> <p><span>88.29</span></p> </td> <td> <p><span>9.43</span></p> </td> <td> <p><span>4.94</span></p> </td> <td> <p><span>NA</span></p> </td> </tr> </tbody> </table>

Many of these firms are heavily investing in new projects, making cash flow multiples almost useless as a basis of comparison. I am also hesitant to use price-to-book multiples because failed drilling is often capitalized on the balance sheet (though it doesn’t have much economic value at all). Based on price-to-sales and price-to-earnings multiples, Exxon Mobil and Chevron are particularly attractive investments right now.

BillEdson11 has no position in any stocks mentioned. The Motley Fool recommends Chevron. The Motley Fool owns shares of 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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