The Latent Long Term Risk in Oil Stocks
Joshua is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Oil is a finite resource. Even with the growth of non-conventional reserves, western companies are struggling to replace their reserves. The shrinkage of the reserve to production ratio (R/P ratio) is not visible over a quarter, but over decades the trend becomes obvious. This paper points out how from 1973 to 2003 the world's R/P actually increased while the non-OPEC R/P ratio decreased from 23 to 16. It would be easy to think that the boom after 2005 would have changed the situation, but the reality has stayed the same. Even with non-conventional reserves such as synthetic oil and the oil sands, ExxonMobil (NYSE: XOM) has a total liquids R/P ratio of 14.5 based on their 2011 annual report.
The shrinking R/P ratio is a hidden risk which should not be ignored. If firms cannot find politically and geologically accessible reserves then their volumes and revenue will eventually suffer. Upstream companies are facing more competition not only from each other, but also from foreign actors. This map shows how a large portion of the world's reserves are found in politically unstable nations, which are commonly hostile to western firms. National oil companies are common in such nations and they exist as a branch of their perspective governments. These nations look after their own interests and at times decide not to increase production in order to focus on national economic interests. Even though reserves have increased it does not imply that such reserves will be extracted.
Large integrated producers
ExxonMobil is one of the major oil companies and they provide a template for the industry. They carry little debt with a total debt to equity ratio of .07 and a very strong ROI of 25.2%. They have a number of expansion projects like the Kearl project in Alberta's oil sands, deepwater development in the Gulf of Mexico, and deepwater in Angola. ExxonMobil does not suffer from a lack of financial resources, but that is not able to change the geological reality. With their 2011 R/P ratio of 14.5, reserves may become uncomfortably low by the end of the decade. The silver lining to the story is that their downstream resources provide a balance to upstream challenges. Even though reserves are becoming harder to replace they are still able to use their refineries to process imported oil.
Total SA. (NYSE: TOT) is another large integrated oil company facing the same situation. Based on their 2011 report they have a R/P ratio of 13.0 excluding the share of equity affiliates. Replacing such reserves will prove to be a challenge. Geopolitical instability and challenging non-conventional resources create a large amount of ambiguity. Total's debt to equity ratio of .48 is one number to watch. Their ROI is currently 10.7% which is much lower than ExxonMobil's. In addition to their downstream segments they have decided to branch out and expand into other energy sectors. Total has invested over $1.4 billion in Sun Power. This is a very positive sign as it shows that Total is looking beyond traditional crude oil into other types of energy sources.
The adoption of solar is a gradual process, but over the coming decades the industry is expected to see strong growth. Recently the industry has been going through a rough patch. Between Chinese oversupply and the subsequent price wars manufactures have suffered. SUNPOWER (NASDAQ: SPWR) finally posted positive normalized income in the latest quarter. 2013 is still unclear with analysts's estimates varying between an EPS of $.14 to a loss of -$.34 per share. SunPower's total debt to equity ratio of .74 is on the high side, but less than that of some of their competitors. The company is vertically integrated and uses leasing to help decrease the upfront cost to the end customer. They focus on high efficiency technology to help reduce the overall footprint of the installation. Like any good value play they are currently trading at a discount with a price to book ratio of .85.
First Solar (NASDAQ: FSLR) is another strong solar manufacturer with a total debt to equity ratio of only .15. Unlike SunPower they are expected to be profitable in 2013 with an expected EPS of $4.02. Based on their current share price of $31.17 the company is trading at a 2013 P/E ratio of 7.6. First Solar focuses on thin film technology which is cheap but less efficient. Their gross margin of 32.8% is very strong, but in the long term First Solar's low efficiency may prove to be a stumbling block. This company is trading at a very low price and shouldn't be ignored.
Oil has become harder to find and the declining R/P ratio amongst western companies shows this. Total's P/E ratio of 8.9 and ExxonMobil's P/E ratio of 9.6 show how uncertainty has helped to price a strong discount into these firms. With their downstream assets and investments in non-petroleum sectors, these firms should be able to manage the shift to a less oil-dependent world. These companies are quality firms and trading at great prices. Regardless, investors should be aware of the underlying reserve constraints and consider additional investments in alternative energies to help buffer their portfolio. SunPower and First Solar are two solar manufacturers to consider.
MrCanadian1 has no position in any stocks mentioned. The Motley Fool recommends Total SA. (ADR). 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!