Oil and Gas Firms: More Oil, Less Gas
Chris is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Surely you have heard of Chesapeake Energy’s (NYSE: CHK) woes. Chesapeake CEO Aubrey McClendon leveraged the company to the max – then leveraged some more. Now the company is making $13 to $14 billion in asset sales this year to cover its investments in drilling. In oil drilling, that is.
Chesapeake is one example of a major firm that has stopped drilling for natural gas and started heavier drilling for oil as natural gas prices fell to decade-low levels. Now, Chesapeake is even selling some of its rich natural gas assets to others like Royal Dutch Shell (NYSE: RDS-A) so it can raise cash to invest even more into oil drilling.
Plains Exploration and Production (NYSE: PXP) is moving in this same direction. Plains bought a stake in the Gulf of Mexico, an area the firm has not traversed since BP’s (NYSE: BP) Deepwater Horizon spill in 2010. The deal wades Plains back into deep waters.
In all, Plains spent just north of $6 billion to finance its way back into the Gulf, a move that Plains CEO James Flores says: “… will be the first opportunity for an independent to do that in the deep water because the infrastructure has been so expensive.”
Plains scooped up the assets from large firms BP and Royal Dutch Shell. BP earned roughly $5.5 billion from selling its stake while Royal Dutch Shell pulled in $560 million from the deal. Royal Dutch Shell has been in a flurry of asset sales lately, recently buying part of Chesapeake’s natural gas stake in Texas’ Permian Basin.
Risk wise, Flores made a wise move by acquiring his way into the region instead of exploring or forming a joint venture. Exploration costs run high, and the exploring firm risks not finding any usable assets. Joint ventures for exploration operate the same way, except that losses are shared with one or multiple partners. Though the move is risky, Mr. Flores executed well.
Where Can We Find Profits?
Since finalizing the deal, Plains has quickly laid plans to profit from its asset acquisition. The company plans to bump its offshore payroll to 300 workers, and it expects to boost production an incredible 40%. If Plains hits its marks, then production efficiencies will quickly produce strong earnings.
However, the deal is not without controversy. Plains took on $7 billion in debt to fund the acquisition, and critics believe that cash flow will be hampered for years. Plains hopes to add some stability to its cash flow by hedging oil prices in the futures markets. Hedging oil will at least give the firm a consistent price for each barrel of oil.
Finally, some have criticized Plains for buying oil assets when oil prices are high and selling natural gas assets when prices are low. This, of course, is not a sustainable strategy. But – Plains could reap strong profits right now if it gets its math right – meaning that locking in costs now and a favorable oil price for future years could create a steady spread.
Personally, I find Plains’ move into deep water offshore drilling a very risky play. Typically only the “big boys” have the resources to drill there, but it looks like Plains is taking its shot for success. In order to achieve the goal, the company has saddled itself with considerable debt, and it sold some favorable natural gas properties to BP and Royal Dutch Shell.
The question that I pose is this – why are BP and Royal Dutch Shell buying? Do they plan to drill, or are they simply buying assets on the cheap, hoping to sell the assets again when natural gas prices reverse. To me it does not make much difference. The firms appear to simply be capitalizing on Chesapeake's and Plains' gambling mentality.
ChrisMarasco has no positions in the stocks mentioned above. The Motley Fool has the following options: long JAN 2013 $16.00 calls on Chesapeake Energy, long JAN 2013 $25.00 calls on Chesapeake Energy, long JAN 2014 $20.00 calls on Chesapeake Energy, and long JAN 2014 $30.00 calls on Chesapeake Energy. 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.