Bazhenov or Bust

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

Hydraulic fracturing of the Bakken oil shale in North America exemplifies how America can shake itself loose from OPEC and other oil exporting countries.  Think of the size of the Bakken and its 800,000 b/d from North Dakota alone and multiply that by 80.  Then you’ll have another oil shale formation known as Bazhenov.  Located in Western Siberia, the Bazhenov oil shale currently produces about 400,000 b/d; hopes are for at least doubling that production using modern “tight oil” extraction technology.  

Russia needs this new oil production.  Russians traditionally maintain their oil fields poorly and subsequently experienced a decline in production.  Mr. Putin needs Ural oil to sell for as much as $150/b to finance his campaign promises.  Latest oil prices come in around $117/b.  I doubt Mr. Putin can somehow compel oil prices to rise to $150/b, so Russia will have to make up for the lower price with higher export volume.  To do this, Russia needs foreign tight oil technology.

Who Wants to Deal With the Russians?

If you’re like me, your first reaction to the idea of a Western oil company doing business with Russia is, “Are they nuts?”  Let’s face it; Russia hardly exemplifies democracy, free enterprise, private property rights, and the rule of law.  Ask British Petroleum about all that.  However, ExxonMobil (NYSE: XOM) and Statoil (NYSE: STO) have signed deals with the Russian firm Resnoft to help extract oil from the Bazhenov.  The key: Rosneft has an equity stake in Exxon and Statoil fields.  So if Russia seizes Exxon’s stake in the Bazhenov, Exxon will seize Rosneft’s stake in the Exxon field.  Ditto Statoil.  Referred by some as “hostage taking,” I see it more as a financial balance of terror, not unlike the military balance of terror during the Cold War.

Big is Beautiful

I think Exxon has the clout to pull this off.  The “hostage” strategy hedges its risk of loss and Russia can’t afford to alienate every foreign oil company around; eventually no one will come out to play with them.  Exxon also has been working in Russia for 15 years without major mishap, so it would seem both Exxon and Russia know how to play nice with each other.  Exxon should benefit as its oil and gas production dropped this past quarter.  In the past, Exxon pursued a strategy of accumulating oil assets when the markets went down.  The Bazhenov deal certainly fits with that strategy.  While this may hurt earnings in the near term, Exxon’s refining operations helped last quarter’s earnings to beat expectations.  And helped maintain the 57 cents/sh in dividends.  Exxon reports a 28% return on equity, a 10% profit margin, improving cash flow and $13 billion in cash.  These metrics, combined with share repurchasing, further leveraging of acquired XTO shale gas expertise and 120 reported upstream projects should help drive Exxon earnings and dividends in the future.

Not Sold on Statoil

I’m not terribly enthusiastic about Statoil as an investment.  Yes, it pays more in dividends than Exxon, sells at a lower PE ratio, and has a comparable return on equity.  Unlike Exxon, Statoil has not recovered in price since the 2009 stock market sell-off.  Additionally, Statoil is not only dealing with mercurial Russia, it’s dealing with temperamental Argentina.  You may recall a hissyfit between Spanish firm Repsol (NASDAQOTH: REPYY) and the Argentine government?  President Fernandez accused Repsol of not doing enough to develop Argentina’s shale gas fields in northern Patagonia, then nationalized them.  Well, looks like Statoil is going to get involved with the development of these fields.   

At least Statoil will have company; Chevron (NYSE: CVX) also expects to sign a deal with Argentina to develop these same fields.  Repsol hasn’t forgotten its little snit with Ms. Fernandez and is pursuing legal remedies for $10 billion.  Between the risk of nationalization and the Repsol lawsuits, I seriously wonder if this is such a good idea.  Details of the agreement between Argentina and Statoil (or anyone else for that matter) have yet to be released.  The Norwegian government is a large stakeholder in Statoil and I suspect that reduces the risk of Statoil losing its stake to nationalization. Still, Statoil is only one fifth the size of Exxon by market cap; getting involved with two countries with a history of seizing foreign assets, and doing so at the same time leaves me a little underwhelmed with Statoil.

Foolish Final Thoughts

Development of Bazhenov oil shale looks like a win-win for Exxon and Russia.  If Statoil can use the “hostage” strategy to successfully protect itself from the Russian government, they should do well, too.  Overall, I like Exxon best, for its experience and sheer size to deal with Russia.  Last year, they also had a major domestic oil find in the Hadrian 5 oil field in the Gulf of Mexico that should boost their production related earnings.  In good times and bad, Exxon increases its dividend.  In down markets they acquire oil fields, and in good markets reap the profits therein.  Even if the Bazhenov goes bust, Exxon will still be around, bringing returns to its investors.

 


dylan588 has no positions in the stocks mentioned above. The Motley Fool owns shares of ExxonMobil. Motley Fool newsletter services recommend Chevron and Statoil (ADR). 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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