Splitting Up the Shale Oil Revolution

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The Houston-based oil companies ConocoPhillips (NYSE: COP), Marathon Oil (NYSE: MRO) and Noble Energy (NYSE: NBL) have announced that they will spend $15.8 billion, $5.2 billion and $3.9 billion, respectively, in capital expenditure next year. ConocoPhillips will spend most of its budget on North American oil and gas production projects, 65% of Marathon Oil’s will go towards its oil assets, and 43% of Noble’s will be allocated to the Denver-Julesburg Basin. All will be focused on U.S. shale developments.

ConocoPhillips’ budget for 2013 is roughly same as this year’s. It has been on a drive to sell underperforming assets and intends to raise as much as $20 billion in three years to focus on less risky and more lucrative North American projects, particularly unconventional shale. Most of its 2013 CAPEX will be funded from these disposals. Recently, it announced its intention to sell its 8.4% stake in the Kashagan oil field near Kazakhstan for $5 billion to India’s ONGC Videsh Ltd. The company has raised $2.1 billion in 2012 from asset sales through the end of September while the ONGC deal is expected to close by the end of June 2013, putting it on track to raise the projected $8 billion-$10 billion by the end of 2013.

Meanwhile, a consortium of Indian oil companies, including ONGC, is vying to purchase ConocoPhillips’ Canadian oil sands assets valued at around $5 billion. Since the asset sale is not a takeover bid, Canadian regulators are not going to be as involved, as was in the case of China’s CNOOC bid for Nexen and Malaysia’s Petronas’ for Progress Energy, which were approved only after months of negotiations.

Earlier this year, ConocoPhillips spun off its refining unit to create Phillips 66 (NYSE: PSX), which caused a dip in its share price and market cap to $70 billion. Phillips 66’s market cap is $33.20 billion and its stock has risen by as much as 62% since its inception in May 2012, making up for the 18% dip in the value of ConocoPhillips’s stock in the same period, making that a very effective way to unlock shareholder value.

ConocoPhillips’s strategy to focus on North American shale is also being followed by Marathon Oil and Noble Energy. Like ConocoPhillips, Marathon Oil also spun off one of its business units about a year ago. Marathon Petroleum (NYSE: MPC) listed on the NYSE in July 2011.  Marathon Petroleum focuses on downstream operations and petroleum assets while Marathon Oil aims to be targeted specifically at U.S. shale oil. Like ConocoPhillips and Phillips 66, the 18-month old MPC has been up 65% since its birth while Marathon Oil recovered some of the value lost over the corresponding period.  In both cases, splitting the company off created cleaner investment vehicles for price discovery by investors. 

<table> <tbody> <tr> <td> <p><strong> </strong></p> </td> <td> <p><strong>COP</strong></p> </td> <td> <p><strong>PSX</strong></p> </td> <td> <p><strong>MRO</strong></p> </td> <td> <p><strong>MPC</strong></p> </td> <td> <p><strong>NBL</strong></p> </td> </tr> <tr> <td> <p><strong>YTD Stock</strong></p> </td> <td> <p><strong>-20.13%</strong></p> </td> <td> <p><strong>+61.93%</strong></p> </td> <td> <p><strong>+4.24%</strong></p> </td> <td> <p><strong>+84.79%</strong></p> </td> <td> <p><strong>+7.87%</strong></p> </td> </tr> <tr> <td> <p><strong>P/E</strong></p> </td> <td> <p>7.15</p> </td> <td> <p>6.12</p> </td> <td> <p>11.96</p> </td> <td> <p>8.36</p> </td> <td> <p>37.66</p> </td> </tr> <tr> <td> <p><strong>EPS</strong></p> </td> <td> <p>8.14</p> </td> <td> <p>8.67</p> </td> <td> <p>2.55</p> </td> <td> <p>7.36</p> </td> <td> <p>2.7</p> </td> </tr> <tr> <td> <p><strong>Yield</strong></p> </td> <td> <p>4.50%</p> </td> <td> <p>1.90%</p> </td> <td> <p>2.30%</p> </td> <td> <p>2.30%</p> </td> <td> <p>1.00%</p> </td> </tr> <tr> <td> <p><strong>ROA</strong></p> </td> <td> <p>6.33%</p> </td> <td> <p>4.26%</p> </td> <td> <p>5.40%</p> </td> <td> <p>9.12%</p> </td> <td> <p>1.80%</p> </td> </tr> <tr> <td> <p><strong>ROE</strong></p> </td> <td> <p>15.44%</p> </td> <td> <p>23.13%</p> </td> <td> <p>10.07%</p> </td> <td> <p>23.79%</p> </td> <td> <p>5.30%</p> </td> </tr> </tbody> </table>

In 2012, Marathon spent almost half of its annual budget on the Eagle Ford shale basin in Texas while next year, about one third of its $5.2 billion budget will go towards Eagle Ford. Out of the $3.9 billion, Noble Energy will spend 60% of it in onshore U.S. projects. The company, like ConocoPhillips, also plans to divest from its non-core assets that produce 23 million barrels of oil equivalent per day (boepd) and focus on two of its core areas: the Denver-Julesburg Basin and the Marcellus Shale formation. ConocoPhillips will also spend more than $4 billion on drilling and infrastructural operations of unconventional shale, particularly in Eagle Ford where it is one of the biggest players. In its previous quarter, ConocoPhillips extracted 86,000 boepd at Eagle Ford. This output level is expected to increase to 100,000 boepd in Q4.

The U.S. shale gas and oil story is one of the most compelling in the markets today.  The relatively high costs of extraction will place a bid under the price of crude oil, but as this plays out over the next decade there will be fabulous opportunities for investors.  I like the downstream and transport players in this industry more than I do the producers.  Because of this, Marathon and Conoco-Phillips splitting off their refining and distribution businesses were excellent moves, making those stocks more attractive than the parent companies who still bear both the regulatory and capital risk of drilling.  The cap-ex numbers discussed at the beginning of this article bear this out. 


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