A Look at 3 Major Oil and Gas Stocks
David is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Relative to, say, consumer goods companies, natural resource companies can be very daunting to value. It's seemingly easy to project out a growth rate for a widget maker: You have normal real GDP growth of 2.5% and then an assumption to make about whether the company can outperform or underperform the broader market. But oil and gas stocks follow commodity prices, which can't be controlled by any one domestic producer. So let's take a look at commodity prices.
In 2008, crude oil prices reached an all-time high of $147.27 per barrel. This is 5.9x the 150-year average price of $25 (2010 dollars) per barrel between 1861-2011. The post World War II era has also only averaged $20.53 per barrel in 2010 prices. World oil prices since 1970 averaged $37.93 per barrel. After crashing from the ~$150 high between 2Q08 and the end of 4Q08, prices hit a low of ~$33 per barrel. WTI crude is now at around $91.
If oil prices could be set based on equilibrium prices, they would be around $45 per barrel today. But unrest in the Middle East, supply uncertainty in Asia and Venezuela, and sanctions against Iran have pushed up prices. With unconventional resources expected to make up 50% of North American production over the next decade, could oil prices crash? While that question is beyond the scope of this article, I will say for now that I believe there is an inevitable secular transition towards natural gas that is being largely ignored by the "forward-thinking" market. Below, I highlight some important points about oil-concentrated producers Exxon and Chevron and a more heavily-concentrated natural gas producer, Chesapeake Energy.
Exxon has the greatest economic moat of all oil and gas companies by virtue of its size. It has 24.9 billion bbls in proven reserves: 16.1 billion bbls is developed and 8.8 billion bbls is undeveloped. The resource base is 97 billion bbls. Below, I include the locations of developed and undeveloped proven reserves.
As you can see, four-fifths of proven developed reserves come from Asia, US, and Europe, roughly half of which are in Asia. But a lot of potential is coming from Canada and South America, where 16% of proven undeveloped reserves can be found.
Between 2009 and 2011, production gradually increased from 3.9 mboe/d to 4.5 mboe/d. At that rate, it would take 9.8 years to extract the proven developed reserves and 15.2 years to also tackle the undeveloped. The rate is likely to slow from oil well maturation, so these numbers understate the reserve life. In total, at 9x past earnings, Exxon looks relatively cheap for such a strong producer.
To get a sense of Exxon's immense value, consider this: If you project a consistent production rate of 4.5 mboe/d over a 15.2 years and $91.33 per barrel, just the proven reserves would generate sales worth a present value of nearly $1.15 trillion. A consistent $60 per barrel would generate a still-impressive $750+ million. Both figures discount future streams of oil equivalent sales by the industry standard 10%. The current developed reserves, again, mature over time, and this will cause production rates to slow. That delay in turn reduces the present value, since there would be more discounting. The hope is that management can use its cash flow to acquire more and more resources. Factor in 15.6 million net acres, and the company looks cheap at only $388 billion.
Exxon has devoted $37 billion per year between 2012 and 2016 to increase production by 1 mboe/d. It has a triple A credit rating from Argus and can get very cheap debt because of its moat. In addition, Exxon has significantly increased its exposure to natural gas through acquiring XTO Energy and now has 76 Tcf worth of it. But its heavy risk-mitigating diversification has consequentially lowered upside.
Chevron is still a relatively safe major oil and gas investment, but it is more concentrated towards a liquids shift. The company has also seen two new offshore gas discoveries near Australia, which makes the 19th in three years. Chevron has also teamed up with Sinopec to develop China's shale gas. Shell has done the same, and so has Conoco, but Exxon has been behind the race that is sure to benefit from the Chinese government's vision to increase output to 6.5 Bcf by 2015 and 100 Bcf by 2020. It's not a far out vision either: Chinese upstream producers have already done some training in North America to improve their capability. Chevron has further taken actionable steps to grow value: (1) It signed partnership deals with YPF to begin exploring Argentina's shale plays--the goal is for 100 non-conventional wells at a $1 billion cost. (2) It also reached an agreement with Apache to acquire the Pacific Trail Pipeline and Kitimat LNG project for exposure to natural gas and petroleum right in British Columbia. This shift towards natural gas makes sense...
Chesapeake Energy (NYSE: CHK): King of Natural Gas
Unconventional resources, such as shale gas, have opened a new alternative to expensive crude oil. Natural gas is priced at $3.47 per MMBtu, or a little over $20 per barrel of oil equivalent. The US Energy Information Agency has called hydraulic fracturing a "a game-changer in the making," and natural gas development will drive a surplus of 5-7 million bpd by 2017 as global production hits 102 million bpd. As already mentioned above, the US economy is moving towards unconventional shale, and the Chinese government is pushing likewise. While Chesapeake is obviously a beneficiary of greater demand, it is effectively concentrated in the United States, unlike Chevron.
The upside is still very strong. Chesapeake has been selling off assets to improve its financial position, but many companies are seeking to do the same thing. With too many dollars chasing too few buyers, the result is an obviously poor and desperate financial position. However, this has already been well factored into the stock price. Chesapeake generated $5.9 billion in FY2011, and it is currently worth less than twice that amount as a whole. With Carl Icahn upping his stake to 8.89%, board accountability to shareholders is only likely to improve even more from here. The specific goal right now is to improve the firm's financial position so that it can properly capitalize on its second leading natural gas position when commodity prices improve.
Some have lamented that Chesapeake is not clearing off debt fast enough. But as Canaccord Genuity correctly notes, if the company is successful in just meeting $2.5-$3 billion in proceeds, net debt to EBITDA will remain under 3x through 2017. That would be a huge headwind off the terrific volume sales during an improved economy. While natural gas prices have struggled in recent months from warmer than average weather and greater demand declines than supply declines, the variables are in order for a long-term tailwind. I encourage buying Chesapeake off of this bet.
TakeoverAnalyst has no positions in the stocks mentioned above. The Motley Fool owns shares of ExxonMobil and has the following options: long JAN 2013 $16.00 calls on Chesapeake Energy, long JAN 2014 $20.00 calls on Chesapeake Energy, long JAN 2014 $30.00 calls on Chesapeake Energy, and short JAN 2014 $15.00 puts on Chesapeake Energy. Motley Fool newsletter services recommend Chevron. 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!