|
Even as
major oil companies enjoy high profits, declining production is putting
pressure on them to acquire assets that will keep production up. An
interesting buying season seems likely.
Synopsis:
It's
fascinating that so many investors realize that gold matters, while many
others try to knock it down. According to the naysayers, it's just a barbaric
metal sought out by crazy gold bugs. Though this view has become less common,
it's still present. And every time gold retreats, the media come out with
article after article proclaiming the end of gold. With the price tipping
over the $1,800 mark, the critics have been proven wrong again.
Just think
about how important gold has become to the market. When I open up the Bloomberg website, I'm greeted by
the prices of only a few indices and commodities: the DOW; S&P 500; Nasdaq; oil; the 10-year US Treasury note; and gold. The
same is true of Morningstar, which lists the prices of gold, oil, and natural
gas on the front page. Surely gold isn't on the front page because investors
are concerned about the future price of gold jewelry. In many ways, gold has
become a barometer of economic conditions.
Everyone
now realizes that gold is important. The people still bashing it to the
extreme are frankly in denial. No matter one's opinion on gold's
investment-worthiness, gold has become a factor that market participants must
follow closely. The market's perspective on the precious metal has come a long
way, and we likely still have further to go. In the meantime, we'll continue
to stay ahead of the curve.
Next, the
Casey Research energy team will discuss declining production among the major
oil companies. While profits have risen thanks to elevated oil prices,
production has decreased. As a result, these major oil companies with piles
of cash on hand will likely seek out new acquisitions to replace the
declining production.
A Battle for Oil Production Is Brewing
By the Casey Research Energy Team
High oil prices have put record earnings into the
coffers of the world's big oil companies, but those splashy headlines are
masking an industry-wide decline in oil production. Exxon Mobil (N.XOM),
Royal Dutch Shell (N.RDS-A), BP (N.BP), ConocoPhillips (N.COP),Chevron
(N.CVX), and others reported surging third-quarter profits alongside
production decreases – an unsustainable situation that is setting the
stage for a battle to buy producing assets.
Almost across the board, major oil companies are
producing less oil now than they were a year ago. It's not due to a lack of
exploration and development – these companies have all devoted billions
of dollars to finding new oil deposits. The problem is that for the most part
it will still take years – and many more dollars – before those
investments start producing.
In the meantime, big oil's output will keep
declining unless majors start using some of their record profits to buy up
producing assets from smaller companies. Oil wells produce less each year;
Exxon's oil fields, for example, are declining by 5 to 7% each year, which
means the company needs to add 200,000 to 300,000
barrels of production a day just to break even. This year, Exxon has not come
close – its production levels are down 8% compared to a year ago. Some
of the production decline stems from contractual limits on Exxon's
production, but even without those limits production would have still been
down more than 1%. Over the first nine months of the year, Exxon's production
averaged 2.33 million barrels of oil per day, the company's lowest average
since 2005.
Things are even worse for other major oil companies.
BP said oil production dropped 10.6% in the quarter, in terms of barrels of
oil equivalent (BOE). Shell's BOE production fell almost 2% in the quarter.
ConocoPhillips produced 6% fewer BOEs.
There's an important note to add about BOEs. The BOE
concept combines a company's oil, natural gas, and condensate output into a
single production number, based on energy equivalence. It takes roughly 6,000
cubic feet (cf) of natural gas to release the same
amount of energy that is in one barrel of oil, so companies book gas reserves
as "barrels of oil equivalent" using a ratio of 6,000 cf:1 barrel.
A problem arises when a company then values its reserve books using oil
prices. One barrel of oil may have the same energy content as 6,000 cf of natural gas, but in North America the barrel of oil
is worth something like US$86, while the 6,000 cf
of gas is worth only about US$22. Adding lots of natural gas to the books is
an easy way to make it appear that oil reserves are growing, but at a
fraction of the typical cost. And there are lots of inexpensive shale gas
deposits for sale.
The Casey energy team hates being misled in this
way, so we've created programs that calculate the real value of a company's
reserve book; using our methods often gives some very different results when
it comes to company valuations. We think this is one of the biggest frauds to
hit the energy sector in decades, and we make sure to steer our subscribers
away from companies that try to pass off gas reserves as equivalent to the
black gold that is crude oil.
Getting back to the story, oil output may be
stalling but oil prices have remained high enough to more than cover the
cracks. Exxon's profits jumped 41% in the third quarter to US$10.3 billion
because the company sold oil in the US for an average of $95.58 a barrel, a
35% increase compared to Q3 2010. For the same reason, Shell doubled its
earnings this Q3 compared to last, bringing in $7.3 billion. BP earned $4.9
billion in the quarter, a 175% year-over-year increase. Chevron pulled in
$6.2 billion in the third quarter, 74% more than last year. ConocoPhillips
exited Q3 with $3.5 billion in earnings, a 59% increase over 2010.
The pattern is pretty clear: big oil companies are
producing less but profiting more. With oil prices expected to remain
range-bound for the medium term (assuming no major supply disruptions), these
majors cannot rely on rising prices to keep their profits aloft in the
future. They need to boost production instead, especially given that global
oil demand is expected to increase by approximately 1.5% annually for the
next five years. Since it takes years to bring new discoveries online, the
short-term fix is to buy production.
With big oil's bank accounts full to the brim with
cash, the stage is set for some significant acquisition activity… or,
to put it another way, for a battle to buy producing assets. There are quite
a number of contestants in the battle – big oil companies are not only
competing against each other to sweep up good assets but also against the
national oil companies of developing, energy-hungry nations like China, South
Korea, and India. Oil demands are rising in these nations so quickly that
just to cover expected annual demand increases those three countries would
have to jointly spend $30 billion on acquisitions each year.
BHP Billiton's (N.BHP) move last quarter to buy Petrohawk Resources for $15 billion is exactly the kind
of purchase we are talking about. So is Statoil ASA's (N.STO) recent
$4.4-billion acquisition of Brigham Exploration. And the stars are aligning
just perfectly for big oil: They are making record profits; oil prices are
expected to remain strong; and the world's market turmoil has only pushed
their share prices down by some 20% over the last six months. Small to
mid-sized oil companies, on the other hand, have fared much worse, losing an
average of 35% to the economic uncertainty. The Statoil-Brigham deal is a
perfect example: Statoil offered a 34% premium over Brigham's 30-day average
trading price, yet the offer was still almost 4% below Brigham's 52-week
high. With that kind of discount available, the time for majors to start
bidding on small and mid-sized producers is ripe.
The Casey
Research energy team is analyzing all of these small and mid-sized producers
to determine the most likely takeover candidates. We will publish our results
in a special edition of our flagship publication, Casey Energy Report.
[Make no mistake, the end of easy oil is looming ever closer. But
savvy investors can profit handsomely from this turn of the tide… learn how you can be among
them.]
|
