Energy Exploration & Production Companies Still Bargains

Over the last two months we have issued about a dozen reports on energy companies subscribers should consider owning. We will probably issue another six to eight more over the next few months.

We do prefer the oil exploration and production companies; they are the focus of today’s report, Update.

Oil Exploration and Production Companies

By definition, exploration and production (E & P) companies focus on exploring for and producing oil and natural gas. They normally have no operations in refining, marketing, the transportation of energy or other ancillary businesses. When investing in energy companies, they are the purest play. Because that’s all they do, they are easier to analyze, understand and value.

Of the E & P companies we follow, we prefer the companies that have significant or a higher ratio of oil reserves versus natural gas. The global economy needs oil to run the hundreds of millions of cars (approximately 900 million and growing, only about 10 million are hybrids), trucks, planes, boats. Solar, wind and nuclear can’t be substituted for oil, gasoline.

The number of companies that have a high ratio of oil or large oil reserves is getting smaller. We’ve mentioned in past Updates that companies have been replacing their reserves with natural gas and less and less with oil. This is a dangerous trend for global oil consumers. Briefly, the reasons for this are many; nationalism, harder to find new oil reserves, costs, easier to replace reserves with natural gas.

We think these companies that have more oil reserves will become more valuable over time, and is one of the reasons why we prefer them.

Below is a list of the companies that we follow that have a significant amount of oil or have a high ratio of oil to gas.

These are the top companies we would recommend owning.

The reserve information is from 2006 annual reports. We will do an update on reserves for 2007 later in the year once we finish our anlaysis.

Let’s review the table:

The third row lists the amount of proved oil reserves each company has. APA, APC, and DVN all have around 1 billion barrels of oil. SU has the largest amount, but they are oil sands and are difficult and expensive to develop.

APA, APC and DVN would be our top picks of the 8 companies listed.

Some of oil giants have larger reserves (Exxon Mobil, XOM, has about proved reserves of 7.7 billion barrels of oil), but they have been having a difficult time replacing those reserves. They also have other businesses that aren’t as profitable. Also, they’re market caps are so big that we don’t see the type of appreciation we see for the companies we follow. For example, XOM’s market cap is about $466 billion; if the stock were to double, the market cap would be close to $1 trillion dollars. We doubt this would happen.

% of Oil, Oil to Natural Gas Ratio

The fourth row lists the oil to gas ratio for each company. The first four companies listed have the highest oil to gas ratios. PXD has less than 50%, but we added the company because of the low value and projected long life of its reserves.

Market Value Per Barrel

The fifth row, we believe is one of the most important valuation metrics investors should consider when investing in E & P companies, the market value of a proved barrel of oil.

It’s easy to calculate the market value of a proved barrel of oil. Let’s break it down with an example, SU.

Most financial, investment websites provide the market capitalization, but it is also easy to calculate. The market capitalization is the amount of money it would cost for a buyer to own 100% of the company; the cost to buy all of its shares.

The current price of SU is about $65 and the company has 927.01 million shares outstanding. To buy out the company it would cost $60.26 billion (927.01 million shares times current price $65), the market capitalization.

We now divide the market capitalization by the proved oil reserves to get the market value of its reserves, the amount the market is paying for those reserves.

$4.00 market value of SU’s barrel of oil = $60.26 billion (market cap) divided by 15.078 9billion barrels of oil). Investors are paying only $4 a barrel for SU reserves.

Some investors, analysts would argue that the market value of reserves is not a good measure of valuation because it takes time to pull out those reserves and therefore need to be discounted to present values.

We believe the valuation is not only fair but possibly conservative because the calculation does not include possible and probable reserves (if possible and probably reserves were included for some of the companies , the valuations would fall down to about $7 a barrel), potential new discoveries and the prospect that oil can get to $200 and above over the next few years.

The average market value of reserves of the companies on the list is only $15.76. These companies are still bargains.

In a deal late last month by XTO Energy Inc. (XTO), they paid $1.85 billion for drilling rights for an oil producing area near the U.S.-Canadian border. The land contains proved reserves of 68 million barrels of oil equivalent. That’s about $27.20 a barrel of equivalent, much higher than the average market value of the companies above.

Finding and Development (F & D) Costs Per Barrel 2006

The F & D costs of the group are as low as $14.51, OXY, and as high as $34. The larger companies normally have lower costs because of the scale of the projects they pursue. This is especially true of the big oil giants like XOM, CVX, COP, BP.

Notice that the costs are higher than the average market value of a barrel. The market is pricing the company’s oil less than their costs. Another metric that let’s us know these stocks are undervalued.

Market Capitalization Plus Debt

The last column is the market cap plus long-term debt, sometimes called enterprise value. Even though a company may take over a company by buying its shares, it still has the obligations of the takeover’s debts. Some investors and analysts prefer using a company’s enterprise value to calculate the value of the company’s reserves. Most of these companies have a low amount of debt compared to their total capitalization, so the difference between market cap and enterprise value is not great.

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