Eastern Europe is eyeing energy independence through a shale gas revolution. The region has traditionally relied on Russia for its energy needs. Poland is the largest European Union economy in Eastern Europe which has recently shown an impressive 0.8% quarterly economic growth indicating an economic upswing. Poland was betting its energy independence on its massive shale gas reserves. But things turned sour when exploration firms found less gas and estimates were drastically cut as energy firms started packing their bags to leave the country. But the U.S oil major Chevron Corp (CVX) is still betting on Poland's unconventional resources.
In this article, I will discuss the initial signs of improvement shown by the Polish economy, its shale gas ambitions and the dominant role that Chevron is now playing in the country. Although the article is mostly about Chevron and Poland's shale gas ambitions, I would also like to highlight the recent rally of the two Polish ETFs.
According to Bloomberg's survey, Poland's recent GDP growth number was above market's growth expectations of 0.5% to 0.7%. Warsaw-listed BRE Bank SA has identified that real income growth, low interest rates and the end of the savings cycle has caused an increase in consumption. The country's PMI also switched to expansion gear by rising to 51.1 in July from 49.3 a month before. With more signs of improvement, Poland's outlook appears brighter now than it did in the previous quarter. The country's capital markets are represented by iShares MSCI Poland Capped ETF (EPOL) and Market Vectors Poland ETF (PLND).
The larger iShares MSCI Poland Capped ETF has a basket of 43 equities and represents some of the biggest Polish firms. Both iShares MSCI Poland Capped ETF and Market Vectors Poland ETF have similar P/E and expense ratios and allocate more than 40% of their funds to the financial sector. However, investors should be extra careful before putting their money into Market Vectors Poland ETF since it's a very small size ETF with net assets of just $28.1 million.
PKO Bank Polski
Powszechny Zaklad Ubezpieczen
The Polish economy is closely linked with Eurozone economies. Therefore the iShares MSCI Poland Capped ETF and Market Vectors Poland ETF could be an interesting play not only during times of Poland's accelerated growth but also during Europe's recovery. Overall, the iShares MSCI Poland Capped ETF has fallen by 2% this year while Market Vectors Poland ETF is up by just 1.16%. But since July, following better than expected growth in economy, the two ETFs are up nearly 17%.
This trend is also evident in the fund flows. In the first half of the current year, iShares MSCI Poland Capped ETF recorded net inflows of $1.51 million while Market Vectors Poland ETF witnessed net outflows of $4.21 million. But since the beginning of H2-2013, iShares MSCI Poland Capped ETF has reported net inflows of $142.1 million while Market Vectors Poland has broke even.
With renewed optimism regarding Poland's economy and some stability in the Eurozone, I believe there is reason to be bullish on iShares MSCI Poland Capped ETF and Market Vectors Poland ETF.
Shale Ambitions Cut Short
Poland's shale ambitions received a setback when it was discovered that the country didn't have as big reserves as it would have liked. The U.S Energy Information Administration has reduced Poland's shale gas estimates from 187 trillion cubic feet in 2011 to 148 trillion in a report published two months ago.
However, this wasn't a surprise as Exxon Mobil (XOM) had left last year which was followed by the exit of Marathon Oil (MRO) and Canada's Talisman Energy (TLM) earlier this year. The foreign energy firms' problems in Poland were summed up perfectly by a Talisman executive as "geological uncertainty and unclear legal framework." Meanwhile the international environmental agencies are critically analyzing the shale projects of local and international firms.
Chevron: Still Confident
But Chevron is still willing to bet big on Poland. Despite the reduction in estimates, Poland still has huge reserves. While some of the earlier anticipated and highly optimistic reserve numbers could provide energy to Poland for 300 years, the current more realistic estimates are still enough to fuel the nation for several decades.
Despite enormous challenges, Chevron is willing to stick around for another five years and is expecting support from the government - which, I believe, will come in abundance.
Chevron has been leading shale gas development work in Eastern Europe. The company has exploration licenses for more than 5.6 million acres in Poland, Bulgaria, Lithuania, Romania and Ukraine while it is eyeing an additional 450,000 acres in Ukraine. In Poland, it could very well be operating a total of six wells by the end of the current year. According to the most recent data, Chevron owns 4 out of 108 shale gas exploration concessions awarded by the Polish government.
Chevron's Quarterly Results
Chevron's previous results were a disappointment as its revenues dropped by 8.4% to $57.37 billion while net income fell by 25.6% to $5.36 billion. Since the announcement of its results, its stock is down 3.5% and is currently looking attractive from a valuation standpoint given that it's a well established energy giant. Its P/E ratio is just 9.89, which is below the industry's average of 12.35. Its financial position is as solid as ever. Its debt/equity ratio is just 13.98, well below the industry's average of 29. It has been under margin pressure due to repair work at its refineries in the U.S which has hit its downstream earnings while the shrinking WTI-Brent spread would create long-term problem for all players in the industry. But overall it has operated on a net profit margin of 10.42, far above industry's 5.70%. As a result, it has generated a solid return on equity of 17.62%.
The exploration and production work at shale formations in Eastern Europe is still in very early stage therefore Chevron has taken a logical decision to first finish its homework before announcing its verdict.
The Polish government is already under pressure following the exit of three leading oil firms. It simply doesn't have the technological ability to frack on its own. If Poland (and the rest of Eastern Europe) wants less reliance on Russian imports then it has few options but to extend full cooperation to Chevron. The Polish Premier Donald Tusk and his team are currently working on regulation which would be implemented in the near future. Chevron and other operators are also expecting tax breaks for the next seven years while the government will also cooperate to convert the current exploration licenses to more lucrative production licenses. The business environment will become less challenging in the coming years. During its exploration activities, if Chevron discovers even a small part of the 148 trillion cubic feet of reserves, then it could yield significant returns in the long run.