A few weeks ago a wrote an article
in which I suggested a plan for the larger oil companies like Exxon (XOM
), Shell (RDS.A
) and Chevron (CVX
). Use the reasonably valued stock of those companies to go on an acquisition binge and buy up unconventional producers which are trading at lower multiples, yet have years and years of growth in front of them.
It only makes sense to me that this would be accretive for the oil majors. Trade stock in no growth company for stock in a rapidly growing company when both are valued the same by Mr. Market.
It is no secret that the oil majors as a group have all basically stopped growing production and reserves. The reason for this is fairly simple. There just isn’t very much conventional oil left to be found on the globe, and the stuff that we are finding is in difficult or even dangerous locations. Consider the recent production growth numbers for some of the larger oil companies:
Here is Deutsche’s summary of the greatest second quarter drops in global liquids production, ranked by the volume decline (percentage decline in parens). Libya was a factor for most though not for BP, which saw the largest drop.
BP (BP) -11% (-254,000 barrels per day)
ENI (ENI) -19% (-187,000)
Total (TOT) -10% (-130,000)
Repsol (OTCQX:REPYY) -26% (-117,000)
Lukoil (OTCPK:LUKOY) -6% (-103,000)
ConocoPhillips (COP) -10% (-95,000, ex Lukoil)
Statoil (STO) – 8% (-76,000)
Chevron (CVX) -2% (-44,000)
Murphy Oil (MUR) – 29% (-38,000)
Hess (HES) -12% (-37,000)
Occidental Petroleum (OXY) -6% (-33,000)
Sinopec Shanghai Petrochemical (SHI) -2% (-16,000)
Woodside Petroleum (OTCPK:WOPEF) -26% (-16,000)
This problem of not being able to grow production or reserves is not going to go away for the oil majors without a change in strategy. I don’t think that spending billions to explore is the answer, unless that exploring is done on Wall Street.
I’ve written a few times about how I think an oil major should move fast and swallow Chesapeake Energy (CHK
) and lock up its enormous base of unconventional acreage in the United States. I often hear comments that this is not viable because Chesapeake is already too big for a major to purchase. That might be true for an all cash deal, but how about doing it with stock instead? Same premise, an oil major uses its equity trading at 6 times cash flow to acquire Chesapeake at a similar or slightly higher multiple. The oil major has no growth ahead of it. Chesapeake has an inventory that allows for 25 years of growth ahead of it. Take advantage of Mr. Market valuing no-growth and growth at the same multiple.
Same Idea Different Source of Oil
My original idea was for the majors to start acquiring companies focused on unconventional players by taking advantage of Mr. Market ignoring growth in his valuation. I was looking at some of the larger Canadian oil sands players and the same strategy would be effective here in my opinion. If an Exxon or a Shell targeted one of the big boys like Suncor there would be enough oil reserves added to take care of concerns of replacing production for years.
Consider how these companies are being valued today:
- Enterprise value $416 billion
- Enterprise value / EBITA = 5.3
Royal Dutch Shell (RDS.A
- Enterprise value $260 billion
- Enterprise value / EBITA = 5.1
- Enterprise value $59 billion
- Enterprise value/EBITA = 5.3
Exact same multiples of EBITA. Completely different growth profiles.
How can companies with virtually no ability to growth production be priced at the same multiple as a company that has a reserve base that guarantees production growth for as far as the eye can see?
In the most recent presentation
Suncor lays out the expected growth in production through 2020.
From a current production base of roughly 500,000 barrels a day Suncor is planning to hit 1 million barrels a day by 2020. That is a CAGR of about 8% per year. Suncor doesn’t have to go out and find new oil reserves in order to create this growth. There is no exploration risk.
If anything there is a pretty likely chance that there will be technological improvements in oil sands development that increase the amount of oil that can be produced and expedite how quickly it can be done.
I think of the Suncor valuation like this:
- You buy 500,000 barrels a day of production at a very reasonable multiple of EBITA
- Growth in that production is virtually assured
- Technological improvements are likely to increase the amount of oil Suncor can develop and make it more economical
- The price of oil is likely to increase the value of production and reserves
- 7 billion barrels of 2P reserves against a 59 billion enterprise value is around $8 per barrel
- 20 billion barrels of contingent reserves
I think for an Exxon or a Shell trading stock for stock in Suncor is a no-brainer. Given my feelings on the price of oil Suncor as a long term investment for me is starting to feel like a no-brainer as well. This isn’t something that is going to double overnight or in a year. But over a ten year period it seems extremely likely that at worst the stock price appreciation should follow the 8% per year of production growth higher.
Since 1992 Suncor’s stock has delivered 23% annualized to shareholders because steady production growth and increasing oil prices. That sounds like a recipe set to continue over the next decade as well.