2 Companies Poised To Profit From Peak Cheap Oil

Includes: SDRL, STO
by: Power Hedge

The price of benchmark WTI crude oil passed $100 per barrel on Wednesday for the first time in nearly four months, although it has since receded back below that level. One reason for this is that the government announced that U.S. crude supplies fell by 1.1 million barrels for the week ending Nov. 11. Other reasons that analysts gave for the rising prices were the increasing tensions in the Middle East due to Iran and production problems in Nigeria.

An increasing price of oil is good for oil companies and their shareholders. The stocks of oil and oil-related companies tend to rise and fall with the price of oil. Additionally, companies in the industry typically make more money when the price of oil is high. This is why oil company stocks are a good way to play oil prices.

A recent post on financial blog ZeroHedge makes the case for much higher oil prices going forward than what we have had in the past. The reasons for this conclusion are:

  1. Demand for oil, in both the United States and abroad, is not going anywhere. Most likely, demand will increase as the developing world continues to come online and the population in the United States continues to grow.
  2. Production of oil from conventional sources has peaked and will begin to decline as conventional oil reserves become depleted. Production from unconventional sources will increase to make up the difference. The world’s remaining reserves of oil are located in the Athabasca oil sands, various shale formations in the United States, under the ocean floor, in Arctic, and in other areas that are difficult or expensive to access.
  3. Tapping these remaining reserves of oil is expensive. This necessitates a higher price for oil to cover the costs involved in finding, recovering, and refining this oil.

Given these trends, it would make sense to have at least part of your portfolio devoted to oil companies. As unconventional production ramps up, companies operating in these areas should see growing profits from both the production increase and from higher oil prices. Here are a few companies that are well-positioned to prosper in that environment.

Statoil ASA (NYSE:STO) is a vertically-integrated multinational oil and gas company headquartered in Stavanger, Norway. Statoil was formed in 1972 by the Norwegian parliament to build up the Norwegian oil and gas industry and exploit the reserves found in the Norwegian Continental Shelf. The company was privatized in 2001, although the Norwegian government retained majority control. Today, the Norwegian government owns 67% of the total shares of the company.

Statoil has been undertaking great efforts to expand outside of the Norwegian Continental Shelf in recent years for a good reason. According to the Norwegian Petroleum Directorate, production from the North Sea and the Norwegian Continental Shelf is in a state of decline although recent discoveries could extend the production life of the life.

Statoil now has a significant presence in Brazil, the Eagle Ford shale, the Canadian oil sands, and the Williston Basin, among other areas. Statoil has very little exposure to the Middle East so they are unlikely to be affected should tensions (perhaps involving Iran or the recent clashes in Cairo) flare in that area. Statoil does have a presence in Nigeria, including a 20.21% stake in the Agbami field off of the Nigerian coast. Nigerian production is not a large percentage of Statoil’s total production, however.

Statoil has the stated goal of increasing their total production to 2,500 mboe per day by 2020. This would be 47.75% production growth over the levels achieved in the most recent quarter. The expectation is that a large amount of this production growth will be coming from the company’s investments into the development of unconventional oil deposits. Statoil is not a pure play on unconventional oil production or peak cheap oil but they will most certainly benefit from it.

Statoil is quite cheap compared to many of their competitors. The company trades with a trailing P/E of 7.34, a forward P/E of 9.26, and an EV/EBITDA ratio of 2.16. Statoil’s most recent dividend was $1.104. The ADR shares are subject to a 15% Norwegian withholding tax for U.S.-based investors.

SeaDrill Ltd. (NYSE:SDRL) is a Norwegian-Bermudan offshore oil drilling company. SeaDrill’s offshore fleet consists of 60 drilling rigs of various types. The various classifications of vessels include semi-submersibles, tender rigs, and both harsh and benign environment jack-up rigs. SeaDrill also owns stakes in Archer Ltd., Asia Offshore Drilling Ltd., Varia Perdana Bhd., SapuraCrest Bhd., and Ensco plc.

SeaDrill’s drilling operations span the globe. The company has a large presence in Norway and in Asia. The company has only two rigs in the Gulf of Mexico, one of which is in Mexican waters. This should offer some protection from the still-hostile U.S. political environment towards deepwater drilling. SeaDrill also has minimal presence in the Middle East. If tensions flare in that area, the company’s operations will not be significantly impacted.

Earlier in the article, I stated that some the world’s remaining oil reserves are located underneath the ocean floor. This means that offshore drilling is one of the areas where production will need to increase as production from more conventional sources declines. SeaDrill is well-positioned to be a beneficiary of this trend. SeaDrill currently has the most modern fleet in the offshore drilling industry. This gives the company a very potent competitive advantage in the post-Macondo world. There remains a strong possibility that some countries could pass strict safety regulations on the offshore drilling industry. This would have the most impact on older rigs which are less likely to be equipped with the most modern safety equipment. Older rigs would need to be refitted or replaced in that case (or kept in countries without these regulations) which could be a major cost to their owners. SeaDrill should be able to avoid that scenario.

SeaDrill is certain to beat analyst estimates for this year. The stock is, however, not particularly expensive using analysts’ incredibly low estimates. SeaDrill trades with a trailing P/E of 7.19, a forward P/E of 12.11 (using 2011 estimates that I am positive are far too low), and an EV/EBITDA ratio of 10.94. SeaDrill pays one of the highest dividends in the offshore industry, yielding 9.00% at current levels. The current dividend is $2.80 with a $0.05 per quarter special dividend that will be paid for the remainder of this year. SeaDrill’s dividend is not subject to withholding taxes.

One of the biggest risks here is oil prices. Offshore drilling and other unconventional oil production (such as the Canadian oil sands or U.S. shale) are much more expensive than more conventional means of obtaining oil. Thus, a significant and prolonged reduction in oil prices could hurt the growth and profit potential of the companies involved in it. A steep decline in the price of oil (possibly triggered by a worsening of conditions in Europe) will also likely send these stocks reeling.

All financial data in this article comes from Yahoo! Finance. Forward looking estimates are courtesy of Zacks Investment Research.

Disclosure: I am long STO, SDRL.