The Black Swan Makes The Case For Total, Anadarko

The probability of our vision of $150 oil in 2010 being achieved may be higher than is priced in the market, if it is true that investors tend to underestimate the likelihood of unusual events. Derivatives trader turned professor, Nassim Nicholas Talleb, in his bestseller, The Black Swan, argues that investors are being misled by the wrong mathematics that don’t allow enough for surprise outcomes.

When we make financial valuations,Talleb urges us to throw out the probability distribution known as normal, binomial, or Gaussian, widely used in standard deviation, correlation, regression, reversion to the mean and the pricing of options. Put in its place an expression like the kind he names Mandelbrotian, in honor of its IBM (IBM) mathematician originator. It looks to us like the recent meltdown of computer driven hedge funds and prime-rated sub-prime debt proves his point.

Our simple interpretation is to reemphasize the timeless guidance that investors be exposed to the upside and protected against the downside. To illustrate the upside, or extreme event, for our stocks, we calculate Net Present Value for $150 oil (NPV150).Own oil and gas stocks including Total (TOT) and Anadarko (APC); be careful selling options against them.

NPV150 Highlights Upside

Our quick estimate of NPV150 starts with the current mix of natural gas, oil and other businesses for each stock. The current values presume long-term producer prices of $11 a million btu and $66 a barrel and long-term refining margin of $11 a barrel. The experience of the past few years seems to support the idea that present value may be proportional to price as price increases from here. Thus, we multiply oil present value by 2.27, just as oil price of $150 is 2.27 times $66.

Though one might have been rightly skeptical the past few years, we think natural gas has more long-term potential and multiply present value by 2.73 just as a natural gas price of $30 would be 2.73 times $11. Because other businesses including refining may see dampened demand as a result of higher oil price, we multiply present value for that segment by 1.82. Leverage adds to NPV gain, but we neutralize for that when we recommend portfolio weightings in proportion to unlevered value. Thus we have specified all the inputs for a simple calculation of NPV150.

While life is not that simple, we do it to illustrate that stocks may have further potential beyond current estimates of NPV at oil price of $66.