The Wall Street Journal annually looks at the annual reports of 100 large energy companies to see how many companies believe actual risks need to be factored into their communication with their shareholders. In the 2012 version of the survey, 74% of companies cited hydraulic fracturing for natural gas as a risk, up from 52% a year earlier. This process, known as "fracking" has been used for decades, but improvements in techniques has caused an expansion in fracking in North America and beyond in recent years. Allegations of impacts to fresh water supplies have been made from Pennsylvania to Colorado, and Vermont recently became the first state outright to ban the practice. Fracking, hailed as a savior to the natural gas industry a few years ago, also appears to be flopping overseas as well. The utter collapse of natural gas prices has suppressed the controversial practice, but any serious indication of a reignition of gas prices will reinvigorate fracking, as well.
Also experiencing substantial increases on the "worry meter" this year were risks related to climate change or global warming regulation, which was cited by 81% of oil and gas companies, up from 64% a year earlier. Companies citing risks inherent in offshore drilling, such as BP's (NYSE:BP) Macondo Well in the Gulf of Mexico, amounted to 19% of the time, versus 16% a year ago. I would have thought exactly the opposite - that risks from offshore drilling would fade from memory. Apparently, I thought wrong.
International, integrated petroleum giant BP, has had a tumultuous few years, highlighted by its lead role in the catastrophic 2010 Gulf oil spill. Much of the following 18 months represented the company's attempts to deal with that issue, and now, much of the heavy lifting is behind BP.
In the first quarter of 2012, BP reported profits of $4.8 billion, or $1.56 per ADR. This was a fall of about 13% from the year ago quarter, and about 4% below analysts' expectations. Both upstream and downstream parts BP's business suffered. Oil equivalent production per day fell by 3.6% from the first quarter of 2011, to 3.45 million barrels, and as with all integrated oil companies, downstream refining margins were under pressure.
In April, BP settled for $7.8 billion most of the private economic and personal injury claims. What is left open is the Lollapalooza of litigation, the wide ranging environmental claims against BP and other operators of the stricken well, concerning the environmental damage the leak caused, which could be as much as $60 billion, though a settlement for far less than that is likely. However, a recent release of information that fish and wildlife is still being impacted by oil poisoning will not help BP's negotiating leverage. Various other, smaller suits also exist, and will exist for years more, over things such as pension fund losses and securities fraud.
Looking at the core business itself, BP is in a transition. It is in the midst of selling off some $38 billion in assets to pay for legal settlements and other purposes. But new production is scheduled to go online by next year, more than offsetting the production declines accompanying the divestment of producing oil fields.
As long as Gulf of Mexico litigation persists, BP will always trade at a discounted price to earnings ratio relative to other energy companies. Yet its 5% dividend is certainly attractive, as is the fact that BP stock has fallen over 20% from near $48 per share in early March. There is a great deal of upside from today's depressed price level, and as long as one can be patient, BP offers excellent risk adjusted potential for the 3 to 5 year time horizon, and beyond.
The other "litigation king" of the oil patch is Chevron (NYSE:CVX). The slump in oil prices has carried Chevron stock down to levels not seen for nine months, or about 10% below its price on May 1. This otherwise extremely well run company has its well-publicized South American legal problems, specifically the Texaco fueled Ecuadoran problems, where local judgments have already been entered, and two separate, relatively small spills in the Atlantic off the Brazilian coast. These matters will cast a pall over Chevron's valuation for the foreseeable future. Its yield of 3.6% is not as attractive as BP's, nor does it have the defined growth profile of its British peer. I like BP better going forward.
Halliburton (NYSE:HAL) is one of the world's largest suppliers of oil and gas drilling equipment. It was caught a bit short as many energy producing companies shifted focus from gas to oil after the collapse of natural gas prices. As an aside, I note that natural gas June futures are $2.67, a three month high.
Halliburton's earnings of $0.89 per share in the first quarter of 2012 beat Street estimates of $0.85 per share. The 2012 profit number omits the $300 million charge Halliburton booked in the first quarter as a reserve against future issues arising from its role in the Macondo Gulf disaster. Revenues have been growing sharply. Full year revenues for 2011 were up 38% from 2010, and first quarter 2012 revenues were 30% above the first quarter of 2011. Standard and Poors had earlier put Halliburton under review, but affirmed the existing "A" credit rating with a stable outlook after a closer look at the company.
Halliburton's earnings and revenues hit all-time records in 2011. Its stock price did not, as investor's fret about one thing or another and the company's price to earnings ratio continues to contract. The oilfield service equipment industry is dominated by just a few large players including Schlumberger (NYSE:SLB) and Baker Hughes (NYSE:BHI). Halliburton's revenue growth is the strongest of the group, and its current extremely low valuation gives it a microscopic 5 year expected PEG of 0.35. This stock screams of being undervalued as much as any healthy energy related company out there today, and belongs in any value investors' portfolio.