A number of respected commentators are predicting that oil will continue to slide in the near future. They cite a strong supply side with record production by Saudi Arabia, Iraq output pushing through the 3 million Bpd barrier, Libya already back to full pre-revolution levels, and US oil output surging on the back the boom in shale and other unconventional sources. Meanwhile, oil demand growth has ebbed because of slowing Chinese growth, improved fuel-efficiency from the motor vehicle industry and weak economies in the USA and particularly in Europe.
Given that the marginal costs for some oil producers is about $60 Bbl, it appears unlikely that oil will drop very much from today's level without a global economic collapse. Realistically such a collapse probably isn't on the cards despite the efforts of European sovereign debtor nations and other unnamed economic miscreants. Besides, a lower oil price is in-itself a boost for consumers via lower gas prices at the pump. This in turn propels better economic growth thus supporting oil demand and so on.
In the near future it appears we may see WTI and Brent trade lower.
Over the longer term, Iran is likely to come back into the mix and oil shale technology will surely spread from the US to countries with large known oil shale reserves. It may be many years before we see oil prices hit new highs.
So, what are we left with? Probably a WTI oil price that sits mostly in a range of $80 to $110, give or take a few $ either side for short periods.
For E&P companies the more immediate question becomes: What effect would softer oil prices have on earnings in 2012 and 2013?
I have tried to gauge the effect that lower oil prices may have on 6 well known value plays; Bonanza Creek, Carrizo, Kodiak, Northern, Oasis and Whiting. Four underlying assumptions were adopted: (1) An oil price decline of $10 would represent about 10% of the company's oil revenues as currently estimated by analysts, (2) no change to nat gas pricing, (3) no significant changes to P&L costs except for income tax which would be lower because of reduced profits and (4) for simplicity, ignore oil and nat gas hedges that already exist.
Bonanza's primary asset is about 63,000 acres in the Niobrara and its oil / nat gas sales split is 75%-25%. Currently analysts are estimating sales of $233 million for 2012 and $361 million for 2013, generating EPS of $1.64 and $2.68. A $10 drop in oil prices would reduce the EPS to $1.33 for 2012 and to $2.18 for 2013. At the current $18.20 stock price that would translate into a next year p/e of 8.4. The stock is clearly cheap today, and would still be cheap with oil prices $10 lower. Bonanza has the added advantage of having an unleveraged balance sheet.
Carrizo has 41,000 oily acres in Eagle Ford, 58,000 acres in Niobrara, some nat gas properties, a smallholding in the Utica and a share in a North Sea oilfield that it plans to sell in 2012. Excluding the North Sea asset, its oil / nat gas sales mix is 75%-25%. Analysts are forecasting sales of $428 million for 2012 and $636 million in 2013, with EPS of $2.46 and $4.57. A further $10 drop in oil prices would cut EPS to $1.97 in 2012 and $3.76 in 2013. Currently the stock is $24.68 and, with that lower oil price, would give a next year p/e of 6.6. The current stock price would still be very cheap even with lower oil prices, although the high level of borrowings would lead to some downward pressure.
From its approx 157,000 acres in the Bakken, Kodiak has a very high oil/gas sales ratio of about 95%-5%. Recently KOG's earnings estimates have softened and no doubt a $10 drop in oil prices would edge the numbers down again. Currently analysts are forecasting sales of $545 million for 2012 and $920 million in 2013 with EPS of $0.61 and $1.07. A $10 oil price drop would lower the EPS to about $0.46 in 2012 and $0.84 in 2013. KOG stock is currently trading at $8.26 and these 2013 figures would put it on a next year p/e of about 10. That is still good value considering the long-term growth potential although not a screaming buy. The company has recently been increasing borrowing levels and this may weigh on sentiment.
Northern has approx 170,000 acres in the Bakken and, like KOG, produces a very high oil/gas mix of 95%-25%. NOG's earnings have also been softening recently. Analysts are forecasting sales of $310 million in 2012 and $435 million in 2013 with EPS of $1.20 and $1.78. Oil $10 lower would translate to EPS of $0.88 in 2012 and $1.36 in 2013. With the stock trading at $17.20 these low-ball EPS figures equate to a next year p/e of 12.6. Pretty decent considering the fairly moderate of borrowings but, again, not entirely compelling.
Oasis' primary asset is 307,000 net acres in the Bakken and the company has an oil/gas sales mix of about 90%-10%. Analysts are forecasting sales of $667 million for 2012 and $976 million in 2013 with EPS of $1.63 and $2.61. A $10 oil price drop would translate to EPS of about $1.25 in 2012 and $2.03 in 2013. At today's $26.47 stock price this works out as a next year p/e of 13. Considering that OAS's acreage is about twice that of KOG, and that both companies have similar market capitalizations, then OAS stock should become increasingly attractive at these levels as a long-term value play.
Whiting has over 700,000 net acres in the Williston basin and other valuable assets including Niobrara. It generates 90% of its sales from oil and 10% from nat gas. Current estimates are for sales of $2.32 billion in 2012 and $2.59 billion in 2013 with EPS of $4.46 and $5.08. A $10 drop in oil prices would leave EPS at about $3.40 in 2012 and $3.80 in 2013. Currently the stock price is $44.27, equating to a next year p/e of 11.7 using the reduced estimates. This is pretty good for a $5 billion market cap company with a large oil shale footprint.
A $10 drop in oil prices, from those used today by analysts in their sales and EPS estimates for the above companies, would lead to some but not a hugely serious erosion of earnings. Further, if a $10 oil price did occur and it was accompanied by a significant drop in the stock prices for these companies, and bearing in mind that oil prices are unlikely to drop more than $10 from current levels for an extended period, then that significant drop in stock prices is very likely to represent an excellent buying opportunity.