Marathon Oil: The American Elephant Hunter

| About: Marathon Oil (MRO)

Prologue: The Last Great Elephant Hunt

In 1956, the geophysicist M. King Hubbert presented a now-famous paper to the American Petroleum Institute warning that the world's supply would soon decline; U.S. production might max out in the early 1970s, he said. The world's supply would peak by the end of the century...

Whether the supply of oil was actually peaking or not, the oil companies' ability to produce it certainly was...

It was just going to get a lot harder, a lot riskier, and a lot more expensive to come by. It wasn't the end of oil, not yet. But it might very well have been the end of easy oil.

To find more, the oil companies would have to explore corners of the world that had until then been too unstable or too violent to consider, or simply too difficult to get to...

The Gulf of Mexico, for example, was promising but almost completely unexplored...

Unconventional oil supplies were sought after with increasing intensity...

In Canada, pioneering companies were taking mud saturated with tar and melting it down to separate the particles of dirt from an oily resin called bitumen that could be refined into the crudest form of crude. The oil sands, as they are called, had been considered fringe resources in the 196o0s but were attracting more interest by the late 1980s.

In Colorado, Utah, and Wyoming, geologists had determined that the shale underlying the northern Green River Valley was also saturated in a basic form of hydrocarbons and that with extensive processing the rock could also be broken down and turned into oil.

If the American West was mined for this shale, it could nearly match, in quantity, the oil coming from Saudi Arabia, according to some estimates.

[Quotes from the book Run To Failure by Abrahm Lustgarten]

in 1989 BP's (NYSE:BP) then boss, John Browne calculated that there were 1,300 "recognized sedimentary basins" in the world likely to contain oil.

Only 300 of them remained unexplored. At this point in time there was still a chance of finding major oilfield or elephants, as they were known, that could make or break oil companies. If history was any measure, half of the basins would yield some sort of oil field, and one in twelve of those would be the elephants.

In the future the oil companies that survived and profited would be those that could secure supplies and get them to market.

The Present: Marathon Oil Corporation in 2012:

Marathon Oil Corporation (NYSE:MRO) in its modern form was born in 2001, when USX, the holding company that owned United States Steel and Marathon, spun off the steel business and in 2002 USX renamed itself Marathon Oil Corporation.

In July 2011 Marathon spun off its refining, marketing and pipeline business into Marathon Petroleum Corporation (NYSE:MPC) . As a stand-alone oil and gas exploration and production company, the MRO stock should theoretically trade at a higher multiple.

In 2011, Marathon's oil production came from four areas:

In 2011, Marathon continued to grow an inventory of strong projects across the globe, including a significant acquisition in the Eagle Ford Shale play in Texas. The Company also invested in the Bakken Shale in North Dakota, the liquids-rich portion of the Anadarko-Woodford Shale of Oklahoma, and the Niobrara Shale in Southeast Wyoming and Colorado.

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A recent article in the 6/12 edition of Popular Mechanics, "The Big Play", which is about the Bakken Shale boom in North Dakota, says:

The new techniques have given rise to the current Bakken boom, but there are no guarantees that it, too, won't go bust like booms of the past.

Even when coaxed with the latest techniques, the formation is stingy about releasing hydrocarbons: for example while production from a new well in a conventional oilfield declines by about 5 to 8% per year, the output from Bakken wells declines about 65% after the first year.

Ultimately even if the most wildly optimistic estimates of Bakken oil reserves are correct--around 200 billion barrels--the amount of oil that can actually be recovered may still only be 10 billion barrels or less.

[From: Popular Mechanics "The Big Play", 6/12 edition.]

The other uncertainty, the article says, is the price of oil. A regional manager for Statoil (NYSE:STO) claims that drilling in the Bakken will be profitable even if prices drop to $60 per barrel.

However $60 per barrel inflation adjusted is not guaranteed indefinitely, although with the spot price for West Texas Intermediate oil currently around $90 , it seems unlikely to fall that low at the present time.

In a Feb. 1st statement Marathon said it plans to ramp up its production in the continental U.S. to 35 rigs by the fourth quarter of 2012 and to average 120,000 to 130,000 barrels per day for sale. That would be more than a 30 percent increase over the fourth quarter of 2011.

One of the major sources of extra production, Marathon said, would be the Eagle Ford, where it said it signed multiple deals during the fourth quarter.

The Eagle Ford Shale is a Texas hydrocarbon producing formation rich in oil and natural gas fields. The Eagle Ford Shale is 50 miles wide and an average of 250 feet thick and found at a depth between 4000 and 12,000 feet. The shale is brittle and easier to use hydraulic fracturing to produce the oil or gas than in the Bakken, where the rock is very hard.

The Eagle Ford oil reserves are estimated at 3 billion barrels with total potential output of 420,000 barrels a day.

Marathon Oil CEO Clarence Cazalot has claimed that "the Eagle Ford is the best unconventional resource play, not only in the U.S., but also in North America, and maybe in the world..."

The company also has wells in production in the Iraqi Kurdistan Region and Poland. Marathon also has wells in Norway and Equatorial Guinea. Marathon's African and European production wells are revenue producing, but not expected to contribute to future growth.

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It is expected United States acreage will provide the majority of growth going forward. The company is also actively seeking new sources of oil and gas in the Gulf of Mexico.

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Marathon Oil has interests in more than 20 prospects, with resource potential of approximately 1 billion barrels of oil equivalent net.

From 2001 through 2011, the Company expanded its P50 (oil reserves having a 50% certainty of being produced) resource base from 1.9 billion barrels of oil equivalent (bboe) to 6.8 bboe. During the same period, the company increased proved reserves approximately 80 percent from 1.0 bboe to 1.8 bboe. Total resource at year-end 2011 was 11.2 bboe. The total resource represents a high side, or P90 estimate. The graphic below shows the magnitude of this growth of reserves.

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All this seems to suggest that Marathon has a sound long term plan to exploit oil reserves primarily in the United States, a de facto politically stable jurisdiction although it is currently showing some interest in a oilfield in Greek waters off the coast of Cyprus, a less politically stable area.

It seems to me that oil companies need to be looked at primarily from a dividend paying point of view, since, while they are all capable of striking oil, none of them are likely to hit the ball out of the park relative to their competitors, plus the world's largest oil companies are in fact state owned entities sitting on national reserves.

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From a dividend point of view, the company compares unfavorably with Chevron (NYSE:CVX) which has a 23% payout rate compared to Marathon's 22% payout rate, but a superior yield, or Exxon (NYSE:XOM) also at a 23% payout.

For higher yields BP pays out only 23% due to the overhang of some legal issues, but I expect it to pay out more in the future, and the Norwegian company Statoil which pays out 22% for a yield over 4%. BP is also discussed here.

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On the long term debt to equity ratio there is a large difference between Marathon Oil at 26% and Chevron in single figures, and BP and Statoil with higher ratios over 30%, and this reflects the cost of acquiring the increased reserve capacity in shale oil plays.

Caveat: These figures are taken from Seeking Alpha tables and the numbers differ from results on Finviz. The only way to get guaranteed accurate ratios is to calculate each by hand from the most recent primary data.

Marathon Oil common stock is trading around book price, and a future significant increase in the price of oil can only enhance the value of the stock.

Should the geopolitical situation in the mid east deteriorate, Marathon Oil might be well placed with its primarily domestic oil reserves.

For example Reuters reported on March 6th, 2012:

But Romney... was slightly more circumspect than Santorum in his choice of words about how he would respond as president to an Iranian nuclear program. Romney said he would end Obama's "procrastination" on the matter by imposing further crippling sanctions on Tehran, and "I will make sure Iran knows of the very real peril that awaits if it becomes nuclear."

"As president, I will be ready to engage in diplomacy. But I will be just as ready to engage our military might," Romney said.

One does not have to be a strategic genius to see that such a militant stance could threaten the movement of global oil supplies.

Iran has roughly 10% of the world's oil reserves and a blockage of the Straits of Hormuz could stop movement of 20% of the world's oil supplies ,so that a company like Marathon Oil with its main strategic reserves in the US and little exposure to the mid-east would stand to benefit from another outbreak of war in the region with the world's largest oil production.

Disclosure: I am long BP.