Evaluating Operating Performance At Large Exploration And Development Companies

by: Jeremy Johnson, CFA

Independent exploration and production (E&P) companies offer investors the opportunity to participate in the oil and gas sector without the overhang of refinery, chemical and to a large extent, midstream assets. Although the latter are performing well currently, they have distinctly different economic characteristics than E&P assets in that they tend to have very long payback periods or put differently, long asset lives. This article will look at a range of operating metrics for the seven largest E&P companies in terms of equity market cap in the U.S. and Canada in order to get a sense for the companies’ relative performance. In addition, we will look at recent trends in capital expenditures and valuations for these companies.

Figure 1 below displays the production profile in thousands of barrels oil equivalent per day (kboe/d)[1] for Canadian Natural Resources (NYSE:CNQ), Anadarko Petroleum (NYSE:APC), Apache (NYSE:APA), EOG Resources (NYSE:EOG), Devon Energy (NYSE:DVN), Marathon Oil (NYSE:MRO) and Noble Energy (NYSE:NBL). CNQs production profile has been adjusted for the full restart of the Horizon oil sands project. As the figure shoes, CNQ and MRO are the only two companies with material production from mined oil sands. Meanwhile CNQ, APA and MRO have the greatest percentages coming from crude liquids although in some cases this comes from thermally produced oil sands especially in the case of DVN. Natural gas is a major contributor for every company, but is particularly important for APC, APA, DVN and NBL. NGLs are only significant for DVN and APC.[2]

Investors keep an eye on all forms of production growth, but with crude fetching far higher returns per unit than natural gas, liquids production has been a particular focus. Figure 2 shows quarter-over-quarter (q-o-q) changes in production of all forms of liquids, including oil sands and NGLs, for the past several years. EOG by far has shown the most consistent growth in production with no negative quarters since 2Q09. APA and APC have also shown consistent production growth in liquids although the former has been significantly boosted by acquisitions of producing properties. DVN has also grown relatively well especially after considering the company’s large divestiture program. Meanwhile, NBL has shown some of the lowest growth rates of the group in liquids.

Another way to look at the data is the volatility of production, especially where output has not grown quickly. CNQ and MRO have shown relatively low growth and production has been more volatile. In CNQ’s case, a large portion of this is due to the industrial accident at the company’s oil sands upgrader. For MRO, the Libyan war caused the shutdown of a significant amount of production.

Natural gas is an important long-term source of value for E&Ps but pricing in the short-term has been challenging and most producers have been pulling back on investments leading to weak production growth. As the figure below shows, where production has grown, as in the case of APA, much of it has come from acquisitions of established plays. Of the slower growing companies, MRO has shown the most volatility in results.

Capital expenditures are the fuel that drives production growth and E&Ps have been investing heavily over the past several years. The figure below displays capital expenditures relative to depreciation for rolling trailing twelve month (TTM) periods which indicates the rate of growth of capital invested in the business and which should translate into production growth over time. What can be seen from the figure is that a few of the companies are growing investments rapidly relative to their historical base while others are growing at a much lower rate. DVN, NBL and EOG stand out as companies making very strong investments while CNQ, APC and APA have been more subdued. Due to the separation of MRO’s capital intensive refining business, the trend there is difficult to interpret, but in recent quarters it appears investment is picking up.

The final figure displayed below shows two valuation metrics for the seven E&P companies (as well as three other larger E&P companies to improve the significance of the trend line). These simple valuation tools can be used to get a general idea of opportunity in the space, at least on a relative basis. APC and EOG stand out for having high price to book and price to earnings ratios. It is expected that companies trading at high book values should be generating returns or growth high enough to justify the premium. In the case of EOG, growth may go some way to explaining the premium since it has shown a strong growth profile over the past three years. APC may still be facing a hangover of sorts from the Deepwater Horizon accident which may be affecting the variables. Both cases demand more study before drawing definitive conclusions, but the market seems to be discounting a significant rise in earnings. On the other hand, CNQ and NBL better justify their premiums to book value given matching high levels of profitability.

At the other end of the scale, MRO, DVN and APA exhibit relatively consistent price to book and earnings multiples. In the case of DVN, the large amount of capital expenditures in the last couple years may portend future production growth – indeed, the company has done well to grow liquids production over the past few years, although natural gas has been stagnant. If the trend can continue, it is possible the company’s stock could generate a premium valuation or at least reflect the additional profit from the expenditures. On the other hand if the additional capital only produces a similar level of production, the company’s valuation may be warranted.

APA has managed to grow production as well, although mostly through acquisitions which may be the reason for the lack of premium valuation. Finally, MRO’s production growth has been somewhat mediocre while capital expenditures have been subdued. This may imply some stability in the business, but not significant scope for generating a premium valuation or benefiting from asset growth with returns above the cost of capital.


[1] Natural gas is converted at 1 kboe = 6 MMcf

[2] NGLs for CNQ and MRO are estimates based on year end data

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.