Marathon Oil's $1.8Bn Permian Basin Push Can Boost Valuation

| About: Marathon Oil (MRO)
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Summary

Marathon Oil has recently announced another Permian Basin acquisition.

Previously, the company, unlike some of its peers such as PXD, CXO and DVN, did not have significant exposure to the Permian Basin.

The company has done an impressive job of improving the quality of the asset base without damaging its financial health.

Marathon Oil (NYSE:MRO) is quickly expanding in the Permian Basin, and this can have a positive impact on the company's valuation.

Yesterday, Marathon Oil announced that it has agreed to acquire 21,000 net acres located in the Northern Delaware Basin in New Mexico, which is a part of the larger Permian Basin, from Black Mountain Oil & Gas and other private operators for $700 million in cash. The acquired properties currently produce around 400 barrels of oil equivalents (boe) per day, but they are home to around 230 million boe reserves, representing 440 gross drilling locations.

The latest announcement comes just 12 days after Marathon Oil made an even bigger acquisition in the same region. Earlier this month, the company said that it will acquire 70,000 net acres in the Permian Basin, including 51,500 acres in the Northern Delaware Basin, from BC Operating and other entities for $1.1 billion in cash. These assets were already producing 5,000 boe per day and were expected to hold around 350 million boe reserves, representing 630 company-operated drilling locations.

Both of these deals, which represent a total price tag of $1.8 billion, are slated to close in the second quarter of this year. But this won't damage the company's liquidity, which was $5.8 billion at the end of last year, including $2.5 billion cash reserves and $3.3 billion available under the revolving credit facility. That's because Marathon Oil has also recently sold its interest in the Canadian oil sands assets for $2.5 billion. The proceeds from the asset sale, which is expected to close in the mid-2017, will help the company in funding the two acquisitions.

A number of large-cap independent exploration and production companies, such as Pioneer Natural Resources (NYSE:PXD), Concho Resources (NYSE:CXO) and Devon Energy (NYSE:DVN), have significant operations in the Permian Basin, which is the most prolific and lowest cost shale oil play in the US. The markets have also rewarded some of these companies with a premium valuation. But Marathon Oil did not have meaningful exposure to the region, which is one of the reasons why its stock has traded at a discount to its peers. The company gets its US oil production from Eagle Ford in South Texas, Oklahoma Resource Basins and the Bakken play in North Dakota. However, Marathon Oil has now built up sizable and lucrative positions in the Permian Basin.

Marathon Oil now owns 91,000 net acres in the Permian Basin, including 71,500 acres in the Northern Delaware Basin where companies, such as EOG Resources (NYSE:EOG) and Concho Resources, have drilled some of the best oil wells in the industry. Marathon Oil has said that its Northern Delaware wells can produce more than 90% before-tax IRR (internal rate of return) at $55 oil. Moreover, the Northern Delaware Basin, like the entire Permian Basin, is a multi-stacked play that has up to 10 target benches. Marathon Oil's reserve and drilling inventory numbers are based on six benches, which means the actual reserve and inventory estimates could climb significantly if it exploits all 10 benches. Successful downspacing might also help the company in expanding its reserves and inventory. As per the company's estimates, it owns 580 million boe of risked resources and 1,070 gross drilling locations at the Permian Basin, but the total resource potential could climb to 1.45 billion boe reserves and 2,650 gross drilling locations.

Overall, Marathon Oil has done an impressive job of high-grading its portfolio by increasing its exposure to low-risk, high-return US shale plays while exiting from less-lucrative regions, without damaging its financial health. In addition to the oil sands assets, Marathon Oil has also sold its oil and gas producing properties and midstream assets in Wyoming for $870 million. Overall, the company has unloaded $3.8 billion of assets since the start of last year. At the same time, it has spent $2.7 billion on making the above-mentioned acquisitions in the Permian Basin, including $888 million spent on buying PayRock Energy from EnCap Investments. PayRock owned 61,000 net acres in Oklahoma's oil-rich STACK play. The STACK properties, like Permian Basin, also generate strong returns in a low oil price environment (60-80% before-tax IRRs at $50 oil).

Conclusion

Shares of Marathon Oil have fallen by 8% in the last four weeks due to the weakness in oil prices. At the time of this writing, the WTI crude oil futures were at $47.51, close to their lowest level in the last four months. If oil prices stay low, then that could continue to hurt Marathon Oil, particularly since its future production is not as well hedged as some of its peers like Pioneer Natural Resources and Devon Energy. But Marathon Oil has managed to improve the quality of its asset base, particularly by expanding in the Permian Basin. The company has grown its portfolio of oil drilling locations that can generate strong returns in a low oil price environment. That not only puts Marathon Oil in a better position to withstand low oil prices, but also can also fuel the rerating of Marathon Oil's stock in the long run.

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