Equinor: Eyeing Arctic Expansion

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About: Equinor ASA (EQNR), Includes: E
by: Power Hedge
Summary

Equinor recently announced that it has drilled another successful well at Johan Castberg in the Barents Sea.

This well found 12-25 million barrels of oil, which allows it to more accurately determine the resource potential of Johan Castberg.

The Johan Castberg field is estimated to contain 400-650 million barrels of recoverable oil.

The development of this field will increase the company's knowledge of operating in the Arctic, which contains very vast resources.

Equinor appears to be significantly undervalued.

On Monday, October 29, 2018, Norwegian energy giant Equinor ASA (EQNR) announced that an exploration well drilled in the Johan Castberg license in the Barents Sea has discovered oil. This shows us that Equinor has not given up on the resource potential of the Arctic region, despite all of the concerns that were expressed about the economic viability of this area during the now-ended bear market in oil. Admittedly, there are still some concerns about Arctic exploration but Equinor seems determined to make it work and this is certainly a gamble that could pay off well for the company.

About Johan Castberg

The Johan Castberg field is an oil-rich field located in the Barents Sea, which is a marginal sea of the Arctic Ocean. The field is located approximately 100 km north of the Snøhvit field located in the same sea.

Source: Equinor ASA

The Johan Castberg field was first discovered in 2011 when the Skruugard exploration well struck oil. The company expanded on its knowledge of the extent of the field in 2012 and 2014 with the Havis and Drivis wells, respectively. Based on the resources discovered by these three wells, Equinor estimates that the Johan Castberg field contains between 400 and 650 million barrels of recoverable oil. This makes Johan Castberg one of the larger fields known to exist so it is fairly easy to understand why the company is interested in developing the field.

The new well that was just drilled, Skruis, should help Equinor better determine where in that range the field's actual recoverable resource amount is likely to lay. This new well discovered 12-25 million barrels, which is somewhat respectable in its own right, but it also adds to the total for the region itself.

As might be expected, Equinor and its partners ENI (E) and Petoro have put together a fairly ambitious plan for developing Johan Castberg. This plan was revised somewhat to reduce costs when oil prices plummeted in 2014. While oil prices have somewhat recovered, the companies have not changed their plan back to the original more expensive one. This is good to see as the reduction in development costs will increase the returns that Equinor will realize from the development of the field regardless of the overall price of oil. Investors should appreciate this.

The company currently intends to develop the field using an FPSO production vessel along with other subsea solutions to get the resources back to shore. Norway has become quite adept at offshore engineering and similar techniques due to the development of the country's other offshore fields and these techniques are often quite helpful at reducing costs because offshore pipelines are generally cheaper to operate than using tankers to bring the oil to shore or a similar solution. The use of an FPSO (floating production, storage, and offloading) vessel is not surprising. These vessels are designed to process the extracted oil and condensates before the resources are moved to shore using either tankers or pipelines and are generally preferred for frontier regions because they are easy to install and can often result in lower capital expenditures than other solutions.

Equinor expects that the total costs of bringing the Johan Castberg field to a full development state will be approximately NOK 50 billion ($5.90 billion). This is certainly a great deal of money, but it is much less than the NOK 100 billion ($11.79 billion) that the field's development was originally expected to cost. When we consider the amount of oil present at the site, however, the development of the field should still result in significant positive returns for Equinor.

About The Potential Of The Arctic

The fact that Equinor is still proceeding with the development of Johan Castberg tells us that Equinor remains interested in the potential of the Arctic despite the turbulence that we have seen in the oil markets over the last few years. This is potentially a very good thing as the resource potential of the Arctic is enormous. I have discussed this several times over the past ten years that I have been publishing on Seeking Alpha.

Perhaps my most notable article on the resource wealth in the Arctic can be read here (no paywall). The most important takeaways from this report for our analysis of Equinor are two data points that come from David Gautier and his team at the USGS:

  • Approximately 13% of the world's undiscovered oil reserves are believed to be in the Arctic. This amount totals approximately 90 billion barrels.
  • Approximately three times the amount of oil can be found in the region's natural gas plays when measured in terms of oil equivalents. These gas deposits total an estimated 47.3 trillion cubic meters (1.670 quadrillion cubic feet) of natural gas and 44 billion barrels of liquefied petroleum gas. To put that in perspective, that is nearly four times the largest estimate (480 trillion cubic feet) of natural gas in the Marcellus shale.

It is clearly easy to see why the development of the Arctic resources could be appealing to Equinor or any other energy company, although most of the Western ones have shied away from the area over the past few years. Admittedly, even Equinor itself has not stated whether or not it intends to pursue any other Arctic exploration or development projects outside of Johan Castberg. We can certainly hope though that the company will be able to use the knowledge that it gains from the development of Johan Castberg to more effectively pursue opportunities to exploit the resource potential of the Arctic.

Valuation

Equinor has admittedly long been one of my favorite big oil companies for investment purposes and the company's increasing Arctic potential only increases my convictions. However, as is always the case, it is critical to ensure that we do not overpay for any stock in our portfolio, no matter how much we like it. This is because over-paying for any asset is a sure way to guarantee sub-optimal returns from that asset. Fortunately, Equinor's current stock price is more appealing now than it has been for quite some time, which is largely due to the decline that it suffered from in the second half of October:

Source: Seeking Alpha

One metric that we can use to value the company is the price-to-earnings growth ratio. This is essentially a way of adjusting the more commonly known price-to-earnings ratio to take a company's earnings growth into account. As a general rule, a price-to-earnings growth ratio of less than 1.0 is an indication that a stock may be undervalued at the current level and vice versa. According to Zacks Investment Research, Equinor is expected to grow its earnings at a 22.12% rate over the next three to five years. This gives the stock a price-to-earnings growth ratio of just 0.52. This is a clear indication that the stock may be undervalued at the current level.

Conclusion

In conclusion, Equinor is showing clear indications that it continues to be interested in exploiting the massive resources of the Arctic. This could certainly prove to be a good thing for the company's future given the resource potential of the area and the improving ability that it displays to develop them profitably. The stock additionally looks to be dramatically undervalued and thus may present an excellent opportunity for investors.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in EQNR over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I am long ENOR, which contains EQNR as its largest holding. I may initiate a long position in EQNR directly within the next 72 hours.