On November 12, 2018, French oil supermajor Total (TOT) announced an agreement with the Abu Dhabi National Oil Company to acquire a 40% share in the Ruwais Diyab Unconventional Gas Concession. The deal has certain implications for both. The country targets a 1B scf/d unconventional gas production by 2030 and attracts IOCs to achieve this ambitious goal. For Total, which is not a neophyte in the region as well as in shale operations, this means promising additions to its NG portfolio, which is now fairly abundant enough to claim the firm the distinction of being the 2nd-largest LNG producer in the world. The company will finance 40% of exploration and appraisal capex for six to seven years before the first gas will be recovered. ADNOC retained a 60% controlling share. By combining the supermajor's expertise and capital with government investments, the UAE will likely achieve its strategic target of cutting its dependence on Qatari NG imports and satisfying the growing internal demand backed by the economy running on all cylinders.
Today, it is fairly complicated to estimate the production of the share because the partners had just entered the exploration phase and 7-year research and appraisal will follow. Now it is worth taking a more in-depth look at the economic motives of the deal.
Economic rationale: growing gas demand
In the previous article discussing recent Eni's (E) decision to enter the Emirates ultra-sour gas business, I have touched upon the UAE gas demand and the federation's ambitions to become a net exporter of NG. It is worth reiterating these points as far as the rationale behind the enhanced cooperation of Total and ADNOC and step-up in the utilization of unconventionals is similar to the reason to invite Eni to develop ultra-sour gas fields.
It is common knowledge that the region is rich in hydrocarbons, and the UAE is no exception. However, since 2008, the country has become a net importer of NG. There are two main culprits of this. First, the Emirates have considerable oil reserves, but oilfields are mature. Hence, production must include intricate techniques to maximize output. Upstream firms use the enhanced oil recovery technique (EOR), which requires a reinjection of extracted gas to sustain better oil output. According to the U.S. Energy Information Administration, in 2015, 26% of recovered gas was reinjected. In this field, the federation is among the world's leaders. Second, the UAE's affluent deposits are not apt for immediate use. A major part of the Emirates' gas contains sulfur impurities required to be removed. Sulfur poses a threat to the pipelines causing corrosion, so the purification is inevitable. In the previous article, I have discussed this matter in more detail.
The UAE is among the few countries with phenomenal gas consumption per capita, and the visualization presented in the BP Statistical Review of World Energy 2017 makes it crystal clear. With a population of 9.4 million in 2017, the federation consumed roughly the same amount of gas as the UK, while the UK's population was 66.02 million.
Source: BP Statistical Review of World Energy 2017, p. 32
The fact is that electric generation plants in the UAE use mainly natural gas (87% of electricity in 2015 was generated using NG), while the share of coal and renewables is insignificant. Though the Emirates plan to add solar and nuclear energy to the installed capacity, the preponderance of gas-fired plants will likely remain unchanged. Currently, the UAE is dependent on Qatar’s gas supply. The country receives fossil fuel through the Dolphin Gas Project pipeline. The project meets around 26% of domestic demand. Interestingly, TOT has a 24.5% stake in Dolphin Energy Ltd., the limited partnership that markets Qatari gas to the UAE. The major shareholder is Mubadala, owned by the government of Abu Dhabi.
With growing demand and substantial reserves (1P comprised 3.1% of global in 2017), the UAE cannot stay inert, and NG self-sufficiency is a part of Abu Dhabi Economic Vision 2030. Cooperation with IOCs in the field of ultra-sour and unconventional gas is inevitable to achieve this goal.
Unconventional gas in the Middle East
The unconventionals industry is gaining momentum in the region. ADNOC has recently partnered with the U.S. firm Baker Hughes (BHGE), which has world-class knowledge in hydraulic fracturing. Among other unconventional gas players in the Middle East is BP plc (BP), Total's competitor. The firm currently uses hydraulic fracturing in the giant Khazzan field in Oman to recover tight gas. However, according to "2018 Outlook for Energy" made by Exxon Mobil (XOM), local shale gas production will likely not play a major role in Middle East supply even by 2040.
Source: 2018 Outlook for Energy, p. 39
Total SA in the UAE
Total SA is not a novice in the Emirates. The company has an extensive history of presence in the Persian Gulf and in the UAE, in particular, and so do BP and Royal Dutch Shell (RDS.A, RDS.B). Contrarily, their European peer Eni did not operate in the Emirates until 2018. Total established its presence in Abu Dhabi in 1939, and since then, has successfully developed a wide array of conventional oil projects, for instance, the Abu Al Bukhoosh field.
Total’s experience in unconventional gas
The cornerstones of the unconventional gas (shale and tight) production are hydraulic fracturing and horizontal drilling, which are not new for the French supermajor. Total SA is experienced in the unconventional gas industry. Its key projects are as follows:
- Assets in the Barnett Shale, the U.S.
- The JV operated by Chesapeake Energy Corporation (CHK) in the Utica Shale, the U.S.
- The Vaca Muerta, Argentina
Total’s valuation update. Oil price pressure
While oil market sentiment is erratic spinning around the $60/bbl landmark, oil producers face pressure; their capital gain was hurt, and TOT was no exception. The performance of the SPDR S&P Oil & Gas Exploration & Production ETF (XOP) could provide a meaningful benchmark:
In the previous article on Total's Q3 results, I mentioned that 92.5% of its 9M CFFO had come from the E&P segment. Though the firm's operations are versatile and multi-faceted, its E&P unit is the principal contributor to the profitability, and cash inflows could be hurt because of lower Brent price, while the consolidated figures will undoubtedly reflect it. Liquids and gas are roughly equally weighted in the production of Total. In this regard, gas sales could serve as an additional hedge amid oil volatility. Despite oil marker sell-off, the U.S. gas price remained relatively firm:
And in 9M FY18, TOT sold its gas at a premium to the Henry Hub price:
Source: Third-quarter 2018 results, P. 3
Here is the updated valuation of the firm based on the relevant market cap and enterprise value figures on November 29, 2018. I used two separate segments: the peer group itself and the upper-end sub-group.
The renewed takeaways are as follows:
- Total SA has attractive EV/EBITDA multiple in both groups. The first one specifies a 14% discount from the average figures, and the second one a 34% discount.
- Its P/E is slightly less advantageous. In the 1st group, 13.16x is not cheap, and 1% downside is a consequence. However, in the sub-group, an average P/E indicates 8% upside.
- Regarding EV/BOE/D, BP and Eni are the leaders, while Total is less attractive having a 4% upside in the peer group and 19% upside in the sub-group.
Though I remain quite bullish in the long term, I see the inevitability of the Q4 CFFO and FCF decline as a direct consequence of cheaper Brent crude. However, TOT is not a highly leveraged company, and its balance sheet is sound, total debt-to-EBITDA stood at 1.6x, and the recent oil correction is not insurmountable for it.
For Total, the recent Ruwais Diyab Unconventional Gas Concession agreement is a chance to enhance the versatility of the portfolio and benefit from the obvious demand in the UAE and cash flow generation opportunities that arise from it in the 2020s.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within 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.