Exxon, Chevron, And Texas Pacific Land: Titans Of The Permian

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About: Texas Pacific Land Trust (TPL), Includes: CVX, XOM
by: Joseph L. Shaefer
Summary

Russia and Saudi Arabia each currently produce about 10 million barrels of oil per day.

However, Russia’s production is likely to decline as a result of failure to invest in new technology.

And Saudi Arabia, having squandered one of the world’s great aquifers, must use 1 million of their barrels per day to desalinate sea water.

The Permian Basin in west Texas, once thought mostly played out, is now producing as much as OPEC member Kuwait -- and closing fast.

Here is the best way to play this “hiding in plain sight” opportunity.

In the next 48 months, the Permian basin alone is projected to surpass the daily production of the nations of Brazil, United Arab Emirates, Iraq, Iran, and China – from just one basin.

Please look carefully at this chart of the world’s current three biggest producers of oil…

I wrote the following on Seeking Alpha back in 2010, the *beginning* date for the chart above.

“When I began my career in the brokerage business in 1972, our firm’s analysts put out a report about the world running out of oil. Since then, we have more than doubled our estimates of the oil, gas and coal remaining under the earth’s crust and have barely begun to explore in parts of Africa and under the world’s seas. (A few weeks later, these same analysts also sent out buy recommendations based upon the “certainty,” then all the rage among leading scientists that, because of our addiction to fossil fuels, the planet was rapidly cooling and we were all going to freeze to death unless we developed alternatives to oil.)

Since then (2010) the United States has *again* doubled its production and more than doubled its estimates of reserves of oil and natural gas!

Make no mistake, it is U.S. shale that had delivered this good news. U.S. shale growth is turning the world’s oil and gas calculus on its head. Erstwhile providers to the world’s largest consumer markets, the United States and Europe, who reckoned they could dictate terms geopolitically because of the economics of oil and gas, are running scared and the US is in the driver’s seat.

Even those vehemently opposed to using Mother Nature’s compressed fuel in the form of highly efficient oil and gas might enjoy this good news. After all, all those billions spent kowtowing to bullying dictators sitting atop mountains of oil and gas can now be spent for research on ever-more-efficient energy alternatives!

Norway's Sovereign Wealth Fund Sells Oil & Gas Holdings!

This past Friday Norway's SPU (Statens Pensjonsfond Utland – its sovereign wealth fund) announced it was divesting $7.5 billion worth of pure exploration & production firms from its portfolio. Oil and gas stocks took a hit, of course, and I took the opportunity to add to a couple of favorites.

Here’s the thing: The SPU is a $1 trillion fund. $7.5 billion sounds like a decent-sized number until we put in perspective that it is less than 1% of their total holdings, an amount it would not be unreasonable to imagine them trading on any market day. It is an even smaller amount relative to the size of the oil and gas portion of the world's energy sector.

But of course the Chicken Littles were out in force. (Fear sells, or at least gets you to page view then click into other Important! Exciting! Stories of equivalent value…) The theme Friday was that other sovereign wealth funds may do the same because, after all, “everyone knows” that oil and gas are evil.

Except… please note also that the SPU is *not* selling any of the big global integrated companies it holds. And note, too, that so much of Norway’s economy itself is dependent upon earnings from its own massive offshore oil and gas fields that it really doesn’t make sense to make it even more dependent upon that one sector.

I think the fund realizes this and just decided to make a statement about the need to switch to alternative and renewable energy sources as a social feather in their cap, with a “look how correct we are, and how leading edge” approach – while coincidentally reducing exposure, albeit just a little, to their biggest sector.

So why didn’t the SPU sell any of the integrated oil firms? Their stated rationale was that these larger firms were no longer just oil and gas companies, but true “energy” companies. (And in truth Exxon Mobil (XOM) alone spends more than $1 billion per year on alternatives research – they want to supply energy on whatever form they can wherever they can.) Also, I think, perhaps a bit more cynically, that the trustees of the SPU realizes that these big firms are the most efficient at what they do, have the deepest pockets for future development, and are likely to provide the best returns going forward.

The Permian Basin

This compelling advantage is nowhere more evident than in the Permian Basin in west Texas, which has staggering potential to drive the United States even further into providing the oil and gas needed by a hungry world.

When I say “staggering potential” we have no idea as yet of just how much oil and gas are available via hydraulic Fracturing in this windswept desert region. Until recently, it wasn’t even on the ,map of the world’s 10 largest oilfields. Then it was number 5, then number 3, then in 2018 it surpassed the Greater Burgan field in Kuwait and today is second only to Saudi Arabia’s Ghawar field – so far.

There are actually some 26 exploration and production firms with active drill fields in the Permian Basin. But many of them have their own problems, even as they are producing more oil and gas from the region. These include:

1 – Debt. A lot of these companies, even some of the best-known, have way too much debt and way too little dependable cash flow. Their continued ability to survive depends upon a relatively high price for their product.

2 – “Parent-child” problems. We all know about this one... only I refer to something besides human beings. Someone got the bright idea that if getting product from one well was good, why not put another right next to it -- or within close proximity -- and double the output. It doesn't work that way. In fact, they ended up spending more only to cannibalize their existing "parent" well. It is an expensive lesson.

3 -- A lot of them overpaid just to get in to the Permian or just to get it into their quarterly reports that they, too, were in the hot place to be.

4 –Everyone in the business knows there is a decline curve when extracting the carbon remains of old plants and dinosaurs via fracking. However, in their enthusiasm they didn't allow for the rate of decline. That doesn’t make fracking less viable; it just means that the astute reader needs to take with a grain of salt some companies’ PR flacks extolling the output of a brand-new series of fracked wells. The output declines steadily over time.

5 - Pipeline congestion. Oil from the Permian currently sells at about a $10 discount per barrel compared to the US West Texas Intermediate benchmark. The reason is that they simply cannot get enough of it out via existing pipelines so they compete to sell cheaper than their neighbors to at least make some profit and move some product.

Who Is Not Saddled With These Problems?

By and large, the biggest of the big. They own huge tracts of land in the Permian but they have laid back and watched -- and learned -- from the mistakes of their junior brethren. I refer specifically to Exxon Mobil (XOM) and Chevron (CVX). Unlike some of the smaller firms, neither are encumbered by a level of debt that seriously impinges upon their cash flow.

In addition, both can easily divert future CapEx funds from what might have been planned for offshore global production in Nigeria, Angola, Venezuela or some other less-than-ideal geopolitical partner back to something safer and more certain right in the USA.

Also, using income from other offshore or legacy fields, both have been able to wait while the cost of production has steadily declined due to the rapid pace of new technologies and new materials. 2016 was the last year I could find a graphic showing the pace of decline at which a company can break even, though my research shows it is now even less than this in many places, especially the Bakken and the Permian.

Neither XOM nor CVX have gone through the Teenage Years parent-child fiasco. Most importantly, both can -- and are -- financing their own proprietary pipelines to get the product to market.

In fact, now that Permian Titan Exxon is ready to move, it is moving at the speed of summer lightning! Exxon, Plains All American Pipeline, and Lotus Midstream just announced they will build a pipeline capable of transporting more than *1 million barrels per day* of crude oil and condensate from the Permian to the Texas Gulf Coast. The companies have formed a joint venture, Wink to Webster Pipeline LLC, and have already ordered 650 miles of domestically sourced 36-inch-diameter line pipe. The project is targeted to start operations in the first half of 2021.

The Wink to Webster Pipeline will provide pipeline transportation from XOM “and other Permian producers” – guess who gets first dibs -- to market destinations in Texas including Exxon’s own massive Beaumont, Texas refinery. Soup to nuts? Exxon pumps the product, ships the product, and refines the product. That’s vertical integration!

Chevron is not standing still, either. One of the biggest landholders in the Permian, Chevron and its legacy companies have been a fixture in the Permian since the early 1920s. Fortunately they never sold off those holdings in the pre-fracking era.

Indeed, Chevron simply updated their methodology for extraction. They call it their “factory model” and note that it has allowed them to triple the pace of their drilling program. Basically, with so many thousands of possibilities due to their large landholdings, CVX has been able to lower its drilling costs and reduce the number of days from start of drilling to first production.

Having purchased most of its acreage at 1920s prices (!) Chevron doesn’t need to spend today’s per-acreage money to get the benefits of the Prolific Permian. As Chevron’s vice president of global exploration, Liz Schwarze, said at a Permian-focused conference in Texas in January, “We always knew that there was more to give from the Permian, but we didn’t quite know how.”

Chevron plans to double its production in the Permian by 2022 and is investing in growing production at high-return short-cycle projects.

The benefit of sticking with these major integrated energy firms is that we have virtually zero risk of default or bankruptcy. No matter how low oil prices tumble, their diversification into both upstream (exploration and production) and downstream (refining and distribution/retail sales) keeps them in good stead. When oil and gas prices are high, they make the most money, of course. But even when prices of the commodity itself are low, that just reduces the big integrated firms' cost of feedstock for their refineries and chemicals and plastics businesses.

The Dark Horse

My final Permian Titan is a company many investors have never even heard of. That would be the Texas Pacific Land Trust (TPL). People complain they sold Amazon too soon or Apple too soon. Heck, my biggest regret is selling TPL after I had a mere 250% profit. That would have been 900% today!

TPL is the largest landholder in the Permian. It owns all the mineral rights and, increasingly more important, all the water rights on its massive holdings. How did it come to own so much land? It, or its predecessor company, went bankrupt.

TPL was formed on February 1, 1888 as a result of the bankruptcy of the Texas Pacific Railway Company. The bankruptcy judge ordered the formation of the Texas Pacific Land Trust as a way of reimbursing, over time, the creditors of the defunct railroad.

It employs, I believe, 71 total individuals whose job it is to sell land, lease land to provide cash flow, and buy back stock to continually reduce the number of shares. This approach allows them to pay small dividends or buy out the "certificate" holders. That would be any of us who buy shares, even today.

Back then, their property was pretty much worthless desert scrubland. But with the discovery of oil and gas, TPL found itself not just the biggest landowner in and around the Permian, but as I mentioned above the biggest holder mineral rights in those areas and, even bigger, all water rights, a most precious commodity not just to frackers but to every living thing.

TPL derives income primarily from land sales, oil and gas royalties, easements, grazing leases, and interest. There are no material liens or encumbrances on the Trust's title. The Trust also owns a 1/128 nonparticipating perpetual oil and gas royalty interest under 85,414 acres of land and a 1/16 nonparticipating perpetual oil and gas royalty interest under 373,777 acres of land in west Texas. TPL's landholdings also include some in the path of urban development. It is a land company and, by virtue of its perpetual leases, an under-the-radar oil and gas company without the debt (which is zero) or risks of the explorers. Dry hole or gusher, TPL gets something; it just gets even more when there are gushers.

I would caution you against rushing out to buy shares, however. Savvy players have been bidding the stock up over the years and especially this past year. TPL now sells for $712 a share – the price I paid for it on Friday. We could have bought it for $6 a share in 1980. Of course, we would likely not have held. It was the same price in 1997. As recently as 2010, you could have owned it for $25. I didn’t buy then, either. I did buy at a shade under $100, then thought I was pretty darn smart to sell at $280 just two years ago this month. Did I mention it is now $712?

I don’t mind buying 10 shares today. I consider those shares a placeholder to remind me that if it continues with its charter and the Permian continues to be the gusher it is today, on any investor panic, I need to buy 20 more at $600, 30 more at $500, etc. Even at today’s price, it sells at just 26 times earnings. No debt, a simple business model, and in the right place at the right time.

PS – If you decide to join me, place limit orders and only buy a little. TPL is thinly traded, with just 20,000 to 25,000 shares traded on an average day.

In one of my next energy articles, some of which I will release to my subscribers first, I will talk about U.S. refiners. There is a bunch of money to be made here. Due to vocal opposition, often from faraway places, to anything having to do with oil and gas, there has not been a refinery built in the United States since 1977. Such shortsightedness effectively gives a compelling advantage to those already in the business…

Good investing,

JS

Disclosure: I am/we are long XOM, CVX, TPL. 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.