Texaco's West Africa Push Could Give Reserves a Big Boost

The vast potential of a hot drilling area could hold the key to finding value in Texaco (TX) shares.

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Texaco is gearing up to explore in Angola's Kwanza basin early next year. For the patient investor, that's a good sign. A string of discoveries off Angola this year, including a recent one by Exxon(XON), has oil observers buzzing about the region's prolific reserves, despite political risks and lack of infrastructure. A strong exploration program in west Africa stands to bump up not only Texaco's reserves, but also its recently underperforming shares.

With worldwide oil and gas reserves of 4.7 billion barrels, Texaco is no slouch. But compared with the 11 billion barrels the combined Exxon and Mobil(MOB) will control, or the 11 billion-plus barrels BP Amoco (BPA) will boast after it buys Atlantic Richfield(ARC), Texaco looks decidedly diminutive.

In fact, Texaco may be second only to France's Elf Aquitaine (ELF) in the percentage boost its reserve base may see with exploration success in west Africa, analysts say. Texaco's reserve base could grow by as much as 42% as a result of the west African efforts, according to Prudential Securities. Combine that with its modest valuation in terms of reserves and you have an energy giant with $32 billion in annual sales that some investors and analysts say makes for a solid bet.

Falling Star Texaco shares lag behind peers'

Source: BigCharts

"I think that you could make the case that [Texaco's west African play] could add 10% to net asset value," says Gene Gillespie, an analyst at Howard Weil who has a long-term buy rating on Texaco. (His firm hasn't underwritten for Texaco.) And although oil discoveries typically don't immediately move large-cap oil stocks, "as you get closer to the point in time investors can see the earnings and cash impact, then they'll begin to pay for it," he says.

Tom Medcalf, an analyst at Texaco shareholder American Express Financial, sees the stock as "modestly undervalued," and likes the fact that Texaco is focusing on cutting costs. The stock closed Friday at 61 3/8, giving Texaco a market capitalization of around $34 billion.

After all, internal costs are a rare variable over which oil companies have control. Through Sept. 30, Texaco had cut its per-barrel costs by 9% from a year ago, to $3.38, putting it a year ahead of schedule in its goal to reduce costs by $650 million.

And Texaco is making other strategic investments to boost near-term cash flow and long-term growth. Last month it took a 45% stake in a Philippines natural gas field that's said to contain 4 trillion cubic feet of gas. But west Africa remains a core area for the White Plains, N.Y., company. "Clearly we consider that an area that has promise for the future," says Maripat Sexton, a Texaco spokeswoman.

Late Push Texaco expands capital spending in the fourth quarter

Figures in millions of dollars. *Estimated. Source: Texaco.

To be sure, west African drilling carries some risks along with the potential reward. For one, it typically takes 3 to 5 years between a discovery and the time a project might start helping a company's bottom line. For another, there's significant political risk attached to nations such as Nigeria and Angola, Gillespie says (see related story).

And as big as Texaco is, "it's hard for a company of that size to have major exploration success impact the stock," says Medcalf.

But west Africa is one of the few growth areas left where huge finds make it economical for oil companies to replace reserves, says Fadel Gheit, an analyst at Fahnestock who has a buy rating on Texaco and whose firm hasn't done any Texaco underwriting. "The big companies are really forced to go to these areas," Gheit says. "They cannot sustain their production profiles unless they replace reserves in a very big way, and they cannot do that in mature areas like the U.S."

Even without potential reserve increases, Gheit says Texaco is the cheapest among major oil companies based on its implied reserve value.

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