It's getting easier to separate the haves and the have-nots in the oil and gas sector.Well, at least it was before the threat of regional war in the Middle East sent the share prices of just about all oil producers running higher, along with the price of a barrel of oil. But once the region settles back down to its now unfortunately normal state of grinding small-scale slaughter, the basic trends in the industry will again come to the fore. And you should be looking through the current disaster to own the long-term winners. It doesn't hurt that these same stocks should do well in the short term from financial markets' Middle East fears.
Guess which group of oil and gas stocks I think smart investors should be buying now? Desperation was on full display last week when Repsol YPF ( REP), the Spanish energy company, bought BP's ( BP) stake in the Shenzi field in the Gulf of Mexico for $2.15 billion. According to oil industry analysts at Wood Mackenzie, this price values the oil and gas that BP estimated it could recover from the field at a stunning $97 a barrel of oil equivalent. Repsol has said that it believes it can add enough extra reserves once it finishes drilling to cut the price to about $68 a barrel. Spending $97 a barrel to acquire oil that's still in the sea floor underneath 4,300 feet of water in the hurricane-prone Gulf of Mexico? (By the way, it will cost about $4.4 billion to develop the field over the next nine years.) That's either extraordinarily bullish or just plain desperate. After looking at Repsol's reserve numbers, I'd vote for desperate. In January 2006, Repsol revised its proved reserves downward by 25%, thanks to legal, political and technical changes in Bolivia (the source of 52% of the downward revision), Argentina and Brazil. That brings Repsol's three-year organic reserve replacement rate to a negative 95%, according to Standard & Poor's.
Exxon Mobil's reply boils down to "Why should we?" It's not as if the company isn't spending anything on capital projects and exploration. That part of the budget climbed to $4.8 billion in the first quarter, up 41% from the first quarter of 2005. And the company isn't hurting for either current or future production. The company has been able to both increase oil and gas production -- up about 7% in the first quarter of 2006 from the first quarter of 2005 -- and add to reserves faster than it pumps oil and gas. From 2003 to 2005, Exxon Mobil replaced 108% of reserves, according to Standard & Poor's. The company is on record saying that it doesn't think current high oil prices will last -- and that it doesn't see the point of buying reserves or spending capital on risky exploration projects at current prices. (On the other hand, the company has been perfectly willing to spend money on relatively low-risk liquefied natural gas projects. On July 10, for example, the company announced plans to spend $3 billion on the second phase of its liquefied natural gas project in Qatar. First production is scheduled for 2009).
First, because shortages of everything from oil field workers to drilling platforms are pushing up costs and delaying production schedules in all the world's energy fields. That's an especially big problem for any company that is betting on getting big projects up and running on budget and on time. Second, because loading up on debt to pay for acquiring oil and gas assets at high prices or to build big-ticket capital projects increases the risk that something will go wrong.
Companies that have pushed the envelope have, in effect, rolled the dice, and their fate at the table will depend on such unpredictable elements as hurricanes, politics from Bolivia to Nigeria, stalemate or all-out war in the Middle East and the speed with which new oil field technologies develop.