Energy Investing: Exploration and Production

This article is part of our Energy Investing series. Click back to the series introduction to learn more and access easy-to-follow links to the entire series.

The oil and gas industry presents plenty of ideas for investors in need. There are so many options that entire portfolios can be built to reflect the process of extracting commodities from the ground and turning them into an end product that people use every day. While I'm not suggesting you actually do that, I am suggesting that you take a closer look at energy from start to finish and evaluate the best stocks for your current portfolio.

Today we'll tackle exploration and production. E&P is the first step toward developing energy, and it can be a great addition to your portfolio.

State of the industry
The exploration and production world has cleaved itself into two distinct halves of late: The "Goodness, it's getting hard to find oil" half, and the "We have more gas than we know what to do with" half.

In an effort to locate more reserves, Big Oil has increased exploration and production budgets and is looking to sign deals in the most remote locations in its quest to find every last drop of black gold buried beneath the earth's surface. Just in case the whole oil thing doesn't work out, the majors are also buying into natural gas plays early and often, all across the globe.

Somewhat unexpectedly, the one place new oil production is booming is North America. Onshore oil development in the Bakken Shale and Alberta's oil sands is steadily increasing, much to the delight of investors.

Natural gas on the continent, on the other hand, is so cheap that producers have stopped trying to pull it out of the ground. That's not the case abroad, where methane commands a much higher price in European and Asian markets, making recent discoveries that much more important.

Hot spots
E&Ps looking for oil have been particularly successful in onshore Canada, in Alberta's oil sands, and in North Dakota's Bakken Shale. The Bakken is currently producing oil at 600,000 barrels a day -- which is more than the current midstream infrastructure can cart away.

Kodiak Oil & Gas (NYSE: KOG  ) is a perfect example of the region's success. Over the course of two years, the company grew production 171% to 1.3 million barrels of oil. Revenue jumped 226% to $120 million over the same time period.

Offshore, Brazil's pre-salt fields are receiving a lot of hype now. Wells are showing promising results, which bodes well for the companies who have claimed licenses in the Angola's twin pre-salt fields across the Atlantic Ocean.

Africa is also the scene of some tremendous natural gas finds. Eni has made impressive discoveries off the coast of East Africa, as has counterpart Anadarko. The finds are large enough to warrant an LNG export terminal and will likely drive foreign investment to heights never before seen in several of the world's poorest countries.

What does your portfolio need?
The beauty of investing in E&Ps is that there are all sorts to fit the needs of your portfolio. The best majors will produce consistent returns, while the up-and-coming American onshore producers allow investors to cash in on tremendous growth.

Company

2011
 Performance

2012 YTD

Category

ExxonMobil (NYSE: XOM  ) 14% (2%) Steady as she goes
Kodiak Oil & Gas 44% 2% Growth play
Samson Oil & Gas (NYSE: SSN  ) 32% 26% Growth play
Statoil (NYSE: STO  ) 6% 5% Steady as she goes

Source: YCharts

Keep in mind that the smaller producers carry a great amount of risk. One hiccup in production can drastically impact overall performance. You can typically avoid this sort of thing with the majors, but the returns won't be as great.

Special vehicles
Sometimes oil and gas companies fund E&P expenses by creating royalty trusts. Typically, the trusts get a certain cut of production on a certain number of wells and issue royalties to unit-holders based on those production levels. The upside to these trusts is that unit-holders don't assume any debt from the parent company. The downside is that if production doesn't pan out, neither do the luscious royalties.

Chesapeake Energy launched its Chesapeake Granite Wash Trust (NYSE: CHKR  ) late last year. Let's take a look at how it's performed so far:


Most investors look to these trusts for the unit payments, but increasing value in the stock price won't trigger any complaints, either. And, unlike many IPOs, when a royalty trust goes public it doesn't experience the same price volatility that a tech stock can suffer from. Interested investors should keep an eye on SandRidge Energy, which plans to launch its third royalty trust this spring.

Digging deeper
Chances are there is an E&P that's just right for your investing needs. Checking in with our CAPS community and utilizing the Fool's My Watchlist service are both great ways to do more research and narrow down the field.

In the coming days, I'll cover the tangential plays tied to increasing natural gas production, like pipelines, oil-field service companies, and what Motley Fool analysts consider the "The One Stock You Need To Own for the Coming 'No Choice' Energy Revolution."

Fool contributor Aimee Duffy owns shares of Statoil, but she holds no other position in any company mentioned. If you have the energy, check out what she's keeping an eye on by following her on Twitter @TMFDuffy.

 Motley Fool newsletter services have recommended buying shares of ExxonMobil and Statoil. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


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