Lithuania Deal Could Be Statoil's Breakthrough

Unstable relations between Russia and Europe have created problems for the regional fuel trade. Norwegian energy giant Statoil  (NYSE: STO  )  is preparing to benefit from this fallout by catering to any resulting energy gaps. The company is also focusing on disgruntled customers of the Russian energy giant Gazprom.

Lithuania deal
Lithuania is one of Gazprom's biggest European customers. It supplied 2.7 billion cubic meters of natural gas to Lithuania in 2013. This high dependency has allowed the company to establish a monopoly and charge exuberant prices. Lithuanian customers pay approx. 15% more than the rest of Europe for natural gas. Therefore, Lithuania has more cause than others to reduce its dependence on Gazprom.

Statoil is close to signing an LNG deal with the Lithuanian state-owned company Litgas. Statoil announced that it will be supplying 550 million cubic meters of LNG per annum from 2015 onwards, for a five-year period, at a price lower than the average global LNG market price. The panic-stricken Gazprom has also reconsidered its gas prices and has decreased them by 20%. However, it seems that this reconsideration is too late because Statoil and Litgas have shown confidence in the deal and expect its completion by the end of June.

Lithuania is also constructing its LNG terminal which is expected to be completed by the end of 2014. This terminal will have a capacity of 1 billion cubic meters during its first operational year. This indicates that Satoil's 550 million cubic meters will only account for a small share of the new LNG import capacity. Statoil's Snoehvit LNG facility processed 4 billion cubic meters of gas last year, which can easily cover Lithuania's demand of 2.7 billion cubic meters.

Arctic operations facing hurdles
According to the U.S. Geological Survey, the Arctic region holds 20% of the world's undiscovered reserves. Back in 2011 Statoil discovered 540 million barrels of oil in the Norwegian shelf. But since then the company has failed to locate any other material field and has only been able to identify around 100 million barrels of oil equivalent at the Skavl and Drivis wells combined. Due to these setbacks, Statoil had to slow down its exploration in the Arctic region in order to control costs. For now it has announced that it will go ahead with the Pingvin and Isfjell wells only, which will be drilled next winter amid pressure from the Norwegian government.

The environmentalist group Greenpeace is giving the company a hard time as well. The group is against Statoil's handling of its tar sands project and also opposes Arctic drilling by putting hurdles in the company's way. In the latest incident Greenpeace activists captured one of Statoil's Arctic rigs, but the issue was resolved by the Norwegian government. This indicates that the company will be facing challenges from such groups in the future and this can cause hindrances in the already slow exploration.

Fundamentals
Statoil is trying to keep its capex at $20 billion per year between 2014 and 2016 in order to increase margins. However, this will delay its production target of 2.5 million barrels per day by 3-4 years. This indicates that we should not expect any upside in the dividend levels for at least 2-3 years. On the bright side, the current dividend level is sustainable as a CFO yield of 16.8% is significantly higher than a 3.60% dividend yield.

Last year the company reported a net income of $6.5 billion and an operating cash flow of $16.7 billion. Considering the cash flow, it appears that most of the annual capex of $20 billion can be covered through CFO, while the remaining can be paid off through the company's cash and cash equivalent balance of $14 billion. Therefore, the company does not face any immediate concerns when it comes to capex financing.

Bottom line
Statoil is in good financial health with strong operating cash flow and solid bottom line performance. The Arctic drilling setbacks are a source of concern and the company should be gearing up to address Greenpeace and increase its efforts to locate more reserves.

For now the key catalyst for Statoil is the signing of the Lithuanian deal, which will open new doors into the European region. This will be the first step in breaking Russian monopoly in the region and may lead to more breakthroughs amid a charged political environment.

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