Redefining Crude Oil: Investing in the Condensate Producers

Alaska Senator Lisa Murkowski is the latest official to push the Commerce Department to revise its definition of "crude oil," hoping to see condensate removed from the definition. This is primarily centered on circumventing a ban on exporting crude, and with several other government agencies' definitions excluding condensate, it is a case that has a lot of momentum.

The Commerce Department has already offered permission to two companies in the Eagle Ford to export condensate produced there, also suggesting that a simple revision of the Commerce Department's definition to allow wholesale export by all companies there is a logical next step.

The condensate push
The push to get condensate redefined is not exactly new, though it seems to be getting a lot of new momentum in recent months. The ultralight condensates are a byproduct of the growing use of shale oil, and while Canada has been cashing in on its own condensate industry, the US has so far struggled with oversupply and no way to export the excess, keeping the price lower than it ought to be.

It's not just the relatively small condensate industry that is behind this change, either, as many see this as the next step in a trend toward lifting the ban on crude exports entirely, one which may make increasing economic sense as US oil production continues to increase, and the price difference between WTI and Brent Crude makes exports more lucrative.

Right now, the Eagle Ford formation is the most developed oil producing region which is giving off large amounts of condensate as a byproduct, and so we will look at the largest companies operating here as the most likely to benefit from such a revision in the law, and the inevitable increase in condensate prices that will follow.

The big four
EOG Resources (NYSE: EOG  ) is likely more familiar to most people under its former name, Enron Oil and Gas. The company split off from Enron itself in 1999, before the latter's historic collapse. EOG Resources is the largest producer in the Eagle Ford by a considerable margin, and also has a big play in North Dakota's Bakken Shale, another good source of condensate.

The second largest Eagle Ford producer is Chesapeake Energy (NYSE: CHK  ) , a company which has deep interests not only in the Eagle Ford, but in several other shale production fields, including at the Chesapeake Granite Wash Trust (NYSE: CHKR  ) . The company seems perhaps the closest of the bunch to a pure play in condensate production.

The third largest producer is Burlington Resources, a subsidiary of ConocoPhillips (NYSE: COP  ) , and the fourth largest, narrowly behind them, is another major global player, Marathon Oil (NYSE: MRO  ) .

By the numbers
EOG Resources is the biggest play, but also the priciest, trading at 3.95 times book. That's hardly cheap, but it is a well-run company with a nice 15.87% return on equity.

Chesapeake Energy has worse margins, with a 5.70% profit margin (compared to EOG Resources' 15.36%)  and a 6.90% return on equity. That's perhaps to be expected with such deep interests in shale oil production. It's trading at 1.40 times book, and offers 1.10% dividend yield.

ConocoPhillips also looks cheap by comparison, at 1.98 times book. It has a return on equity that is comparable to EOG Resources at 15.81%. It also pays the best dividend of the bunch, at a 3.20% yeild.

Marathon Oil is no slouch either, at only 1.36 times book. It has the highest profit margin at 17.79%, and pays a decent dividend yielding 1.90%.

In conclusion
Condensate exports are already starting with the Commerce Department's first waivers, and a full-scale export industry seems only a matter of time, meaning condensate prices in the US should soon be more closely in line with the rest of the world.

That's good news for all of these companies, but perhaps most of all for Chesapeake Energy, which is so heavily involved in shale production and could really see some improved margins. ConocoPhillips and Marathon are both worth considering as value propositions in their own right, while in my opinion EOG Resources is simply too expensive right now to consider this an entry point, compared to the cheaper alternatives.

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