It can be difficult to value independent oil and gas exploration and production (E&P) companies like Noble Energy. The reality is no two of them are built the same, or exposed to the exact same risks. While global demand for oil and natural gas is growing -- and this trend looks likely to continue for decades -- there are a number of potential roadblocks that could lead to Noble Energy's (NYSE: NBL ) stock falling. Let's take a closer look at these reasons.
1. Geopolitical risk
While there is some regionality, oil prices are largely global in nature, and a major drop in prices in one part of the world will lead to falling prices everywhere. This is a fact that every oil company has to contend with, even a 100% domestic producer like Continental Resources (NYSE: CLR ) , which operates primarily in North Dakota. However, the stakes are much higher for Noble Energy, with a lot of its production in Africa, Israel, and China. For the first half of the the year, 41% of Noble Energy's total oil and gas production was international.
The majority of Noble Energy's international production is natural gas, which carries a much higher premium outside of the U.S., and Noble Energy's management is willing to take on a higher level of risk in order to exploit the potential gains. If political or social unrest or even war were to happen in one of Noble Energy's areas of operations, it could have potential implications on global oil prices, but the direct harm to Noble Energy would be larger than the impact on producers in other areas.
2. Weakening capital position
Management called out reducing its debt load in its analyst presentation in December 2013. However, debt has actually increased slightly since then, while cash and equivalents have declined:
Yes: It's still only a few months since that presentation, and the long-term trend is more important than just two quarters' worth of data. But E&P is very expensive, and having a solid financial position is the best hedge Noble Energy's management could have against poor production. If the trends (less cash, more debt) continue, this could increase the cost of capital, which in turn could be a detriment to funding enough exploration to replace current production.
It's a tough balance between maximizing resources and growing reserves, while also maintaining a strong balance sheet. Noble Energy needs to reverse the current trend.
3. Oil and gas prices
This is the greatest short-term risk to Noble Energy's stock price, because it's the one the company has essentially no control over. The best any E&P can do is to keep its cost of capital, exploration, and production as low as possible so that it can ride out volatility in the energy markets. Additionally, the company can hedge its production with a number of financial instruments, agreeing to sell future production at a fixed price that protects the downside, at the cost of some upside.
However, Mister Market often ignores these hedges, sending a producer's stock lower in a blind sell-off if the price of oil or gas falls.
Final thoughts: Understand the implications of risk
Risk is best defined as the probability of permanent loss of capital. This is important because your investing goals and timeline will often determine whether a short-term price drop becomes a permanent loss for you. For example, if a producer is hedged against oil or gas price drops, its stock price falling will be short-term in nature because the company isn't really as affected as the market's reaction. However, if you don't understand the company's hedging measures, you could follow the herd and sell, when the market could be giving investors a buying opportunity.
Lastly, none of these risks are guaranteed to lead Noble Energy's stock lower, but as an investor, it's essential to understand the risks even better than the opportunities, and position your portfolio based on those probabilities.
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