The irony of investing in the energy industry is that the companies most visible to individuals on an everyday basis, like ExxonMobil (NYSE:XOM) and Chevron (NYSE:CVX), just happen to be some of the most complex and difficult companies to analyze. There are, of course, the basics, such as income statements and balance sheets, but there are also some more specific things to look at when looking at these energy giants. To help you better analyze these integrated major oil companies, here is a primer on what these companies are, and what you should look for when analyzing them.
Who are we talking about here?
Officially, companies like Exxon and Chevron are known as integrated oil and gas companies, but they're also referred to as super majors, integrated majors, or Big Oil. The reason they are called this is because they deal with the entire value chain of oil and gas: exploration and production, midstream pipelines, refining and chemical production, and retail and marketing.
Exxon and Chevron aren't the only ones that fit into this category, either. Here is a list of the 10 largest integrated oil and gas companies that trade on the major US exchanges by market capitalization and production of oil and gas.
|Company||Market Capitalization ($Billion)||Total Production (thousand barrels of oil equivalent per day)|
|Royal Dutch Shell (NYSE:RDS-A)||
|Occidental Petroleum (NYSE:OXY)||$75.1||767|
A common metric in the oil and gas space is oil equivalent; it is used to lump both natural gas and oil into one. To do this, natural gas production is measured by how much energy it provides, and then divides it by how much energy is stored in a barrel of oil (one barrel of oil=about 6 thousand cubic feet of natural gas). So whenever you see barrels of oil equivalent (boe for short), it means both oil and gas.
Where you should focus: Exploration and production
You could spend hours looking at the entire portfolio of these companies to find weaknesses and strengths within each segment of the business. If you're looking to do a more quick and dirty evaluation, then you should focus your attention on the exploration and production side of the business. The reason is because the majority of all these companies' income comes from there.
|Company||% of net income from exploration and production activities|
|Royal Dutch Shell||77|
And no, those numbers are not a fluke. Both Petrobras' and PetroChinas' exploration and production division actually keep much of the rest of the business afloat. The reason that the other divisions of these companies suffer so much is because Brazil and China subsidize the price of oil and gas to curb inflation. In the case of Petrobras, this means the company's refining and marketing activities perpetually lose money. Eni does not have this problem, but the American oil boom has led to a major downturn in the European refining market, and the company has lost money on its investments there.
The three P's of research: Property, production, and Projects
Even if we do boil these companies down to just their upstream assets, evaluating their production portfolio alone is still a mammoth task. So here are some of the most critical elements you should dig into when looking at a big oil company's balance sheet
Property: Look for Red Flags
There is oil everywhere and, for the most part, it all sells in a very fluid, open market across the globe at similar prices. There are, however, some places that are better than others, and you should know if a certain locale is a red flag for a company.
A perfect example of this right now is Nigeria. For several decades, theft, sabotage, and overall neglect have left much of the oil infrastructure in the region unreliable. This is costing certain companies lots of money. Shell, one of the largest operators in Nigeria, estimates that theft and sabotage there will cost the company $12 billion when 2013 is all tallied up. Other places that have been less than desirable for several big oil companies recently are Iraq, Libya, Egypt, Ecuador, Venezuela, the United Arab Emirates, and, surprisingly, U.S. shale.
Production: It's called black gold for a reason
Whenever a company explores for fossil fuels, they are likely to come across some mixture of natural gas, natural gas liquids, and oil. Even though all these products may come from the same well, they do not carry equal value. There are some exceptions, but it's pretty safe to say that a barrel of oil, or natural gas liquids production, is much more valuable than its natural gas equivalent. For instance, in the U.S., oil is currently three times as valuable as the natural gas equivalent. So when you're evaluating these companies, it's important to know the production mix. Here is how each of these 10 companies' production breaks down; since many of these companies don't break out natural gas liquids, they are included as liquids in the table below.
|Company||Production mix (liquids/gas as % of production)|
|Royal Dutch Shell||50.6%/49.4%|
Again, this isn't a perfect metric, because there are lots of other factors to consider, but it is an important, basic element to know about each of these companies.
Projects: What does the future hold?
Oil and gas reservoirs are diminishing assets, so big oil companies perpetually need to bring new production online to replace the decline at its existing fields. Petrobras, for example, says that it has a natural decline of its entire portfolio of about 9%, so every year, the company needs to bring on 230,000 barrels per day of new production just to maintain its current levels, and they are just over half the size of Exxon in terms of production.
Not only do these giants need to maintain current production, they need to grow, as well. To do this, they need to take on extremely large development projects that can take several years and several billion dollars to develop. The Gorgon LNG project in Australia is one example of this. The project -- co-owned by Chevon, Exxon, and Shell--- involves developing offshore natural gas fields, building a 3.5 million ton per year LNG liquefaction facility, and putting all of the infrastructure necessary in place to get the project up and running.
The benefit to companies like Chevron is that this project will result in huge jumps in production. Both of Chevron's Australian LNG projects- -- Gorgon and Wheatstone -- will net the company 400,000 barrels per day of oil equivalent production for several years. The downside of these projects is they are becoming increasingly more expensive to bring to reality. The Gorgon project was supposed to come online in the middle of 2014 at a price tag of $39 billion, but it has ballooned to $54 billion, and will not start up till mid 2015.
So how can you, as an investor, evaluate these projects effectively? Here are three questions you should ask:
- What is the potential for a project? Most companies have to evaluate not just how much oil they can get for a project, but also what kind of return they can get on that oil. Places like the Brazilian offshore fields hold vast quantities of oil, but Brazilian rules say that no foreign company can be the primary operator of those projects, so companies have been hesitant to spend big money there recently.
- What are the risks involved? Even though some parts of the world hold vast quantities of oil, the risks associated with those projects makes them very difficult to pull off. One only needs to look at the problems Exxon and Shell have had with the Kashagan project to see how a risky project can impact a company. Most of these high-risk projects involve places where lots of infrastructure needs to be put in place, like Kashagan, Gorgon, and the Arctic. Conversely, places like the Gulf of Mexico and Canadian oil sands are proving to be much less risky investments because of track records in the respective regions, and the large amount of existing infrastructure.
- Can they keep the project on time and on budget? In order to realize the potential of a new find, the projects to develop them need to stay within a reasonable budget. Otherwise, the rates of returns start to dry up. The Kashagan project was initially supposed to cost $57 billion, but today, those costs have skyrocketed to $187 billion. Both Exxon and Shell estimate that they will need to be involved with the project all the way into 2040 before they realize a decent rate of return because of these high costs.
If you ask these three questions while coming through the project portfolio of a big oil company, it should give you a much better picture of what the future has in store for these companies in terms of both production and profitability.
What a Fool believes
The idea that energy giants like Exxon and Chevron are safe, stable, no-brainer investments seems almost crazy when you consider what these companies have to do to maintain their levels of profitability. Nearly all of these companies have developed reputations over many years that they are more than capable of churning out strong returns in such a challenging environment. A prudent investor, however, would be wise to look at the elements outlined above, as well as the traditional financial metrics, before making any investment decisions when it comes to big oil.