Source: Marathon Oil Corporation

Oil stocks have been hammered over the past year thanks to the steep drop in crude oil prices. While the whole industry is feeling the pain, some oil stocks are now much cheaper than their peers. In fact, according to S&P Capital IQ data ConocoPhillips (NYSE:COP), Marathon Oil (NYSE:MRO), and Whiting Petroleum (NYSE:WLL) are the three cheapest large cap oil stocks by measuring Enterprise Value-to-Proved Reserves.

Why this metric?
Proved reserves are the lifeblood of the oil industry. It's the amount of oil and gas a company controls underground that it's reasonably certain can be economically produced. The reason these reserves are critical to energy producers is because it's what fuels future production. However, companies face an uphill battle to maintain and grow their proved reserves because they are not only producing these from reserves each year, but finding new reserves are costly.

Because of the cost of organically finding new reserves it can actually sometimes be cheaper to acquire additional proved reserves by acquiring a rival producer. It's something Noble Energy (NASDAQ:NBL), for example, recently did when it agreed to acquire Rosetta Resources (NASDAQ: ROSE) and its 282 million barrels of oil equivalent proved reserves for an enterprise value -- meaning it includes the assumption of debt – of roughly $3.9 billion. In that deal Noble Energy acquired Rosetta Resources proved reserves for $13.65 per barrel using an Enterprise Value-to-Proved Reserves ratio. In a sense that deal put a floor value on what the proved reserves of other oil companies would be worth to another buyer. We can use that floor to uncover other cheap oil stocks that could be acquisition candidates.

Three that fit the bill
Among oil companies with total enterprise values above $10 billion, the three cheapest using the Enterprise Value-to-Proved Reserves ratio are Whiting Petroleum at $14.78 per BOE, ConocoPhillips at $10.65 per BOE, and Marathon Oil at $10.30 per BOE. This suggests that all three are undervalued versus their peers and could therefore be potential takeover candidates by their larger rivals. For example, all three companies could be tempting for big oil behemoths ExxonMobil (NYSE:XOM) or Chevron (NYSE:CVX) as they have Enterprise Value-to-Proved Reserves of $15.08 per BOE and $18.22 per BOE, respectively. The implication here is that Exxon and Chevron could create more value for their investors if they acquired Whiting Petroleum, ConocoPhillips, or Marathon Oil, than they would if they bought back their own stock, for example, as their own proved reserves are more expensive.


Source: ConocoPhillips

What's also worth noting is the fact that ConocoPhillips, Marathon Oil, and Whiting Petroleum are cheap despite the fact that all three own substantial acreage positions in fast growing shale plays. Whiting Petroleum, for example, has actually grown its proved reserves by a 19% compound annual rate since 2011 due to both acquisitions and organic growth with tremendous growth potential in the years ahead. ConocoPhillips, meanwhile, hasn't grown its reserves quite as fast as it's a much larger company. However, it has vast potential. To date, the company has only booked 900 million BOE of proved reserves in unconventional shale resources while it sees upwards of 6 billion BOE of resource potential still to be booked in the future, which is upside an acquirer would get above already cheap proved reserves. Marathon Oil, likewise, has huge resource potential with 3 billion barrels or more yet to be booked across its three shale plays.

Investor takeaway
ConocoPhillips, Marathon Oil, and Whiting Petroleum are the three cheapest large oil stocks if we look at their Enterprise Value-to-Proved Reserves. As such, it makes all three compelling takeover targets for even larger oil companies as they can buy reserves at a steep discount to their own reserves. Further, they'd also buy tremendous upside to future reserve growth given the fact that all three have billions of barrels of yet unbooked reserve potential just waiting to be developed.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.