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The $1.5 Trillion Question Weighing on Oil and Gas Companies

By Alex Dumortier, CFA - Sep 21, 2015 at 1:50PM

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Energy consultants Wood Mackenzie say $1.5 trillion in potential projects are "underwater" at $50-per-barrel oil.

Investors took advantage of the weekend to settle themselves and enjoy a reprieve from fixating on the Fed's interest rate deliberation. U.S. stocks are showing small gains on Monday, with the Dow Jones Industrial Average (^DJI 1.76%) and the S&P 500 (^GSPC 2.47%) up 0.47% and 0.33%, respectively, at 1:25 p.m. EDT.

South Ellwood, Platform Holly -- Offshore Goleta, California.

$1.5 trillion -- that's the sort of number that can begin to reverse even a powerful trend like the collapse in the price of oil. According to energy industry consultancy Wood Mackenzie, that's the total value of potential energy investments worldwide that are uneconomic below $50 per barrel. The oil futures for November delivery of Brent crude are trading just above $48 today.

Those figures give an idea of the kind of pressure exploration and production companies are currently under. Wood Mackenzie estimates that the industry has already shelved projects totaling $220 billion.

The pressure on U.S. operators is set to increase as banks begin the twice-yearly process of revaluing "borrowing bases" -- the oil and gas reserves against which they're willing to extend loans. For smaller, highly leveraged operators, that could trigger an existential struggle to avoid a restructuring or bankruptcy.

The upside is that, in the face of muted demand, reducing supply is the first step toward higher oil prices and, thus, better profitability. Furthermore, value investors need not make a binary bet on whether or not a company will be able to ride out the period of depressed oil prices. Among large-capitalization oil-and-gas producers that trade on major U.S. exchanges, the five names with the lowest net debt-to-EBITDA ratio (bottom quintile) are:

 

Net Debt / EBITDA

P/E (Trailing-12-Months)

ExxonMobil

72%

13.0

Chevron

74%

11.3

Phillips 66

72%

12.8

Valero Energy

18%

8.0

Marathon Petroleum

72%

9.2

Source: Bloomberg.

I'll wager that a basket of those five shares will outperform the S&P 500 on a total return basis over the next five years.

Going against the herd rarely feels right, but it's the only way to go if you're trying to beat the market. Nothing feels right about the energy sector at present, but it's a probable "value patch" ripe for exploration.

Follow-up: Freeport-McMoRan
On the topic of contrarian investing: in last Friday's column, I looked at the double-digit percentage drop in shares of the mining and oil and gas company's shares following the announcement that it may raise up to another $1 billion through a stock offering.

The stock finished the session down 9.7% (they're down another 1.39% at 1:30 p.m. EDT today); however, after the close, billionaire investor Carl Icahn disclosed in a filing that he had raised his economic interest from 8.5% to 8.8% since his initial filing on Aug. 27. Last month, Bloomberg reported that Icahn had alerted regulators and the company that he may ultimately lift his stake to 25%. No investor is infallible, but Icahn's interest is a pretty good indication that Freeport's shares offer value at current prices.

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