Oil & Gas Sector Investing

[Jurgis]

I might agree with samwise regarding "Look elsewhere" <--- targetted even more to myself than to others.

I took a look at SU (positive article in this week's Barron's) and OXY.

Both have pretty much zero sales growth in 10 years. Assuming no sales growth from here, what FCF would investor want? Something north of 10%? Well, they are trading somewhere close to 10% FCF / market cap. OXY is complicated by Anadarko deal - I should look at EV and incorporate Anadarko. I eyeballed CAD conversion for SU .

EDIT: Never mind, I was drunk, E&Ps are valued on reserves not on CF, forget-about-it. 

[vinod1]

I do agree that it depends on whether it resembles 2009 or 2015.

What I trying to get at is the more likely scenario where oil stays in the $50 range, even if it jumps up and down periodically, can the average company do reasonably ok?

Just trying to figure out if market is discounting an even more bleak scenario.

It's a good question, but it's a different question from what you asked above. 

You asked:

during a recovery from near depression levels, it would be the weakest that would have the strongest performance?

Now you are asking:

scenario where oil stays in the $50 range, even if it jumps up and down periodically, can the average company do reasonably ok?

The answers to these two questions are diametrically opposite:

If there is a recovery - and price runup - then weakest and average will likely do much better than stalwarts.
If price stays and fluctuates in $50 range, then the weakest and some average will do badly and may continue going out of business.

So in the first scenario, you'll do better with weak and average.
In the second scenario, you'll do better with stalwarts.

With in depth knowledge of the sector, it might be possible to find companies that will do very well in first scenario and not die in second. But that requires in depth DD.

Just MO. 

Jurgis,

To me, it looked like I am asking the same question. Just shows how ignorant I am about this sector.

My underlying assumption, which I wanted to confirm, is if oil stays at $50 would the average company be able to do reasonable ok? In my mind, I am comparing with the banks during 2011/12 period. They just needed to cut costs, rationalize, wait out the regulatory backlash, elevated credit costs and things should turn out to be reasonable ok. They do not need loan growth or high net interest margins or any of the other drivers of revenue.

Looking at the O&G sector and purely from a stock price perspective, it seemed they suffered similarly and am thinking, do they offer similar values to what banks offered in 2011/12. So is the market discounting oil prices even worse than $50?

From the answers, it now clear that many of the O&G stocks need higher oil prices.

Thanks for sharing your experience. Always good to know what others have experienced.

Vinod

[vinod1]

$50 /brl crude will be bad for the industry,  including the oil majors. The oil majors will survive, but many of the share players won’t.The oil majors probably manage to keep their dividends constant, but not much more than that. Capex companies like BHGE, NOV and SLB will suffer too. A $50 crude price basically means deflationary conditions for this sector and it’s not good for anyone.

I believe from the fossil fuels, NG has the highest staying lower, as it is the cleanest and cheapest fossil fuels. That’s one of the reason why I like NG focused midstream like WMB and EPD a lot. (I own WMB but no EPD yet).

Thank you! This is precisely the sort of information I am looking for. Extremely helpful. I was thinking given the pricing compression, forward returns would be much higher even with $50 oil. It is never that easy, is it?

Vinod

[vinod1]

The oil and gas sector seems to be beaten to a pulp. I keep track of sectors just to see how they are doing. The case of S&P Oil & Gas Equipment & Services ETF (XES) which uses equal weighting is particularly striking.

It has fallen more than 86% from its high. Its returns look like what stocks have experienced in the great depression. It fell -35%, then was again cut down -35%, then cut down -50%, and then cut down again -25%.

The energy sector weighting in the S&P 500 hit a new low of 4.5% now, compared to previous low of 6% in 2000 and a weight of 28% in 1980.

 I am seriously considering taking a diversified position in the energy sector. The main assumption is that the sector would exhibit some mean reversion.

Vinod

Vinod,

Sectors don’t always mean revert. Look at the sad history of transportation.
https://www.visualcapitalist.com/200-years-u-s-stock-market-sectors/

Ultimately you need a view on future profitability of the sector. E.g. you were looking at service companies. For a commodity industry with oversupply you will have to hope the oversupply ends and you earn a decent return on assets. With long lasting assets (oil rigs etc), it is unlikely that the supply will fall. Demand coming back has been the hope for a long time, but the headwind is that customers claim to be getting more efficient. I don’t have a strong view, but the industry isn’t very good.

One added difficulty is the rate of change in this sector. Technology is changing fast, and that creates large uncertainties which can make valuation hard.

I will second longlake. Look elsewhere if you don’t understand this sector. I’d suggest a different country. E.g Britain is pretty cheap even though the risk of a hard Brexit has receded.

I agree with pretty much everything you cautioned about. I had an unusually high number of my portfolio stocks hitting their sell targets at the same time with forward returns in the low single digits and it increased by cash % over the last couple of weeks.

Just doing due diligence on different things, O&G stocks, foreign & emerging market companies, etc that I have not previously looked at. I usually take 6 months to 2 years of research before I go into something completely new. So just wanted to see if it is worth the invested brain damage to do a deep dive into O&G.

Thanks for pointing out UK market.

Vinod

[Jurgis]

if oil stays at $50 would the average company be able to do reasonable ok?

I think not. But I might be wrong, so let's see what others think. 

[John Hjorth]

Vinod,

Not so long ago, Aswath Damodaran published a blog post about valuation of Saudi Aramco related to the IPO now in progress. Table 1 in that particular piece contains some calculations of several metrics for integrated Oil & Gas companies around the world with a market capitalization north of USD 10 B. It may be of interest to you.

[Spekulatius]

if oil stays at $50 would the average company be able to do reasonable ok?

I think not. But I might be wrong, so let's see what others think. 

I guess it depends a bit on how you define OK. Both OXY and EOG give some numbers on $50 crude. EOG claims a >10% ROIC and OXY claims they are FCF neutral and able to pay the dividend at this level. RDS claims a $28/ brl Break even point, but they also have substantial other business, so they should be profitable even at that level assuming break even pertains to crude upstream.

Virtually any energy company will go through great lengths to explain the cost savings they have achieved since 2014, which is one reason why those low energy prices can persist in my opinion, as these companies can continue to operate. The low prices are not the cure for low prices any more, it’s a deflationary sector. As long as this persists, I think it is hard to make a lot of money investing there.

[SharperDingaan]

Data on break-even costs
https://www.google.com/search?q=oil+and+gas+field+breakeven&rlz=1C1OKWM_enCA858CA858&sxsrf=ACYBGNQEqk0UHwoNQfujHi6GrnWKxM2ldQ:1575389375721&tbm=isch&source=iu&ictx=1&fir=2429xUbqjcCsYM%253A%252CeK0hatgA3w5fyM%252C_&vet=1&usg=AI4_-kT603F5aC-ahtqSAv1_XZTAPgKjPQ&sa=X&ved=2ahUKEwjouP3g7pnmAhXCTN8KHdLID2MQ9QEwAHoECAYQAw#imgrc=V67eL6jDY_tDuM:&vet=1

Alberta Tar Sands are B/E at around USD 50, US shale basins are around USD 55-60.
BE is also the proxy as to when new capital stops flowing into the industry. An existing well produces until the cash MR = cash MC.
Hence an industry may be unprofitable, but will continue to produce.

Ultimately you are making a call on the future price of oil during your holding period, looking for torque, and looking for downside protection. Variety of ways of doing this, but you either make some choices or walk away.

SD

   

[Jurgis]

if oil stays at $50 would the average company be able to do reasonable ok?

I think not. But I might be wrong, so let's see what others think. 

I guess it depends a bit on how you define OK. Both OXY and EOG give some numbers on $50 crude. EOG claims a >10% ROIC and OXY claims they are FCF neutral and able to pay the dividend at this level. RDS claims a $28/ brl Break even point, but they also have substantial other business, so they should be profitable even at that level assuming break even pertains to crude upstream.

Virtually any energy company will go through great lengths to explain the cost savings they have achieved since 2014, which is one reason why those low energy prices can persist in my opinion, as these companies can continue to operate. The low prices are not the cure for low prices any more, it’s a deflationary sector. As long as this persists, I think it is hard to make a lot of money investing there.

vinod1 said "average" company. If you pick (super)majors, especially ones with non-E&P business, yeah, they will not go BK. They likely will be profitable as you say. That's not average or weak companies IMO, especially if you look at equal-weighted indexes. OTOH, I might be biased towards small cap E&Ps that are likely to suffer most. So if the "average" is (a bit) weighted towards (super)majors, then the "average" might do "OK". 

[Jurgis]

Ultimately you are making a call on the future price of oil during your holding period

It's this pretty much with any other alpha coming from deep DD on particular companies and/or their situations.