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With the recent crash in oil prices from $100 per barrel to around in $50 per barrel , there is a lot of talk about identifying value opportunities in the Independent Oil & Gas sector. Thus thought of first analyzing the economics of this sector in general.
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HOW DOES AN INDEPENDENT OIL AND GAS BUSINESS MAKE MONEY? Core asset of an Independent oil and Gas business are its Oil properties. The business makes money by Extracting oil from its oil reserves and selling it in the market. The difference in Selling price of oil and the total cost to extract the oil is the net cash the business generates from its operations. As the oil reserves deplete the business also has to re-invest its profits to buy new reserves. Most of the costs associated for generating oil is fixed per barrel of oil. Thus as the Oil prices increases the business generates more cash from operations. The increase in oil prices also brings in more players in the industry and hence the prices of oil properties also increase. So if the existing business has to keep up its oil reserves then it has to pay premium prices to buy new oil properties. In theory , the only smart way out of this vicious cycle is to only buy additional properties when the oil prices are its lowest end. But the institutional imperative holds back the corporations to do this. Instead they are fine paying high premiums to maintain their reserves , otherwise declining reserves will not give a good image to the analyst community. CASE STUDY: ANADARKO PETROLEUM: To portray the above mentioned points lets analyze Anadarko Petroleum. Its one of the largest Independent Oil & Gas producers. As of Dec-31-2003 the company had proved reserves of $2.5 billion barrels. Its current assets was $1.3 billion and Total liabilities was $5.1 billion. Thus the net liabilities (Total liabilities – Current assets) = $5.1 billion - $1.3 billion = $3.8 billion. As of Dec-31-2013 the company had proved reserves of 2.8 billion barrels. Its current assets was $7.8 billion and total liabilities was $32 billion. Thus the net liabilities (Total liabilities – Current assets) = $32 billion - $7.8 billion = $24.2 billion. Thus within 10 years the company incurred an additional $20.4 billion ($24.2 - $3.8)of liability to just increase its reserves by 300 million barrels. (2.8 billion - 2.5 billion).The market value of these reserves has fallen by 50% in last 6 months alone. This showcases a very poor business Economics, hence I plan to stay away from Independent Oil & Gas companies and put the entire industry to NO THANKYOU list. |
