Seeking Alpha: Imperial Oil — Levered Exposure To Oil Prices At A Fair Price

Image source: Imperial Oil Corp. Corporate Overview – Winter-Spring 2017. pg. 5

  • Imperial Oil Corp is a rationally integrated enterprise — assessing any given business segment in isolation ignores synergies which are especially important during the lower half of the commodities cycle.
  • The upstream business segment, by far the largest in terms of capital investment, is heavily exposed to Canadian oil sands projects which are marginal in the current commodity prices environment.
  • Yet, records profits from the downstream and chemical business segments demonstrate how they have benefited from cost advantaged feeds.
  • In the current commodity price environment, IMO’s common shares are likely fairly valued $22 to $32 per share; there is significant uncertainty in that estimate.
  • Given non-compelling valuation and risks, I do not hold the equity outright. However, I believe that call options may provide favorable risk-reward characteristics given their leverage to crude oil prices.

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Seeking Alpha: Cenovus’ Consolidation Offers Counter-Cyclical Upside

Source: CVE Corporation Presentation. Cenovus announces acquisition of Western Canadian assets. Pg 4. 29 Mar 2017. available: http://www.cenovus.com/invest/docs/2017/acquisition-western-canadian-assets-presentation.pdf

  • Cenovus’ expanded asset base, following the $C17.7 Bn acquisition from ConocoPhillips, will be largely of high quality and is expected to more than double 2017 production.
  • Its oil sands position is not terribly exciting in terms of growth, but it does promise commodity-price resilient cash flows which can be used to fund future growth.
  • The companies largely expanded position in the Canadian Deep Basin may be largely under-recognized as a leading foothold in what my be aptly called “The Permian in the North”.
  • Pre-acquisition, I posit that the current stock price of around $10 moderately undervalues the company and largely discounts potential commodity price driven and/or geological upside.
  • Given the dearth of apparent opportunity in the upstream oil and gas space, CVE is favorite yet long idea of 2017.

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Report: Commodities Demystified – A Guide to Trading and the Global Supply Chain

Date of Source: 2016

Summary:
Commodities trading – supply of the basic staples that are converted into the food we eat, the industrial goods we use, and the energy that fuels our transport and heats and lights our lives – is one of the oldest forms of economic activity, yet it is also one of the most widely misunderstood. At no time has this been truer than in the last 20 years, with the emergence of a group of specialist commodities trading and logistics firms operating in a wide range of complex markets […] 

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False Profits: A Prodigal Value Investor Returns from the Oil Patch

Summary

  • There are two ways to create value in the upstream business: find and produce extremely low cost-of-supply resources; and, integrate along a value chain in order to sell at relatively higher prices.
  • Of these two options, rational integration is far more scalable and repeatable.
  • Data of historical free cash flows overwhelmingly supports the notion that integration is the strategy most conducive to value creation.
  • However, omens of an oil and gas upstream and midstream investment bubble have not been conducive to identifying investment opportunities.

I watched There Will Be Blood a few years back, right after oil prices tanked in late 2014. A scene stood out in my brain, though I never really figured out why until now.

2007_there_will_be_blood_001Source: Critical Analysis: There Will be Blood (Paul Thomas Anderson, 2007). The Film Emporium Blog. 9 October 2010

It goes like this:

Our protagonist, Daniel Plainview is “hunting quail” — a cover for prospecting for oil — on private property with his adopted son HW. HW runs off to retrieve a downed quail and returns to his father with a tarry black substance covering the bottom of his shoes. They soon realize that they have found their “pay sand”.

Then, as they both gaze over the horizon, we learn about Daniel’s vision; one which foresaw the crux of petroleum economics through the century and beyond.

so-so. if there’s anything here…we take it to the sea — we can go into town and see a map – but what we do — we take a pipeline from here to Port Hueneme or Santa Paula and we make a deal with Union Oil — this is what we do and we don’t need the railroads and the shipping costs anymore, you see? …and then we’re making money. we make the real money that we should be making and we’re not throwing it away — otherwise it’s just mud.

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Drilling for Value, Pt. 1: The Fundamentals of the Petroleum Industry

Summary:

  • This series is geared toward value-oriented investors who have an interest in valuing upstream oil and gas assets.
  • This article touches on the economic fundamentals and valuation concepts for nearly every other line of business within the oil and gas value stream.
  • The economics of different types of oil and gas assets vary significantly: businesses which are more involved with the extraction of oil and gas from reservoirs tend to be more vulnerable to external market forces.
  • Valuation of upstream assets and companies can be very difficult to learn but also very repeatable once the initial learning curve has been overcome.

Figure 1: Drilling For Oil by Mead Schaffer as Appeared on The Saturday Evening Post, 9 November 1946
mead-schaeffer-drilling-for-oil-november-9-1946_a-g-8290694-8880742
Source: Art.com

Large, integrated oil and gas companies have become a cornerstone for investors seeking stable and growing dividends. Supermajors Exxon Mobil (XOM) and Chevron (CVX) are included in S&P’s Dividend Aristocrats, an index comprised of stocks from the S&P 500 which have been increasing dividends for the last 25 years or more. Yield-oriented investors typically value companies according to their dividends — their yields, abilities to grow, and resiliencies to adverse market conditions. This series of articles is not geared to these people.

Nor is this series intended to appeal to appeal to macro investors. Forecasting macroeconomic conditions is an arcane art of which I am not adept. While it is important to understand the fundamental forces at play which can make or break a business endeavor, I will spend minimal effort discussing petro-politics, the petro-dollar, or forecasting supply and demand. Sorry, OPEC.

This series of articles is meant to appeal to value-oriented investors – those who desire to invest according to perceived discrepancies between value and price and those who desire to locate consistent value creators and/or destroyers within an industry. Valuation of upstream oil and gas exploration and production (E&P) assets will be the primary focus, but I will also cover midstream and downstream assets. Discussions regarding the valuation of other corporate and financial assets and liabilities will chiefly examine decisions regarding how they articulate within the valuation of entire companies.

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Looking for Value in the Oil Patch? Try the Value Chain.

Summary

  • It is difficult to locate value within the conventional notion of the petroleum industry, especially in the upstream.
  • A holistic approach to the much broader petrochemical and petroproduct value chains suggests that most of the economic value in the petrochemical industry is created and realized downstream.
  • Vertically integrated value chain players are able to source cheap inputs and produce value-added products with intangible values.
  • A simple case study of 10 publicly traded companies which occupy the “sweet spot” of the petroleum value chain corroborates the intuition regarding economic value realization.
  • The value chain analysis framework can be applied to any situation in which raw materials are liberated from commodity market forces.

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Right-Headed Investors Should Avoid Upstream MLPs

Summary

  • Over the last seven years, the majority of upstream MLPs have been unable to cover their investment and distribution costs through operating cash flows.
  • Upstream MLPs seems to be indicative of the broader upstream oil and gas industry with respect to investing and distribution/dividend coverage.
  • While some of the upstream majors appear to be fairly priced, high-quality independents tend to be over-capitalized, while under-capitalized firms tend to be of lower quality.
  • The majority of economic value in the oil and gas industry is realized further downstream.
  • Investors who insist on exposure to upstream oil and gas assets are likely better served by focusing on high-quality integrated majors.

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PBF Energy’s Assets Trading Well Below Fair Value; Multiple Catalysts Ahead

Executive Summary
PBF Energy (PBF) is a bargain at current market prices. PBF’s adept management team, in conjunction with private equity partners, acquired its core refining assets at fire sale prices in 2010 and 2011. Among these assets are the Paulsboro and Delaware City refineries which, following initial turnarounds, are now the crown-jewels of the East Coast (PADD 1) refining system. East Coast refineries have historically lacked the structural advantages of their Mid-Continent and Gulf-Coast counterparts. However, management’s aggressive investment program in a “crude-by-rail” logistical infrastructure promises to close the gap by adding much lacking optionality through access to cost advantaged crudes. Although the ownership structure has legacy problems and the company will undoubtedly continue to face cyclical margin and secular regulatory issues, the stock is much too cheap. A discounted cash flow analysis and an economic book value analysis convergingly indicate that the stock is fairly valued at around $50 per share (about 60% higher than current prices of about $31/share). Continue reading

A Crash Course in Refining Fundamentals

Summary

  • Refiners make money by cracking crude oil throughputs into valued-added products (i.e., yields). Crack spreads are cyclical and volatile.
  • Refiners have adapted to margin volatility by engaging in derivatives contracts which off-set short and medium commodity price risks and by investing in assets which are able to process cost-advantaged crudes and optimize yields of higher value products.
  • Vertically integrated refiners are further able insulate themselves from commodity risks and exert more pricing power.
  • Ceteris parabus, long-term crack spreads will be upheld simply due to the fact that markets tend to value refining assets at or below their replacement costs (RCN).
  • Compliance and regulatory measures are a more serious threat to the long-term viability of domestic refiners since they often elicit unintended economic consequences.

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