The Economics of the Upstream Petroleum Industry
The economics of the petroleum extraction is overwhelmingly colored by the economic factors of depletion and commoditization. Due to the fact that production depletes limited natural resources, the upstream industry must constantly explore for and develop additional resources. Given that the capital investments required to replace depleted resources are usually quite significant in relation to operating costs, resource replacement is a primary driver of costs. Commoditization describes the lack of differentiation in upstream business models and their end products. As a direct result of commoditization, the value propositions of upstream businesses are strongly levered to external market conditions (i.e., namely prices). Taken together, high replacement costs and supplier susceptibility to external market conditions have resulted in endemically cyclical petroleum supplies and prices.
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
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.
Sunday, August 4, 2013
10:00 AM to Cafe Lumiere
365 Calle Principal, Monterey, CA
Grading the Gurus I have often wondered if it makes any sense to pay attention to investing gurus. I’m talking about the greats; the legends; the Warren Buffets; The Benjamin Grahams; those with real followings, real track records, and, most importantly, real philosophies. In brief, I want to ask questions and query data in such a way that will help people place the “usual suspects” into one of three groups:
My coworker told me about an email his broker sent about tomorrow’s IPO on Jones Energy (ticker: JONE). Interested, I did some preliminary research, and here is my email to him almost verbatim:
A word of caution on this deal. The main reason you hold off for now is that you probably are not prepared to sift through the 250 page IPO filing over the next 24 hours. Also, I have no idea what each share is worth because they haven’t even disclosed how many shares are going into the float (i.e., outstanding shares available on the market). Also, they have the disclosed the following below their income statement: