Evaluating Exploration and Production Companies as an Asset Play
While these concerns are all very valid considerations for speculations regarding short-term supply-demand price dynamics, they honestly have little barring on the long-term demographics behind global energy consumption. Even with natural gas prices stuck around $4, and oil below $80, I think that a number of high quality firms with proven assets are selling at compelling valuations.
What I am looking for are companies with low debt that appear cheap compared to the value of their proven reserves (P2).
1) Enterprise Value / PV10 = [(shares outstanding * stock price) + long term debt] / PV10
2) Debt / PV10 = long term debt / PV10
3) Total MMBOE per $100 investment = (total MMBOE / shares outstanding) * (100 / stock price)
The purpose of this model is to quickly and easily compare companies against their peer group to determine any given company’s relative valuation. All valuations are based on stock prices at close of day on Sept. 23, 2011, and financial information is from the respective company websites.
Ticker EV/PV10 Debt/PV10 MMBOE/$100
PEYUF 1.41 0.23 10.25
UPL 1.22 0.31 8.04
WLL 1.04 0.20 7.24
SU 0.70 0.13 8.06
Obviously I have a theory to explain the disparity in results. PEYUF has the highest barrels per investment because they are a natural gas company and their higher EV/PV10 ratio is likely a result of management's track record and low cost production profile relative to peers. SU is actually trading below the estimated value of its proven reserves. This is in large part due to its high exposure to shale oil and the increased expense of extracting that oil from the rock. Its all about the rock. Higher quality reservoirs mean lower cost production and higher returns. Low quality reservoirs require higher oil prices to justify the production cost.
The Price You Pay
As recently as October 2010 there was quite a heated exchange on this site about whether Petrobank (PBEGF) was a value proposition trading at a premium to its then reported reserve value of $3.49 billion. With the market cap now shrunk to around $1.8 billion, it's now much harder to present the bear case.
If you couple together the fact that these companies are now trading at much more favorable ratios to the estimated value of their proven reserves with the favorable long term demographics for energy consumption, I think you’ll find compelling values in the E&P sector. One no longer needs to resort to extrapolating values for unproven acreage, increased efficiency in drilling extraction leading to expanding reserve estimates, or a rise in the spot price of the underlying commodity.