MARKET ACTIVITY/ WEEKEND EDITION OF TRADING NOTES JUNE 21, 1998 (6)
PAST WEEK'S STORIES
June 15th
Oil Firms May Have To Rethink Plans
Edmonton Sun
After months of relentless pressure on world crude prices, yesterday's drop could force oil companies to seriously rethink their drilling programs, analysts warn.
Many properties are simply unprofitable to drill at $12 US a barrel, said Judith Dwarkin, managing director of the Canadian Energy Research Institute.
"You have to look at it on a case-by-case basis, but some companies will have to shut-in," Dwarkin said.
"I would imagine producers are very concerned about whether this will last a long time. They're getting some very sharp pencils out of their drawers right now."
Canadian oilpatch officials will be watching OPEC's June 24 meeting closely to see if they can agree to even deeper cuts than they've already promised, said Greg Stringham of the Canadian Association of Petroleum Producers.
"There is some concern among our oil-producing members, but the industry as a whole is all right because they're shifting towards natural gas," Stringham said.
Trish Filevich, Treasury spokesman, said higher natural gas prices are offsetting lower oil prices so far this year.
"If those figures were to prevail for the year, we're probably going to lose about $380 million in oil from the forecast that we have, but, on the gas side, we're likely to see a $627 million gain."
"That's not even counting the (record-low) Canadian dollar," she said. "We get more because oil trades in U.S. dollars. It's better news for us."
Jim Edwards, president and CEO of Economic Development Edmonton, said the low loonie isn't all bad news.
"Since we're an export economy, it makes us more competitive with most of our exports," he said, adding tourism is benefiting from the premium on the U.S. buck.
"Visits from the Pacific Northwest (to West Edmonton Mall) are up very, very substantially. That's partly due to a collaboration that we and the mall and Horizon Air out of Seattle have been working on.
"Horizon Air tells us that Edmonton is their most productive destination at the moment."
Poco Petroleums launches friendly bid for Canrise Resources
Poco Petroleums Ltd. said Tuesday it had agreed to buy Canrise Resources Ltd. in a C$97 million stock-swap offer that extends the string of recent deals in the merger-happy Canadian oil patch.
Calgary-based Poco, one of Canada's biggest natural gas producers, said it would offer 0.3845 of one of its shares for each Canrise share, which would translate into value of C$5.54 a Canrise share, based on the average of the last 10 days of trading.
Poco said it would also assume Calgary-based Canrise's C$38 million of debt, bringing the total price of the friendly offer to C$135 million.
The offer has the blessing of Canrise's board and the company agreed to pay Poco a non-completion fee of C$3.5 million if Poco's offer is topped by another suitor.
Canrise, which produces 4,200 barrels of oil equivalent a day in Alberta, is one of several companies in the sector that had offered itself up for sale as cash flow waned amid depressed crude oil prices.
Its proven and probable reserves total 5.2 million barrels of crude oil and gas liquids and 117 billion cubic feet of natural gas. It also controls 121,000 acres of undeveloped land that Poco said was concentrated in its own main western Alberta operating regions.
Poco stock was off C$0.50 to C$13.30 in light trade on the Toronto Stock Exchange early Tuesday. Canrise climbed C$0.35 to C$5. ($1-$1.47 Canadian)
Fracmaster receipts follow Boliden's
The Financial Post
The suspension of Canadian Fracmaster Ltd.'s instalment receipts from trading on the Toronto Stock Exchange today marks the second time in less than three weeks investor confidence has been shaken in these innovative time payment vehicles.
Yesterday, common shares (FMA/TSE) in the oil services company closed at a 52-week low of $9.50, slipping below the $9.75 value of the second payment for the instalment receipts issued last September. Under TSE rules, that dip into negative territory triggered an automatic suspension of the receipts.
On May 27, investors in the embattled mining firm Boliden Ltd. saw their stock slip below the price of its second instalment receipt, forcing a suspension and shifting trading of the receipts to the Canadian Dealing Network. They'll now be joined by Fracmaster's receipts.
Instalment receipts typically allow investors to defer half the cost of a common share for one year, while reaping the dividend on the full value of the share.
In September, Fracmaster sold 23.9 million common shares at $19.50, represented by two instalment receipts of $9.75 each. The receipts are commitments to pay the balance owing on a share at a specified point in the future. In Fracmaster's case, it is due on Sept. 9.
Unlike Boliden, investors yesterday were still willing to pay as much as half a cent for Fracmaster receipts, which meant they continued to trade.
Michelle Weise at Canaccord Capital Corp. said highly speculative players were buying the receipts because "... at half a cent if [the receipt] goes up anything, you are making money."
The TSE said the receipts with positive values will trade on the CDN as (fmapir/CDN) and with negative value as (fmanir/CDN).
The shares have been hit by low oil prices and heavy exposure to the volatile Russian market. If the price rebounds above $9.75, TSE media services manager Steve Kee said the exchange will take time to assess the situation. "[Fracmaster] has a longer lead time than Boliden so the TSE does not want to get into a position of making a quick decision." The TSE will not move the receipts on and off the CDN every time the price of the shares rises above, or falls below, the critical price of $9.75, he said.
Although no other instalment receipts are in a precarious situation at present, investors may decide to steer clear of them in future.
Fracmaster receipt holders, left with a bill of more than $281 million when the receipts come due, can sympathize with Boliden investors who are legally obliged to ante up $400 million by 1 p.m. tomorrow.
Sectors & Trends
A slick play in the oilfields. Pumped up for a comeback in oil? Be selective. Here's why the pros like well-positioned domestics like Phillips and Marathon rather than the big boys.
When Chevron Chairman Ken Derr told shareholders in New Orleans recently that $18-a-barrel oil was around the corner, he was only confirming what everyone else in the industry already knew: Sooner rather than later, oil will swing back from its current perch around $13. And before long, industry earnings will be riding the upswing.
Does that make this the time for contrarians to invest in major oil stocks? Yes, but with one caveat: Avoid the front-runners, ignore the marquee names, and stay away from those most obviously poised to benefit from higher prices at the wellhead.
Instead, play the names at the bottom of the lineup -- the singles hitters and defensive specialists -- who are most heavily leveraged domestically to take advantage of the environment created by this year's historic plunge in prices at the gas pump.
From that perspective, two clear candidates are Phillips Petroleum (P) and USX-Marathon (MRO). Both combine a presence in one of the world's premier production fields with refining-and-marketing operations that are being streamlined and leveraged solely to focus on U.S. consumer demand. And both offer higher estimate growth rates, lower price earnings multiples and better relative price performance than larger, better known peers like Chevron (CHV), Exxon (XON) and Texaco (TX).
The problem for the major diversified international oil companies is that they depend on strong commodity prices to make a profit on the "upstream" side of their business (exploration), but they can be brutalized by those higher raw-materials prices on the "downstream" side (refining).
Chevron's earnings in the first quarter of this year, for instance, dropped 46% year-over-year due mainly to disastrous margins in its West Coast refining business when prices were rising. In fact, all the major oil companies, with the single exception of Atlantic Richfield (ARC), are net consumers of crude oil due to their refining operations; that means they've been able to offset recent losses in oilfield income through improved results in their refining and marketing operations.
Yet it's the truly domestic refiners and marketers who will see the most earnings momentum from lower refining costs in the current quarter as well as better prices at the pump later in the year. Another factor in their favor: The domestic refineries are finally recovering from the weight of capital spending on compliance with Clean Air Act regulations as well as the oversupply that resulted when they overbuilt capacity at the same time. The refining industry showed losses from 1992 to 1996, but these firms turned the corner into profitability last year and turned out to be more efficient to boot.
Finally, there is the historically documented tendency of the major oil companies to exploit the perception of rising crude-oil prices by immediately raising prices at the gas pump. Some analysts believe they'll start early enough in the summer to capitalize on the vacation driving season, which this year occurs in the midst of a healthy U.S. economy and strong consumer confidence.
At Howard, Weil, Laboussie, Friedrichs, a Gulf Coast brokerage that focuses on energy stocks, analyst Arthur "Bud" Tower confirms that investors would benefit from a focus on downstream oil companies for the rest of the year.
"People are going to have money to spend this summer," Tower suggests. "And they're going to be spending it at The Gap (GPS), they're going to be spending it at the grocery store, they're going to be spending it on their gas-guzzling four-wheel-drive sport-utility vehicles, and they're going to hit the road.
"Even a modestly rising oil-price environment throughout the year, in an environment where we expect to have should benefit those companies with a lot of downstream exposure. Part of our thesis all along for 1998 has been to focus on companies with substantial refining interests."
Details
In all, Tower recommends that energy investors account for four steps in their analysis of major oil stocks:
1.Improvement in comparative price-earnings multiples.
2.Earnings momentum based on the fundamentals of each revenue component.
3.Strategic direction of revenue increase and cost reduction
4.Operating efficiency, which can be measured, if need be, by return on capital employed (ROCE) for each business segment.
Among the big-kahuna stocks, Tower picked Exxon (XON) and Chevron for this year, the former for overall strength and excellence of management, and the latter for exemplary balance and strong West Coast refining exposure, which Tower expects to rebound in serious fashion. Domestically, he's likewise targeted Atlantic Richfield, Occidental (OXY), Phillips and Marathon to outperform their peers.
Defiantly more optimistic is Ed Moran at A.G. Edwards & Sons. Where Tower expects the year to end with oil selling around $18.50 a barrel, Moran's sights are set closer to $19 -- with $20 likely in 1999. In fact, he's anticipating positive earnings comparisons (year-to-year) by the fourth quarter, and double-digit growth in 1999.
"Historically," Moran explains, "when oil prices have dropped this low, they haven't stayed low for a very extended length of time. And whenever they've dropped below $18, within 18 months, they've come back, not just to $18, but well over $20."
Moran tends to favor major oil companies with lower profiles. In addition to attractive valuations, he says, they have the same access to leading-edge technology as the larger majors as well as the ability to cherry-pick exploration projects and partner with the majors in developing them. He has "buy" recommendations on both Marathon and Phillips, the first for dramatic earnings improvement, the second for its relatively low valuation.
Marathon's drilling operations, Moran points out, are mainly focused in the hugely successful Gulf of Mexico fields, with significant exposure to both lucrative deep-water projects as well as natural-gas production, where prices have remained relatively stable. Downstream, he sees efficiency coming from the company's combining U.S. operations with Ashland Inc. (ASH).
Phillips, on the other hand, is concentrating on projects to employ new technology to rework one of the richest fields ever discovered in the North Sea, a strategy that has proved successful for other companies in that and other parts of the world. Downstream, Moran anticipates Phillips benefiting from refinery partnerships with the Venezuelan state oil company, PDVSA, in Texas and Oklahoma.
What kind of money does one of the most optimistic analysts foresee investors making on major oil stocks? Based on earnings of $2.06 per share this year and $2.60 per share in 1999 for Marathon, he anticipates the stock climbing to $44 from $36 before the end of the next fiscal year, a 20% gain. For Phillips, he's looking for earnings of $3.10 and $3.60 per share, with stock moving from around $50 to $58, almost a 15% gain.
Not exactly gangbusters, but nothing to be embarrassed about, either. And you get the opportunity to say you made your money in oil . . . not to mention reaping some of themost lucrative dividends on the market. That's cash you can reinvest in something with hotter short term potential or salt away in something safe for a rainy day.
Either way, when you're filling your tank this summer and notice that the price of gas just went up again, you're likely to be a little less bothered.
Despite low prices, oil companies drill for big payoff in Gulf
Off the Louuisiana coast, La. - From 2,900 feet above the shallow muddy water along the coast of the Gulf of Mexico, oil platforms dot the seascape in every direction. But 2,900 feet below the deep blue water far out in the Gulf are where the engines that drive Louisiana's economy sit atop the surface.
The recent surge in the oil patch can be attributed to federal tax relief, better technology and more substantial hydrocarbon discoveries. Oil companies are investing more and more into deep water, despite uncertain oil prices, hoping they will produce in excess of 100 million barrels of oil over the course of their lifetimes.
Players such as Shell, Texaco, British Petroleum and Chevron invest upward of $1 billion each to build new generations of offshore platforms.
However, as these platforms are raised, deep-water infrastructure is developed and other producing wells are installed below the water's surface and serviced by the existing platforms.
Back along the shelf, or in water less than 1,000 feet deep, is where the previous generation of platforms can be found. A quick comparison of the size of the structures and vast difference in production capacities can tell the tale of why the economies of Louisiana and the other coastal states that service these platforms are booming.
Texaco installed West Delta 109 in 1980, 20 miles off the coast of Louisiana, at a modest cost of $139.6 million. By March 1981 the first well, A-1, was completed and began production. Almost two years later, well A-9 began producing more than 6,000 barrels of oil per day and was the first to reach the million-barrel mark on the platform.
West Delta 109 was a high-producing well for its time, reaching production capacity of about 25,000 barrels of oil per day.
Tim Guidry, now the platform's foreman, has worked on the rig since it began production.
He is in the galley at 10 a.m. surrounded by pastries and fresh fruit prepared for breakfast by the platform's cook. Amid the machinery and the ocean, Guidry still finds comfort.
"This is our home away from home," Guidry said. "We spend half of our lives out here. There is some real good (red) snapper fishing here, and sometimes we'll have a fish fry."
Although not at peak production, the platform is still profitable, currently producing about 10,000 barrels of oil and 60,000 cubic feet of natural gas per day.
But Petronius, part of the new era of drilling, will be Texaco's first dive into the deep water arena. The $400 million drilling and production project is being installed in 1,754 feet of water 130 miles southeast of New Orleans.
The platform, owned in a 50-50 joint venture with Marathon Oil Co., is expected to tap into reserves totaling between 80 million and 100 million barrels of oil.
Petronius is scheduled to begin production in January 1999, and it will have a production capacity of 60,000 barrels of oil and 100 million cubic feet of natural gas per day.
Unlike shelf platforms like Delta 109, that dot the horizon, Shell's Mars platform cannot be missed.
Mars is 130 miles southeast of New Orleans and is two football fields wide. It stands 3,250 feet from the Gulf's floor and weighs 36,500 tons.
Shell and its partner, British Petroleum Exploration, announced plans to develop the project in October 1993 at a cost of $1.1 billion.
The feasibility of the price tag is conceivable when one takes into account the discovery of the vast reserve around Block 807 - 500 million barrels of oil equivalent. At $16 a barrel, that's $8 billion worth of oil.
To recover the reserves, Mars is capable of producing 140,000 barrels of oil and 140 million cubic feet of gas per day.
The living quarters of Mars are as noticeably different as its production capacity. A 25,000-square-foot, three-story dormitory is capable of housing 106 workers and all of the computer and office space needed to operate the platform.
The facility offers a fully staffed cafeteria-style dining area and a stocked fitness facility. Employees also can enjoy Ping-Pong, their own television hookups and private bathrooms.
But for all its conveniences, Mars is a workhorse. It has the capacity for 24 wells and currently has 11 working. At 1:30 p.m., the platform's computer shows that 68,626 barrels of oil have been produced since midnight. The total from the day before reached 113,725 barrels.
There have been few fields discovered on the continental shelf of the Gulf of Mexico since the 1960s that exceed 100 million barrels of oil equivalent, and since then there has been a gradual decline of oil and gas fields found on the shelf at all.
According to a recent study conducted by Offshore Data Services, there is a minimum of 70 deep-water drilling rigs needed just to drill the resources now available. If the rigs under construction are counted, there is a total of 41 deep-water rigs worldwide - a potential shortfall of 29 rigs.
The study also concluded that drilling will not peak until sometime between the years 2013 and 2015. If the 30 and 40 year timetable of production periods are followed as predicted in these deep water fields then service companies will not be out of a job for many years to come.
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