Due to some unexpected schedule conflicts we’re running a previously published article today — what follows is excerpted from the Friday File (our weekly note to paying members) of April 29. The article has not been updated or revised, and the stock teased is down a few percent (though it did also pay a dividend in the interim). Back to normal new stories tomorrow, thanks for your patience!
Over the past couple days several folks have emailed me the latest teaser ad from Bob Czeschin for his Oil and Energy Investment Report — he’s one of the old lions of the financial newsletter business and publishes a very simple letter, doesn’t even have a website as far as I can tell (if you Google “Oil and Energy Investment Report” you’ll get … the reviews of that letter here on this very site, which are mixed).
This teaser letter tells a good story, if a frightening one … based on fears that Al Qaeda, particularly with the Yemen situation very unstable, is likely to be going after the big, lightly guarded (he says — I don’t know) pipelines in Saudi Arabia, and that if they take out those pipelines oil might shoot to $300 a barrel.
Basically, we’re told that Bob is recommending a company that has huge reserves of readily available oil, in a politically stable country, and that lets you buy “recoverable oil in the ground” for about two bucks a barrel (vs. a comparable $20 a barrel for someone like Chevron or Shell), and by huge he really does mean unusually big — he says it has more oil reserves than Mexico and Brazil combined.
Sounds impressive, eh? Well, if you actually think through the logic of it there’s pretty much only one company that this could be … but still, we’ll sort through the clues to make sure:
“Recommendation #1: A little-known company with more oil than Brazil and Mexico combined
“This company is sitting on a mind-boggling 27 BILLION barrels of recoverable oil.
“It’s actually more oil than the entire reserves of Brazil (12.6 billion barrels) and Mexico (11.9 billion barrels) combined. By itself, it has more oil than China, more oil than all the countries in Western Europe combined, and … more oil than any other investor-owned oil company in the world.
“Each dollar that the price of oil rises increases the street value of its oil reserves by $27 billion.
“A $25 dollar rise in the price of oil will increase it by about $650 billion. If oil doubles, as it did in the past when supplies in the Middle East were disrupted, that would add about $3 TRILLION onto the street value of its reserves.
“So its shares are almost certain to explode upwards on any major rise in oil prices.
“The company currently produces about 200 million barrels of oil a year. When compared with 27 billion barrels of recoverable oil, they obviously have huge room for growth. This is what separates them from companies like Chevron, Exxon, or BP.
“BP, for instance, has to drill 2 miles down underwater in the Gulf of Mexico to find enough new oil to replace what it produces — with catastrophic results.
“By contrast, the company I’m talking about already has the oil. It’s on land, near the surface, and in a politically stable region of the world far from the Bab el Mandeb choke-point.
“They’ve been growing production at 5.1% a year for the last 7 years. Now, with improved technology and higher oil prices, I expect them to expand production faster — at about an 8% growth rate per year, through 2020.”
Sounds impressive, no? Well, unfortunately those numbers don’t match up very precisely with any company data I can easily track down — though I’m pretty sure I know exactly what company he’s talking about.
27 billion barrels of recoverable oil is a huge number, particularly if by “recoverable oil” you mean reserves, either proven or probable — all of the companies that have over 50 billion barrels of oil equivalent (and we’re including natural gas in that number, to be generous) are state controlled, the mostly OPEC-connected state oil companies of countries like Nigeria, Libya, Iraq, Venezuela, Qatar and Saudi Arabia, to name a few. It’s in the next stage of companies that our target must lie, and that is a small group — firms that are publicly traded but huge, like Petrochina (which has about 11 billion barrels of oil reserves not including gas) and ExxonMobil (which has about 25 billion barrels of reserves, split roughly 50/50 oil and gas — if you use the broader “resources” term, they have about 85 billion barrels). Companies of that kind of massive size just can’t hide.
And of course, companies of this size should and do produce a lot more than 200 million barrels a year — that’s the major stumbling point of this teaser, since a company with production that low from reserves that high would seem pretty ridiculous. PetroChina’s production, for example — of just oil — was more than 850 million barrels last year. ExxonMobil’s production (oil and gas) was about twice that, around 1.6 billion barrels.
And both of those companies are priced at a strong premium to the stock I think Czeschin is teasing — which is Lukoil (LUKOY for the US ADR)
For good reason, right? Most people are at least a little bit leery of owning chunks of private companies in the natural resources arena in state-dominated Russia, even though Russia itself is enjoying a pretty strong resurgence as a target of investor interest in recent months. The images of the first Russian private oil oligarch in a jail cell, with his company effectively taken over by Vladimir Putin and the government, is seared in investor minds (that would be Khodorkovsky, if you want to revisit the story).
But still, we are talking about $2 per barrel for oil reserves — well, to get to that you have to accept Czeschin’s estimate of 27 billion barrels of oil equivalent (more on that in a minute), but if you do that the numbers sound incredibly enticing. Lukoil has a market cap of about $54 million, with pink sheets ADRs that trade fairly easily in the US on decent volume — that means they have more reserves than PetroChina, for example, but the market values them at just about a fifth of PTR’s $250 billion market cap. Similarly, reserves are arguably in the same neighborhood as ExxonMobil, but XOM is almost 10X larger.
It’s possible that I’m wrong about this one, but he has touted Lukoil before — and really, if you’re talking about absurdly low priced reserves for an oil major there aren’t really any other strong candidates — but as I said, the clues certainly aren’t a perfect match. I can make the 27 billion barrels match if I use oil equivalents and include both proved and probably reserves (they claim about 21 billion barrels in proved and probably oil reserves, plus another 6.5 billion or so in “barrels of oil equivalent” of natural gas) … but I can’t make the 200 million barrels of production fit, their production is, more sensibly, right around 720 million barrels a year.
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Lukoil has pretty much always been dirt cheap compared to the other international oil majors — the question is, should it be? That’s the thought that Czeschin’s ad forced into my head today.
There are a lot of concerns beyond just the overriding fear that the government can do almost whatever they want to Lukoil (some of their assets are overseas, but the vast majority of reserves are spread around Russia, largely in western Siberia). Arguably the bigger concern might be the huge excise tax hike that oil exporters got stuck with from the Russian government last year — though you might also consider that the large tax revenues generated by Lukoil’s production and exports also make them a friend of the government. It’s pretty clear that Putin and his band of merry men are managing the system as they like it, but from what I’ve seen recently it looks like they may be realizing that the huge export tax is hurting oil companies … and that they might try to lighten that burden by cutting production taxes to help more oil production stay at home for domestic use.
So that’s the risk — that the government is taxing the bejeezus out of oil exports, and certainly can manipulate these companies to behave in the way they wish. But on the flip side, I had these same fears about Lukoil years ago and it has seemingly done well in managing its relationship with the government and maintaining a very solid level of profitability and high production. And a decent dividend, which has generally been similar to the other big oil majors lately, in the 3-4% range most of the time (they pay out only once a year, so it’s hard to tell what it might be in the future — though they have consistently increased the dividend every year, at least in Ruble terms). So maybe we should give this company, and this management team, a bit more of the benefit of the doubt?
I can’t tell for sure — but I can say, with oil prices so high, and with natural gas I think destined to remain at a substantial discount to oil for the future, I am sorely tempted by a company with this kind oil-heavy reserves, and with high-margin oil production (yes, it is on land, and not so tough to get out). Maybe, just maybe, I should rethink my fear of Russia. (I do hold shares of another Russian investment, Vostok Nafta, which is basically a closed-end fund for domestic Russian investments — they also hold some of the star-crossed Russian oil firm TNK-BP, and that investment has done horribly, I hedged it with puts on the RSX when I bought it years ago so my cost basis is still decent, but still the investment has done very poorly.) Almost all the oil companies look cheap, including oft-teased Statoil (STO) and the big US firms like ConocoPhillips (COP), to name a couple, but LUKOY is so much cheaper that my eye keeps being drawn back … ugly ducking or swan?
Hell if I know. Share your thoughts below if you like.