“The Most Undervalued Oil Company in the World”

By Travis Johnson, Stock Gumshoe, March 5, 2009

That may well be damning with faint praise — saying that you’ve got the most undervalued oil company these days is not all that much better than saying you’ve picked the highest-dividend subprime lender, it’s a sector that many folks don’t want to touch.

But we continue to burn oil — I drive pretty much exactly the same distance every day as I did when oil was at $147 a barrel, though I must admit that I appreciate the lower gas station bills. Gas consumption certainly goes down a bit when unemployment goes up, or when prices spike, but with a growing world of hydrocarbon consumers it’s not going to go away in short order. I don’t know if gas will next see $15 a barrel or $100 a barrel as we add or lose more marginal consumers, but it seems foolish to assume that it will remain cheap forever.

Bob Czeschin goes a bit further — he thinks that you should subscribe to his Oil & Energy Investment Report, and in return he’ll tell you all about this most undervalued oil company, and why you should buy it.

Or you could just read on a bit more, I’m sure we can figger this one out.

Here’s his big picture argument:

“Yes, everyone knows oil consumption has been falling because of the recession. But what they don’t realize is that oil production is now falling 7 times faster.

So a sharp rebound in oil prices is right around the corner. Meanwhile, battered oil shares are still at their lowest level in a generation, and that spells opportunity.”

So if oil production is falling as fields that require $80 oil are shut down, what’s an investor to do? Buy the stocks with big reserves and lower extraction costs, perhaps?

He goes on to talk about production declines in Iran and Venezuela and Mexico, project cuts in Saudi Arabia and in the Canadian oil sands, and he mentions that Russian officials think production declines will bring a price spike of at least 50%. Of course, that would be pretty good news for Russia, so one takes it with a bit of a grain of salt, but still…

Czeschin tells us that falling oil production “is the ticking time bomb in the oil market. It’s why, despite the recession, it’s only a matter of time before shrinking supplies send oil prices rising sharply again.”

He lists several oil companies that look much cheaper these days than they did a year ago, including most of the names that roll off anyone’s tongue like ExxonMobil, PetroChina, Suncor, ConocoPhilips and the like.

And he goes on:

“Recently, some of these companies have become incredible bargains. My #1 choice is the company I think is …. The most undervalued oil company in the world. When you buy shares in Chevron-Texaco, you get proven oil reserves at about $30.71 a barrel.

“With Royal Dutch Shell, it’s about $31.21 a barrel … and with Exxon, it’s about $35.13 a barrel.

“By contrast, when you buy shares in this company that I’m talking about, you get proven oil reserves at
about $1.89 a barrel.

“The reason why this company’s stock is so undervalued is that it’s located out of the way, in Asia’s “Rim of Fire.” The Rim of Fire is the crescent of Eastern Asia, which is home to the world’s strongest economies today.”

Then we get to some more details… or as I like to call them, “clues.” This company has …

“Far and away the largest oil reserves … more oil in the ground than Chevron-Texaco and Royal Dutch
Shell combined

“6,090 service stations

“More oil production than the fabled oil-rich sheikdoms of Brunei, Bahrain, Yemen, and Dubai

“9 huge refineries”

So … toss all those goodies in the Thinkolator and we find that this is …

Are you getting our free Daily Update
"reveal" emails? If not,
just click here...

Lukoil (LUKOY is the ticker for the official sponsored ADR)

LUKOY is currently trading for about $32.50, and with a market cap of just about $27 billion. If you use their January 2008 proven reserves numbers of 15.7 billion barrels of oil you do end up with something under $2 a barrel for their oil reserves, it’s actually closer to $1.75 at the moment (that doesn’t include their natural gas reserves, which would bring the barrel of oil equivalent up over 20 billion).

Of course, there’s at least one awfully good reason why Lukoil’s proven reserves are cheaper than those of most big oil companies — they are, after all, Russian. Lukoil is an independent oil company, it is not technically controlled by the government like Rosneft or Gazprom, but you have only to look at the good ‘ol Yukos saga from a few years ago to understand how gingerly Lukoil’s management must tread the line between building a multinational company and pleasing Vladimir Putin.

So far, according to this very uneducated Gumshoe, they seem to be getting along reasonably well — Prime Minister Medvedev even pushed a little bit for Lukoil’s investment in Spain’s Repsol just a couple days ago, reviving talks of a deal that most people had considered dead thanks to Spanish resistance to losing control of their biggest oil company.

Lukoil does have a massive network of 6,090 gas stations, mostly in Russia, Eastern Europe, and the US, and they do own a bunch of large refineries — I haven’t seen that they have precisely nine refineries, my count was seven, but they have invested significantly in refining capacity in recent years so I may be missing something.

This is a large Russian company that has been trying to become more international, with projects throughout the former Soviet states and in a few other spots around the world (Iran and Egypt among them) — but it is still driven primarily by its huge reserves in central Russia, mostly in Western Siberia. About half of their overall proven reserves are undeveloped, so there seems to be no reason, other than political risk or the cost of accessing those reserves, or the decline in the price of oil, that would cause concern. Of course, all of those reasons might be pretty good.

And the Pacific “Rim of Fire” bit? That’s probably more of a stretch, when most people talk about the rim (or ring) of fire they mean the volcanic activity that goes from Oceania through Southeast Asia and Japan and circles right around Kamchatka over to Alaska and down the left coast of the Americas. I guess Lukoil’s operations are reasonably close to Japan and Korea, both big gas and oil importers, but more of their product seems to be heading the other direction, to Europe.

Czeschin tells us that he thinks it’s inevitable that Lukoil’s reserves will eventually be valued at parity with the big Western oil companies, and that the shares should double or triple within the next 18 months, and that much more massive gains are possible for long term holders who buy it to hold for ten years or so — or that geopolitical crises, particularly in the Middle East, could break out that would ramp up oil prices again, and magnify that move upward.

I’ve written about Lukoil several times since 2007, it has been picked by Yiannis Mostrous for his Silk Road Investor newsletter, and by Eric Roseman for his Commodity Trend Alert. For the past couple years it has often come up as a favorite for risk-seeking value investors — it has always seemed cheap in comparison to its non-Russian competitors, and it has always had big reserves. The shares have collapsed anyway, though they have remained fairly stable over the last several months, since the initial crash of last fall.

And if you’re a bit Russia-averse, but still like the idea of a bit of exposure to Lukoil’s reserves, you could always look at ConocoPhillips (COP), which owns 20% of Lukoil. Of course, it’s only fair to tell you that Warren Buffett last week announced that buying a big chunk of COP was one of his biggest mistakes of 2008, but it’s certainly far cheaper now. Oh, and ConocoPhillips did have to write down its investment in Lukoil by more than $7 billion, so they may have some regrets, too. Both COP and LUKOY have trailing dividend yields of about 5%, by the way, though the dividend for 2009 is anyone’s guess.

So … ready to jump into Russia? Is it cheap enough to take a risk, or too risky to think it’s cheap? Is oil a good gamble at these prices, or just another commodity destined to continue deflating? Let us know what you think.

And of course, if you’ve ever subscribed to Czeschin’s newsletter please click here to let us know what you think. We’ve just breached the 300 review barrier on the Stock Gumshoe Reviews site, so we’re learning more and more about these newsletters as actual investors have experienced them — but we still need a lot more help building up this resource of newsletter reviews by investors, for investors … please visit the site and review any newsletters you’ve subscribed to today!