“Like Buying $70 Barrels of Oil for just $3.60”

by Travis Johnson, Stock Gumshoe | September 4, 2007 4:42 am

Of course, that oil[1] happens to mostly be in Russia[2]. Dang.

Investing in Russia sometimes seems like it’s not that much more reviled than investing in North Korea[3] these days, eh? I even think that there are probably plenty of folks out there, perhaps you included, who find the wildly uncertain investment in oil exploration in Somalia[4] (Range Resources, for those keeping score at home) to be more compelling than investing in anything in Russia. And especially anything related to natural resources.

And I’m not entirely sure that I disagree. But Russia is certainly a fast growing economy and a big part of BRIC, and investors in general are clearly very tempted — not least because of the huge potential illustrated by the performance of companies like Vimpelcom.

So, conflicted or no, we’ve got a handy dandy teaser ad here from the Silk Road Investor[5], and it’s all about investing in Russia … and in particular, investing in a giant Russian oil company that Yiannis Mostrous, the newsletter’s editor, believes is severely undervalued.

So let’s take a look, shall we?

The teaser is that the reserves they have on their books are so underappreciated that it’s like buying oil for $3.60 a barrel, so that’s a bit of a starting point.

But they also are kind enough to provide some nice, friendly clues:

This is the “largest integrated oil company in Russia.”

They have eight refineries, and sell in”4,700 gas stations it owns around the world (including 2,000 in the U.S.)”

“This energy giant controls a fifth of Russia’s vast oil reserves. That’s 16 billion barrels—more proven oil reserves than any other company in the world, and 5 billion gallons more than runner-up ExxonMobil’s mere 10.9 billion.”

OK, the Gumshoe is willing to stipulate that that’s really a LOT of oil.

We can all make up our own minds about whether we think it’s a good idea to invest in Russia, and in particular in a Russian sector like energy that the government keeps a very close eye on …

But if you do want to look into this company, this is certainly …

the big daddy of publicly traded Russian oil companies, Lukoil (LUKOY for the ADRs).

Or at least, the big daddy for now. Rosneft, the larger state-controlled oil company, is also possibly going to split off some of its old Yukos holdings into an integrated oil company that might be bigger than Lukoil and might go public. There’s a Motley Fool[6] writeup on that from a couple days ago, if you’re interested.

Lukoil does have 2,000 service stations in the US … depending on where you live, you might use one with some frequency. I wonder if they’ll get any backlash from political developments in Russia in the coming years, like it seemed for a while that Citgo would have trouble thanks to their Venezuelan ownership, but my guess is that us Americans will still fill up at a Lukoil station if it’s on the way to work … or if they charge 2 cents a gallon less than the Exxon across the street.

Lukoil is also international to some degree in other ways, too, they’ve got wells in Iran (did I hear a cheer for that nice, placid investment environment? No?), Eastern Europe and the former Soviet Republics, and South America. Perhaps that makes them less likely to crumble if Putin decides to shake his fist at them, or maybe their close relationship with ConocoPhilips will help them, I don’t know.

I do suspect that if company president Alekperov ever decides to say anything mean about Putin’s family, or gets involved in politics at all as anything other than a member of Putin’s inner circle, all bets are off.

But anyway, that’s clearly why the company is priced cheaply — everyone on Wall Street still remembers Yukos and their rapid demise quite clearly. And no one wants to be investing in the next Khodorkovsky[7].

The numbers work out just about as stated, too, with a market cap of about 60 billion clams and reserves of 15 or 16 billion barrels of oil … round up to the equivalent of 20 billion barrels if you include their natural gas[8] holdings … you are paying something shy of four bucks in market cap for each proven barrel of oil in the ground.

How does that compare to other big oil majors, you ask? Exxon Mobil is typically considered among the more staid and conservative oil companies, aside from being the biggest US one, and its market cap of closing in on half a trillion dollars matches up with, if we believe this teaser email, about 11 billion barrels of proven reserves. I didn’t look up the details, but according to a quick scan that’s in the ballpark (I think Exxon’s total reserves are more like 75 billion barrels of oil and their equivalents, which includes natural gas and the ‘probable’ and other categories of uncertain reserves, which, to be fair, means they have a LOT more unproven reserves than Lukoil).

So, as the teaser cites, Lukoil on paper is certainly a LOT cheaper than ExxonMobil if you just do an apples to apples comparison of proved reserves — the XOM barrel of oil costs you somewhere between 25 and 45 bucks, according to this slipshod math, depending on whether or not you’re talking just proven reserves, and whether you include BOE measures for natural gas and other non-crude oil reserves.

No surprise there. A look at the latest updated chart of the mcdep ratio (one analysts way of valuing oil companies) at mcdep.com also shows Lukoil as the cheapest of the large integrateds.

So, stipulated: Lukoil is cheap. For a reason.

I personally have some curiosity about investing in Russia, but absolutely no interest in investing in Russian energy companies. If I were to put my money to work in Russia anywhere right now it would probably be in some kind of consumer-related investment — I’m even a little nervous about the telecom plays over there, but Vimpelcom certainly appeals to me more than the energy firms do. I’m not interested in sticking my neck out on these and being contrarian — they’re cheap, they’re growing fast, but they might be going up against Gazprom (which I would also never buy) and Rosneft and against the Kremlin, which can make “cheap” or “undervalued” turn into “bankrupt” or “imprisoned” pretty quickly. I’ve been willing to invest in state-controlled energy in the past — and made good money from PetroChina, Statoil and Petrobras, none of which I still own, but I do draw the line at Russia at the moment.

I could easily be wrong, of course, and often am — and I can see there is certainly an argument to be made that as far as risky investments go, this one appears to at least be saddled with primarily political risk, which might be more palatable for some people than, say, risk of not finding oil or risk of never being profitable. It’s also probably true that almost all oil companies run into political risk to some degree — after all, Exxon Mobil is still smarting a bit from their more recent run-ins with Chavez in Venezuela.

Lukoil is, by all accounts I’ve seen, a venerable large cap oil company, with respected management, some international diversification, and some good partnerships with other significant oil majors, and if you look at the earnings, reserves and balance sheet, it’s clearly cheap. Cheap is in the eye of the beholder, though, so it might not hurt to look a little more closely if you’re considering investing in this one.

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