Time to bottom fish in oil and gas shares?

Awful us payroll numbers, record Saudi, Iraqi and Libyan output in OPEC, the highest global inventories since 1990 and a slump in Chinese/Europe demand has led to the worst oil crash since Q4 2008. Brent has fallen an incredible $30 a barrel since early March.

By Matein Khalid

Published: Mon 18 Jun 2012, 1:25 PM

Last updated: Tue 7 Apr 2015, 12:04 PM

Can Brent fall below $90 if the failure to cut an output deal at Vienna triggers an oil glut and a price war? Absolutely. However, as Iran sanctions bite and Saudi spare capacity is exhausted, this could mean Brent bottoms at $90-$92. This means it is time to nibble again in Big Oil shareswhose valuations now price even lower levels.

Occidental Petroleum has a unique production growth profile in Big Oil, thanks to its assets in California shale oil, Permian Basin in Texas and Bakken/North Dakota in addition to its LNG/crude assets in the Middle East. Occidental peaked at 109 in early March and the shareshave plummeted with Brent as its beta relative to oil prices is the highest in the sector, even though it has a significant chemical (chloride, caustic soda) business, Occidental Chem. EPS estimates in Occidental in 2012 are at $8.50 (2011 EPS was 8.16).

The beauty of Occidental is that its California (Eck Hills) and Texas (Permian) assets are long life reserves and Occidental has stakes in some of the most strategic oil and gas projects in the world. (Dolphin Energy, Qatar North Field, a participating interest to develop Abu Dhabi’s Shah Field with Adnoc) and its free cash flow means it can raise its dividend every year in the past decade. Occidental’s GCC, North Sea and Colombia/Brazil production sharing contracts get hit when oil prices plunge and its stake in Phibro Trading, run by the legendary oil trader Andrew Hall, also got hit by the Black Death in Brent. In fact, Hall’s hedge fund had what Mr. Hall called a “mensis horribilis” in May. I expect Occidental to bottom at 72-74 if Brent bottoms at $92.

Even though Schlumberger has fallen from its 52 week high of 95 to 65 now, I am still reluctant to recommend the sharesof the world’s leading oil services business. Schlumberger will be hit by an erosion in North American margins in pressure pumping contracts, it is going to hugely benefit from the ramp of Iraq’s oilfield/pipeline/down stream infrastructure and the offshore West Africa/Brazil drilling bonanza that has led to unmistakable pricing strength in marine seismic. However, as Brent falls, EPS estimates for 2012 on the Street could well fall to $4. So the valuation multiple on the sharescould compress to 15.

Upstream producers rarely cut exploration budgets just because oil prices fall for six months. This is particularly true for state owned oil companies in the Gulf, Iraq, Libya, Russia, West Africa, Brazil, Colombia which face geopolitical pressures to increase output and Big Oil supermajors who face dismal reserve replacement ratio metrics. The Smith International takeover deal also makes Schlumberger a dominant force in deepwater drilling in the Gulf of Mexico. This is bullish for international/seismic operating margins and oilfield systemics. If Schlumberger falls to 56-58, it will represent deep value to me.

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