Energy Business

Opportunities Remain in the Oil Patch (RDS-A, E, COP, HAL, WEL, HK, KMP, EPD, XOM, CEO, BP)

Jon C. Ogg

Acquisitions, joint ventures, and ratings news in the oil patch have made for a busy day or two, and have also pointed out a handful of reasons pointing to a reasonable reason to search for opportunities in the fundamentals of the energy business. The news is, generally, upbeat on a lot of different fronts.

In ratings news, Royal Dutch Shell plc (NYSE:RDS-A) and Italy’s Eni SpA (NYSE:E) were raised from ‘Neutral’ to ‘Buy’ by UBS.  The UBS analyst believes that upside for European integrated oil companies now outweighs downside risk. The analyst noted that Eni is currently cheap with a forward P/E ratio of 7.93 and Shell offers “attractive value”, whatever that means.

ConocoPhillips Corp. (NYSE:COP) also got a ratings boost from ‘Perform’ to ‘Outperform’ from Oppenheimer. The stock also received a new price target of $70/share. Conoco’s announced intention to sell $10 billion in assets appears to be on track, especially given the sale of $4.65 billion worth of assets in the Canadian oil sands play to China Petroleum & Chemical Corp. (NYSE:SNP), usually called Sinopec. More about that sale later.

Halliburton Co. (NYSE:HAL) agreed to acquire oil field services company Boots & Coots (AMEX:WEL) for $3/share, comprised of $1.73 in cash and $1.27 in Halliburton shares, or about $232 million. The acquisition gives Halliburton a presence in intervention and pressure control services that match up well the larger company’s well completion and production enhancement capabilities.

Shares in Boots & Coots jumped 25% on the news, as one might expect. The deal is expected to close this summer pending regulatory and shareholder approvals. Boots & Coots’ management will oversee a new service line within Halliburton’s Completion and Production segment, and the company expects the acquisition to be accretive to earnings in the first full year of operation.

Petrohawk Energy Corp. (NYSE: HK) made a two significant moves this morning. First, it sold a 50% interest in its gas gathering and treatment operations in the Haynesville shale play to Kinder Morgan Energy Partners, L.P. (NYSE: KMP) for $875 million. The two companies plan to create an operating company named KinderHawk Field Services LLC to run the business. The transaction is scheduled to close by June 1, 2010.

In a related move, Petrohawk also announced that it plans to reduce its rig count in the Haynesville shale to 14, to reduce its 2010 capex budget by $100 million and to reallocate $175 million of the revised $1.35 billion cap-ex budget to its Eagle Ford shale play in south Texas. The switch is directly attributable to the softness in natural gas prices, currently stuck at about $4/thousand cubic feet. Petrohawk’s Eagle Ford acreage is believed to hold some 340 million barrels of potential reserves, most of which is crude oil, not natural gas condensates. The 20X differential between natural gas and crude oil pricing virtually forces a primarily gas-oriented company like Petrohawk to seek profits in its oil holdings.

The sale of 50% of its gathering and treating system to Kinder Morgan frees up all the capital that Petrohawk plans to spend in the Haynesville shale in 2010, and combined with earlier sales of its shale gas holdings, has exceeded the targeted $1 billion in divestures the company announced late in 2009.

Petrohawk shares are up more than 2.5% so far today, and Kinder Morgan shares are down about 1.5%. That latter figure is just another example of selling the news. Kinder Morgan does not expect to realize any distributable cash from the joint venture until a year after the deal is approved. Right now the system transports 800 million cubic feet/day of natural gas over a 173-mile network. By the end of 2010, the joint venture expects to more than double the mileage and boost capacity to 2 billion cubic feet/day.

And once the cash starts rolling in from the expanded gathering system, all of which is more than likely to be contracted as firm transportation over a term of at least 10 years, that cash will start flowing into Kinder Morgan’s and its limited partners’ pockets. From Kinder Morgan’s point of view, this was an extremely cheap entry into one of the major shale gas fields in the country.

Another major pipeline master limited partnership, Enterprise Products Partners L.P. (NYSE:EPD), has dropped 2.5% today on news of a secondary offering of 11.5 million new common units. Barclays Capital, Citi, Morgan Stanley, UBS Investment Bank, Wells Fargo Securities, and JP Morgan are joint book running managers, and have been granted a 30-day overallotment option of up to 1.725 million shares.

Enterprise plans to use a portion of the proceeds from the sale to pay for its pending acquisition of gas gathering assets in the Haynesville shale from independent midstream energy company M2 Midstream LLC for $1.2 billion. Enterprise got a total of 387 miles of pipeline with current capacity of 685 million cubic feet/day. A planned 50-mile expansion and other enhancements are expected to expand capacity to 985 million cubic feet/day, with further possible expansion to 1.2 billion cubic feet/day.

Conoco’s deal to sell $4.65 billion of its assets to Sinopec is the big story of the week so far. The sale represents all of Conoco’s 9.03% stake in Syncrude Oil Ltd., the Canadian venture that includes Exxon Mobil Corp.’s (NYSE:XOM) wholly-owned subsidiary Imperial Oil (with 25%) and Canadian Oil Sands Ltd. with the largest stake at nearly 37%.

Sinopec has been on something of a buying spree lately, having completed a deal in March with Angola for deepwater rights offshore that African nation to about 102 million barrels of oil. The African oil cost Sinopec about $3.5 billion.

And it’s not the only Chinese buyer either. Also last month, Cnooc Ltd. (NYSE:CEO) paid $3.1 billion for a 50% stake in a unit of Argentina’s Bridas Energy Holdings that holds 40% of Pan American Energy LLC, the other 60% of which is owned by BP plc (NYSE:BP).

The Chinese are investing everywhere, and the received wisdom is that the Chinese government is pushing their oil companies to buy foreign assets to fuel the country’s booming economy. There have been a few fears expressed that China’s investments will cause shortages elsewhere around the world.

Another way of looking at China’s oil investments is as a hedge both against rising oil prices and against the falling dollar. By buying up crude production, China is, in fact, hedging a portion of its expected energy consumption by ensuring that it has some crude to sell at the same time that it is buying crude from somewhere else. The Chinese are not going to put Angolan crude on a VLCC and ship it to the homeland. They’re going to sell it a market price to someone else and use the proceeds to fund their own oil purchases. It’s really the only thing that makes sense.

Similarly, buying crude oil production guards against the deterioration of China’s huge US dollar holdings due either to continued dollar weakening or US inflation. The country doesn’t have a lot of options for spending its estimated $2.5 trillion in foreign exchange reserves. Or at least spending the dollars fast enough to give the global economy a significant boost.

The Chinese government also announced today that it is raising retail refined products prices by 4% for gasoline and 4.5% for distillates. The move indicates that the government believes it has inflation under control, but it is not likely to help Chinese refiners much because it is both too late and too small. The unspoken part of the news, though, is that by raising retail prices, China may cool off demand for oil, which is rising quickly again.

The price of oil, on which most of the companies discussed in this article make their profits, is falling from recent highs of around $87/barrel. This drop is happening despite forecasted increases in demand for the rest of the year. While that may seem like a drag on prices for companies like Shell, Conoco, or Cnooc, it could actually be helping because crude prices above $90-$95/barrel will almost certainly chill global demand and could blunt the global economic recovery. If investors can scale back their expectations of reasonable returns on crude oil, there is hidden strength here.

Paul Ausick