Toby Shute: 3 Oil Deals Shaking the Market

This week, I've spotted at least three billion dollar oil deals that should be of interest to investors (all this as of Tuesday!). Combined with other activity in recent weeks, this suggests that there's plenty more M&A mayhem to come as we approach the end of the year.

A big splash in the Gulf
First off, Energy XXI (Nasdaq: EXXI) agreed to pick up a bunch of ExxonMobil's (XOM) shallow water Gulf of Mexico properties for $1 billion. This follows similar moves by Apache (APA), which grabbed Devon Energy's (DVN) shallow Gulf assets for an identical sum, and McMoRan Exploration (NYSE: MMR), which picked up the pieces from Gulf dropout Plains Exploration & Production (PXP).

Energy XXI is picking up 66 million barrels of oil equivalent (Boe) of proved and probable reserves, and 20,000 Boe per day of production. The cash flow multiple paid is 3.2. Apache got more reserves with its purchase (83 million boe), slightly less production (19,000 boe/d), and paid 3.7 times estimated cash flow. In both cases, oil and natural gas production is split roughly 50/50, so I assume the lower Energy XXI cash flow multiple is largely a reflection of higher oil prices. Any way you slice it, the purchase price looks reasonable.

With this purchase, Energy XXI becomes the third largest oil producer on the Gulf of Mexico shelf, leapfrogging W&T Offshore (WTI) in terms of reserves, and both McMoRan and Stone Energy (SGY) in terms of production. The assets acquired have the potential to deliver around 720 million Boe at a development cost of around $15 per barrel.

That would be a really compelling figure, if a large component of that total resource potential was oil. The potential oil mix, surprisingly, is only around 10%, however, alongside 3.9 trillion cubic feet of gas. So the big upside appears to be in deep and ultradeep gas prospects, such as the ones Energy XXI is exploring in partnership with McMoRan elsewhere on the Gulf of Mexico shelf.

Incidentally, Exxon walked away from one of these ultradeep drilling projects a few years ago. This week's sale confirms that the company lacks an appetite for this activity. Given the likely difficulties in securing future permits to drill these extremely high-pressure wells, I can't really blame it. I'm a decided fan of wildcat drilling in the Gulf, but my preference is for companies sizing their bets more conservatively.

Yet another Bakken buy
Last week we saw Williams (WMB) make a $925 million purchase in prime Bakken territory up in North Dakota. This week, Hess (HES) edges it out with a $1.05 billion buy of privately held TRZ Energy. This follows closely on the heels of the company's acquisition of American Oil & Gas (AEZ) earlier this year.

The 167,000 acres acquired in this latest deal bring 4,400 barrels of daily production to the table. That's a pretty massive $238,600 per flowing barrel purchase price. At under $6,300 per acre, though, this purchase comes at a discount to those executed by Williams and Enerplus Resources Fund (NYSE: ERF). From what I can piece together, TRZ is active in Dunn and Williams County. You may recall that Dunn County is the location of Kodiak Oil & Gas' (AMEX: KOG) core development area. This should be very prospective acreage, suggesting that Hess may have gotten a great deal here.

Another Asian oil sands suitor
Over the past year or two, one of the most active players in the Canadian oil sands has been China. PetroChina (PTR) took a big stake in a pair of Athabasca Oil Sands' projects last September. More recently, Sinopec (SHI) snapped up ConocoPhillips' (COP) 9% stake in Syncrude, and a Chinese sovereign wealth fund snapped up a stake in some Penn West Energy Trust (NYSE: PWE) properties.

Showing that China isn't the only one salivating over the security of long term oil sands supply, Thai energy company PTTEP has also stepped forward. The company is picking up 40% of Statoil's (STO) Kai Kos Dehseh oil sands project for $2.3 billion. The entry looks low-risk, as first production is slated for early 2011.

Thanks to heady oil prices, the oil sands have made a roaring comeback since the dark days of 2008. As long as you believe that the world economy will continue to support $70 plus oil prices, the oil sands are indeed an interesting place for your money. Cenovus Energy (CVE) continues to be my favorite operator in that realm.


Make sure to check out Toby's Book "The Hidden Cleantech Revolution"

Share

UNG: Why I Consider This ETF a Frightening Investment

From overleveraged Delta Petroleum, to overhyped Houston American Energy, to over the hill Energy Conversion Devices, there's no shortage of spooky investments in the energy sector. These are all relatively small companies, though, and unlikely to draw in space monster sized amounts of money.

For me, the most terrifying investment vehicle in the space is an ETF that has vaporized untold amounts of wealth since some mad scientists of Wall Street brought it to life in 2007. I'm talking about the United States Natural Gas Fund (UNG) exchange traded fund.

The ETF's popularity is easy enough to understand. Like the SPDR Gold Trust (GLD) or the Powershares DB Agriculture Fund (DBA), UNG provides investors a way to bet on the direction of a commodity (or basket of commodities, in the case of the agriculture fund) without having to accept company risk, dabble in futures contracts, or take delivery of a silo full of grain.

With commodities increasingly viewed by investors as an asset class, such funds are all the rage with pension funds, hedge funds, and retail investors alike. UNG trades more than 20 million shares daily, or well over $100 million by dollar volume. The liquidity here is tremendous, keeping the fund price closely in line with daily net asset value. Nothing frightening so far, right?

The problem with UNG, as well as countless other ETFs that invest in near month futures contracts, is that the fund's value gets chewed up like a zombie victim as the contracts get rolled from month to month. Compounding this issue of "roll yield" is that the larger the fund gets, the harder it gets to nimbly exit expiring contracts and enter new ones. The fund spreads its roll dates over four days, which in theory should help to minimize the impact of its trading, but I still suspect that other savvy market players are able to game this pattern.

After the past few years' performance, shares are off roughly 85% since inception, you'd think that investors would have run away screaming by now. For some reason, though, they just keep getting lured back in. Perhaps there's a mind control device at work here. That, or investors think they can actually time a recovery in natural gas with great enough precision to avoid getting their faces ripped off by the Negative Roll Yield Mutant.

If you want to trade in and out of this ETF in a matter of minutes or hours, that's your prerogative. For those investors out there who, like me, anticipate an eventual recovery in natural gas prices but want to be able to ride out another year of depressed prices if need be, I'd suggest ditching this frightening fund in favor of a low cost producer who can survive the current rig invasion. Two companies that potentially fit the bill are Range Resources (RRC) and Southwestern Energy (SWN). You can read my case for the latter company, one of the premier shale gas operators here.

From Toby Shute at Seeking Alpha


Share