By: Elliott Gue
Today, shares of my favorite European integrated oil companies offer the best near-term upside and dividend yields, largely because of the ongoing weakness in their domestic stock markets and some company-specific uncertainties.
I highlighted Total (TOT) as a buying opportunity shortly after news broke that leaking natural gas from a production site forced the company to shut-in operations in its Elgin and Franklin fields offshore Scotland. The company’s American depositary receipt (ADR) gave up almost 20 percent between March 23 and June 9, the stock’s recent low.
Recent news flow and comments from management suggest that investors have overreacted to the natural-gas leak, which Total plugged about a month ago. Not only did the disaster pale in comparison to the Macondo oil spill in terms of environmental damage–the natural gas dissipated into the atmosphere–but the Super Oil also has the financial wherewithal to survive the losses associated with the seepage.
Management estimates that response and remediation effort, which spanned roughly two months, cost the company about USD1.5 million per day before taxes and insurance. Meanwhile, the lost production from operations in the Elgin and Franklin fields amounted to about 50,000 barrels of oil equivalent per day, resulting in about USD1.5 million in lost operating income per day.
The firm will also likely face fines from the UK government and could be sued by Royal Dutch Shell and other producers that have been forced to halt operations in the area.
Total shouldn’t have any problems overcoming the estimated USD400 million in leak-related expenses. One of the largest energy firms in the world, the company has USD17 billion in cash on hand and about USD10 billion in undrawn credit lines. In addition, the company has roughly USD750 million in third-party insurance coverage for liability and more than USD1 billion in coverage for property damage related to the Elgin spill.
Based on management’s initial cost estimates, the company has plenty of cash on hand to maintain its current dividend and fund planned capital expenditures for 2012. In the first quarter, the company generated enough cash flow for a dividend coverage ratio of 36 percent, well below management’s long-term target of 50 percent.
During a conference call to discuss Total’s first-quarter results, CFO Patrick de la Chevardière acknowledged that uncertainty related to the leaking Elgin gas well had dissuaded the firm from hiking its interim dividend. However, the CFO also indicated that a higher payout remains in the company’s plans:
[W]hat we think about the dividend is that it was too early and that we need time to control the Elgin situation prior in deciding to increase the dividend. So it is not because we haven’t increased the dividend this time that we will not increase later on. We will see according to the situation. And I remind you that what we said in the past is that we have room to increase the dividend. This remains valid, but it’s just a matter of time.
Although these considerations likewise prevented Chevardière from providing updated production guidance for 2012, the CFO noted that each month of lost output from Total’s shut-in operations in the North Sea cost the firm 0.2 percent of its projected production growth. Management expects operations in the Elgin and Franklin fields to come back onstream gradually toward the end of the year, though this decision hinges on regulatory approval. In the event that the idled operations in the North Sea remain offline, management estimates that production will be flat relative to the prior year.
Nevertheless, Total’s long-term growth prospects remain intact. Management reaffirmed plans to grow output at an average annual rate of 2.5 percent between 2011 and 2015, fueled by a slate of about 25 projects that will add 600,000 barrels of oil equivalent per day to its portfolio.
With work on the second phase of the Ofon field development offshore Nigeria starting in February 2012, about 95 percent of the projects that management expects to contribute to this five-year production target are under construction.
Meanwhile, management noted that a number of projects came onstream during the first quarter, including the Usan oil field offshore Nigeria, the Islay gas field in the North Sea and the Greater Bangkot South gas and condensate field in the Gulf of Thailand.
Total’s future also looks bright beyond 2015. The international oil company in 2011 announced the discovery of three giant oil fields (plays estimated to contain more than 500 million barrels of oil equivalent in reserves): the Zaedyus field in French Guyana, the Aquio-X1001 in Bolivia and the Absheron field in Azerbaijan. This marked Total’s best ever year in term of finding giant oil fields.
Tullow Oil (LSE: TLW) operates the Zaedyus prospect and late last year announced a major oil discovery from a well in about 6,000 feet of water. Tullow Oil also discovered the Jubilee oilfield offshore West Africa a few years ago and has backed up its theory that the fields offshore West Africa would feature geological characteristics to the massive oil and gas plays off the coast of Brazil.
More test wells will be necessary, but some estimate that this find could contain several billion barrels worth of reserves. Total has a 25 percent stake in the play and holds nearby acreage that also appears prospective for hydrocarbons. A major discovery like Zaedyus boosts the value of all acreage in the region because such a find lowers the risks of drilling a dry hole.
The Aquio discovery is located at the foot of the Bolivian Andes. Total has an 80 percent operating stake in the field, which produced natural gas and condensate at impressive rates in early well tests.
Finally, the Absheron discovery is located at a water depth of 1,500 feet in the Caspian Sea. Total operates this play and owns a 40 percent working interest in the field.
In aggregate, the company plans to drill or participate in a 60 exploratory wells in 2012 and 2013, with a heavy focus on prospects in Africa and South America.
Liquefied natural gas (LNG) accounts for about 27 percent of Total’s upstream results and is a major contributor to future production growth.
Whereas frenzied drilling activity in unconventional plays such as the Marcellus and Eagle Ford Shale has glutted the US market for natural gas and depressed prices to record lows, competition for LNG imports in Asia and Europe will intensify in the next several years. In Europe and Asia, LNG routinely fetches four to five times the prevailing price in the US market. About 70 percent of Total’s LNG production is committed to be sold at oil-indexed prices.
Total has increased its LNG output by 50 percent since 2009, and the firm has three major LNG projects under development:
The Australia-based billion Ichthys LNG project, which will produce 8.4 million metric tons of LNG per year and 100,000 barrels per day of condensate, is expected to cost USD34 billion and will come onstream at the end of 2016. Total owns a 24 percent stake in this project.
The France-based energy giant also holds a 13.6 percent interest in the Angola LNG project, which will begin operations at the end of 2012 and ramp up to 5.2 million metric tons of annual output.
The Australia-based Gladstone LNG project, in which Total owns a 27.5 percent stake, is slated to start up in 2015 and produce up to 7.2 million metric tons of LNG per annum.
Total also has exposure to exciting deepwater projects in the US Gulf of Mexico, Asia and offshore South America. However, the firm’s particularly strong offshore Africa–a region in which it has a long operating history–offer the best growth prospects. Management expects the company to more than double its deepwater output between 2010 and 2020.
The Pazflor development off the coast of Angola is one of the largest in Total’s history. The company holds a 40 percent working interest in this play, with BP (LSE: BP, NYSE: BP), ExxonMobil and Statoil (Oslo: STE, NYSE: STO) rounding out the stakeholders. Discovered in 2000 in waters that are 2,000 to 3,500 feet depth, Pazflor is a giant oil field that’s estimated to contain up to 590 million barrels of oil. Total began commercial production from the field in August 2011 and expects output to peak at roughly 220,000 barrels per day.
Meanwhile, Total’s downstream and petrochemical operations account for only 15 percent of the firm’s annual profits.
Refineries in Europe have faced particular challenges because economic weakness has sapped demand for gasoline, while the elevated price of Brent crude oil has eroded profit margins.
Management has launched a number of cost-cutting initiatives and expanded into Asia and the Middle East, regions where refiners enjoy superior profit margins and growth potential. Nevertheless, the firm’s limited exposure to the downstream segment gives it a leg up on the competition.
Investors’ overreaction to the natural-gas-leak in the Elgin field, coupled with general weakness in European equity markets, marks a prime opportunity to pick up shares of this top oil and gas investment at a discount.