Archive for December, 2010
Acquisition speculation Real or not, speculation reported in London’s Daily Mail that BHP is considering a $90 per sh ($45bn) bid for Anadarko is clearly supportive for what we continue to view as the deep value play in the large cap US oils. It has also been a recurring theme since BHP laid out a strategy to expand E&P targeting many of the areas that overlap perfectly with APC and fuelled further by deep pockets left from BHP’s failed bids for Potash and Rio. But on balance, while we believe speculation of a bid at this level is supportive it is not likely credible in our view: the price is simply too low.
Anadarko’s view: $110 is the starting point
Anadarko themselves laid out a base case value at its Spring strategy update that starts at ~$110 based on $75 oil and $6 US natural gas; this number has almost certainly moved up given higher oil prices and multiple exploration successes that have de-risked another swathe of exploration prospects. This is an international E&P – and they trade differently: on the London Stock Exchange value for ‘risked’ exploration potential is routinely awarded – but with no logical US peers our long- standing view is that US market has been reluctant to pay for upside potential leaving this as a free option in the shares. But in any acquisition situation recognizing the value of exploration upside is a pre-requisite: on any reasonable assessment of risk for multi-year drilling programs in Mozambique, W Africa and the US GoM would leave risks to our base case price target significantly higher.
2011: a big year for exploration …and a shift towards oil
2010 derisked several major exploration plays leaving APC poised for one of the most aggressive drilling programs in its history. While activity will slow in the US GoM, the line up of existing discoveries and related prospects will ensure that exploration remains a key part of the investment case for the foreseeable future. Currently, our PO of $92 includes ~$36 for existing exploration success – but nothing for any future drilling program. This remains a major differentiating factor on APC’s investment case vs peers – but in 2011 this is bolstered by a step change in oil leverage as production accelerates in the Eagleford and Permian basins and start up of the first ‘mega’ projects at Jubilee and Caesar Tonga in the US GoM that can again differentiate performance over the next year.
Sum up: $90 would not be enough
It is at best presumptuous to reward acquisition speculation – especially in a lightly traded holiday market. But it does draw attention to underlying value. Exploration potential is real and remains a free option in APC’s shares; at the same time recent underperformance vs a strong E&P sector suggests a $10bn worst case for any Macondo liability fully priced in – leaving a potential settlement with BP as a binary event that risks share performance to the upside. Arguably, the discount related to this uncertainty is partly offset by any speculative premium – but at current levels we continue to view APC as a deep value exploration play and our top exploration pick amongst the large cap US oils. Maintain Buy.
Policy Paradox – In late August, Mr. Bernanke indicated that the Fed would seek to boost the stock market, the housing market and the economy in general by instituting QE2. With a Fed Funds rate at zero, the Fed would resort to buying Treasuries to lower rates across the curve. Yet despite QE2, rates have actually risen. John Hussman is also somewhat puzzled by this apparent paradox.
Why are Treasury yields rising despite hundreds of billions of Treasury purchases by the Federal Reserve? There are two possibilities in the current debate. One is that the Fed’s policy of purchasing Treasuries has scared the willies out of the bond market on fears of higher inflation, and that the policy is a failure. The other is that the policy has been such a success at boosting the prospects for economic growth that interest rates are rising on anticipation of a better economy.
From our standpoint, neither of these explanations hold much water. On the inflation front, the recent bond selloff has hit TIPS prices as well as straight Treasuries, which isn’t something you’d expect to see if inflation expectations were being destabilized. And although precious metals and other commodity prices have been pressed higher, the commodity run can be more accurately traced to negative real interest rates at the short-end of the maturity curve, coupled with a downward trend in long-term yields that has now reversed dramatically (more on that below). I’ve long argued that unproductive government spending and profligate fiscal policy are ultimately inflationary (regardless of how the spending is financed, and particularly if it is monetized), but I continue to view persistent inflation as a long-term, not near-term concern. A rise in T-bill yields of more than 15-25 basis points would change that assessment. Until then, velocity can be expected to collapse in direct proportion to changes in the monetary base, with little impact on prices.
As for the notion that the Fed’s targeted Treasury purchases have directly aided the economy, the argument requires bizarre logical gymnastics. It demands one to believe that although the purchases were intended to stimulate the economy by lowering rates, they have been successful without lowering them, and in fact by raising them, because the expectation of lower rates was so stimulative that it caused rates to rise, so that the higher rates can be taken as evidence that lowering rates without lowering them was a success. Oh, brother.
A bit later, Mr. Hussman suggests a third alternative:
So neither side typically taken in the debate over the Fed’s Treasury purchases is particularly satisfying. Fortunately for fans of logic, there is a third explanation that is much more plausible, and has the benefit of having data behind it. Despite my extreme criticism of Fed actions in recent years, I would argue that QE2 has in fact been “successful” over the short-term, but not through any monetary mechanism. Rather, QE2 has been successful a) by creating a burst of enthusiasm that released some pent-up demand in the same way that Cash for Clunkers and the new homebuyer tax credit did, and b) by encouraging investors to believe that the Fed has provided a “backstop” for stocks and other risky assets, creating a speculative blowoff in these securities, to the detriment of what investors perceive as “safe” assets, which ironically includes Treasury securities.
In short, the main effect of QE2 has not been monetary but has instead been rhetorical – and that rhetoric may very well be nearly empty.
The key event related to QE2 wasn’t its formal announcement, but was instead the Op-Ed piece that Ben Bernanke published a few days later in the Washington Post, which essentially advanced the argument that the Fed was targeting a “wealth effect” in stocks and other risky assets, in hopes of getting people to consume off of that perceived wealth. At that moment, Bernanke unleashed a speculative bubble in risky assets, and a selloff in safe ones. This has rewarded risk-seeking and punished risk-aversion, but it has also unfortunately driven the markets into an overvalued, overbought, overbullish, rising-yields condition that has historically ended in steep and abrupt losses.
More on the QE2 paradox next week.
Impact on our views: NBL and partners announced the success of the Leviathan-1 exploration well offshore Israel. Following an operational update last month, and speculation in the local press of a success, NBL expects the results to confirm the pre-drill resource range (gross mean, 16 Tcfe). While today’s announcement likely implies $3-4/shr absolute upside for the shares, we maintain our view that post-discovery market focus should shift to the value of the resource, timeline for development, and broader fiscal questions surrounding oil & gas regulation in Israel. We maintain our Equal-weight rating.
What’s it worth?: We have adjusted our base case NAV associated with today’s announcement. De-risking the prospect from 75% to 35% risk (assuming $0.40/Mcf of value) increases our NAV from $100/shr to $106/shr (Leviathan value moves from $3.50/shr to ~$9/shr). We expect 50%+ of this upside to be priced in by the market following today’s announcement.
What’s next?: The rig is expected to stay on site to drill the deeper (potentially oil bearing) horizons below. NBL acknowledges higher risk associated with this target (5-10% pos), however the resource potential as discussed by partners is substantial (1+ bn bbl prospects) and worth monitoring. Results here expected by 1Q11 before the rig moves to start development work at Tamar.
Investment thesis: NBL continues to offer one of the most attractive multi-year production growth outlooks in our coverage group. The project backlog from Israel, West Africa, and the Gulf of Mexico provides accelerating growth and incrementally higher returns than the base business. Our Equal-weight rating is driven by what we have viewed as high expectations surrounding the Israeli exploration & development program in an uncertain fiscal environment. We see the stock at 7.4x our 2011e EV/DACF (fwd net debt) at the current commodity strip.]
␣ Leviathan-1 results encouraging; management re-affirms 16 Tcfe estimate NBL disclosed that its highly anticipated Leviathan prospect offshore Israel encountered several Miocene sands with reservoir quality and net feet of pay consistent with the expectations supporting its 16 Tcfe pre-drill estimate. Two or more appraisal wells will be required to further define the resource range. In addition to NBL’s (operator) 39.66% working interest, its partners include Delek Market cap. Drilling (22.67 %), Avner Oil (22.67 %), and Ratio Oil (15%). Shares o/s
␣ How valuable could Leviathan be to NBL? We assume Leviathan will be monetized via an LNG project or pipeline exports to southern Europe, & first production would likely be late this decade. We believe it conservatively adds +$6/share to NBL’s NAV but it may be several years before a development plan is finalized. Note: we value the 8.4 Tcfe Tamar prospect (36% w.i.) higher given assumed lower development costs and quicker time to develop.
␣ What’s next for NBL at Leviathan? The Sedco Express rig will continue to drill toward two deeper objectives at Leviathan with additional gross resource potential of 3 BBoe and 1.5 BBoe and relatively low probabilities of success of 8-15% (vs the pre drill 50% for the gas objective). Results are expected within a few months. A second rig arrives in February to spud an appraisal well of the gas zone. Forecast stock return
Forecast price appreciation Forecast dividend yield
␣ Valuation: Raising price target from $86 to $90 We are raising our price target from $86 to $90, on de-risking of Leviathan. Our
$90 price target assumes 7.0x 2011 “normalized” EBITDX, or 0.85x NAV (in line with peers).
A Surprise To Watch Out For – During my interview on Squawkbox Tuesday morning, I was asked if the worries of 2011 would be the same ones we saw in 2010 (e.g. sovereign debt, foreclosures, etc., etc.). I replied that many of them might linger but that I’d keep a sharp eye on oil.
There are several reasons to worry about a surprise spike in oil. I cited unrest bubbling up in Nigeria, a large and important supplier of top grade bonny light.
Then there’s riskiness of Saudi Arabian succession. The king, Abdullah, age 86, is the subject of recent rumors about his health. Unfortunately, so too is his designated successor, Prince Sultan, age 82.
Under the Saudi system, the crown does not pass from father to son but rather from brother to brother. There are 18 brothers or half-brothers sired by King Saud, founder of Saudi Arabia.
Should there be disputed or simply just confusion about the succession, it might inspire, al Qaeda on the Arabian Peninsula, or some other adventurers, might try to disrupt things. If Saudi Arabia production and/or shipment of oil is disrupted, crude could spike sharply. That could benefit other OPEC members.
There are other potential landmines in the oil picture. Mexico’s production is facing some hurdles. Venezuela is anything but stable.
Keep your eye on crude.