Introduction

The Securities and Exchange Commission (SEC) requires oil and gas companies to estimate the year-end value of their proved reserves in the annual report (10-K filing). At this point most companies have filed their annual reports. This year I am undertaking a project to categorize and compare all U.S. oil and gas companies using specific metrics. I am developing an Excel spreadsheet that can update certain metrics automatically, but some values can only be obtained by extracting them from the annual reports. My intention is to do this for all of the ~110 publicly traded oil and gas companies.  

I have focused on certain valuation metrics and projections for future cash flow. Today I present the valuation data for the 10 largest pure exploration and production (E&P) companies based on their enterprise value (market capitalization plus net debt.) This list does not consider companies with significant logistics (midstream) assets or refining (downstream) capabilities.

There are a lot of discrepancies between various sources on company rankings. NASDAQ maintains a complete listing of publicly traded energy companies, but some are incorrectly categorized. For example, ConocoPhillips (NYSE: COP) is listed as an “integrated company,” despite spinning off its refining assets as Phillips 66 (NYSE: PSX) in 2012. Occidental Petroleum (NYSE: OXY) is listed as an “oil & gas production” company, despite having substantial midstream and downstream assets. MarkWest Energy Partners (NYSE: MWE) is in the same category even though it’s a midstream master limited partnership (MLP).

I have attempted to correct the list to only include exploration and production (E&P) companies.

To be clear, there are a number of integrated oil companies with proved reserves greater than those on the list. ExxonMobil (NYSE: XOM), for instance, ended 2014 with proved reserves of 2.3 billion barrels — ahead of several companies on the list. But the comparison I am making would show inflated financial metrics for integrated companies given the contributions of their downstream operations. Therefore, we would expect integrated oil and gas companies to trade at a premium relative to pure E&P companies based on those metrics. If an integrated company doesn’t trade a premium, then it may very well be undervalued.

One of the key metrics I evaluated is the standardized measure (SM), which requires some explaining — as well as some caveats.  The SM is the present value of the future cash flows from proved oil, natural gas liquids (NGLs), and natural gas reserves, minus development costs, income taxes and existing exploration costs, discounted at 10% annually. The SM must be calculated according to specific guidelines set by the SEC. All oil and gas firms traded on a U.S. exchange must provide the Standardized Measure in their filings with the SEC.

Companies often report a PV10 as well, which is the present value of estimated future oil and gas revenues based on proved reserves (developed and undeveloped) minus estimated direct expenses, discounted at an annual discount rate of 10%. But the PV10 is a non-GAAP measure, and so there can be discrepancies in how different companies arrive at their estimate. (GAAP stands for generally accepted accounting principles, the most formal and inflexible set of rules for assessing a company’s finances.) So the standardized measure allows for a more apples-to-apples comparison between companies.

Both the SM and the PV10 are calculated according to the average prices received over the past 12 months for oil, NGLs, and natural gas. Because the first half of 2014 featured oil prices above $100/bbl, the SM for these oil companies was calculated at a value higher than today’s prices. EOG’s (NYSE: EOG) annual report, for instance, calculated its SM based on the following:

“Estimated crude oil prices used to calculate 2014 future cash inflows for the United States, Canada, Trinidad and Other International were $97.51, $95.11, $80.60 and $94.09, respectively. Estimated NGL prices used to calculate 2014 future cash inflows for the United States and Canada were $34.29 and $27.03, respectively. Estimated natural gas prices used to calculate 2014 future cash inflows for the United States, Canada, Trinidad and Other International were $3.71, $4.79, $3.71 and $5.34, respectively.”

Thus, if the average oil price is significantly lower in 2015 than it was in 2014 (and I expect that it will be), then the SMs that will be calculated at the end of this year will likely be much lower. Therein lies the risk in using the SM as a valuation metric; the cash flows are seriously dependent on commodity prices, as well as changes in reserves. So the SM is not a measure of the absolute value of an oil or gas company, but gives us rather a more consistent basis for comparing different companies.

I also gave the 2013 SM as a comparison, to see which companies increased the value of their reserves. The EV/EBITDA is similar to a price/earnings ratio; Current ratio (CR) divides a company’s current assets by current liabilities. CR is useful for understanding a company’s ability to cover short-term liabilities with short-term assets like cash, inventory and receivables. The higher the CR, the less burdensome the debt.

Finally, the share of production attributable to natural gas is listed because gas is generally the lowest-value commodity for a driller. The remainder of a company’s reserves will be natural gas liquids, crude and condensate, bitumen, and/or synthetic crude oil. The higher the gas percentage, the lower the value of the reserves. In other words, 1 barrel of oil is worth more than 1 barrel of oil equivalent (BOE) of natural gas. On the other hand, oil prices have fallen more than natural gas prices since last year, so the companies with greatest proportion of oil in their reserves may see larger downward revisions if oil prices remain weak.

Here are the metrics for the 10 largest oil and gas companies based on enterprise value:

EV = Enterprise Value in billions of dollars as of April 9
SM = Standardized Measure, also sometimes called “standard measure,” “net future cash flow” or “future net cash flow,” in billions of dollars as of Dec. 31
2013 SM = Standardized measure at the end of 2013
Reserves = Proved reserves in billions of barrels of oil equivalent as of Dec. 31
CR = Current assets for the most recent quarter divided by current liabilities for the same period
% Gas = percentage of the proved reserves estimated to consist of natural gas
1 year = change in share price over the past 12 months

We can see from the table that several companies — ConocoPhilips, EOG and Devon Energy (NYSE: DVN) — significantly increased their SM over the last year. Each of these companies is currently rated a Buy in one of the Energy Strategist portfolios, and they all held up well during the market correction that began last summer. Southwestern Energy (NYSE: SWN) also increased its SM, but it took on significant debt in doing so.

The valuation ratios for Pioneer Natural Resources (NYSE: PXD) look relatively high, but it is one of those companies with some businesses outside of oil and gas production. For instance, it owns pumping service and a company that produces sand for hydraulic fracturing (fracking). Pioneer also has a significant midstream business. Thus the EV is higher relative to its oil and gas reserves.

Chesapeake Energy (NYSE: CHK) stands out for its low ratios relative to the rest of the group. This suggests that Chesapeake is relatively undervalued, and in fact it is the remaining TES portfolio Buy on the list. Based on their standardized measure, Chesapeake, ConocoPhillips, and Apache are all trading barely above their expected future net cash flows, though again those are based on last year’s commodity prices.

Conclusions

The first pass of the new screening tool I am developing has highlighted several values among the top 10 oil and gas companies in the U.S. Most are already listed as a Buy in one of the TES portfolios. The one exception may be Apache (NYSE: APA), which looks cheap based on the valuation metrics but did post a year-over-year SM decline (as did Chesapeake).

In the next issue we will take a look at smaller companies to see if we can uncover any new buys.  

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