At times investing is like buying scotch. If you buy the cheap stuff, be prepared for a serious bout of buyer’s remorse the following day. In the coming decades the largest oil companies will have a very difficult time economically replacing their reserves while maintaining production levels. Many large caps trade at substantially lower valuations than their smaller brethren, but smaller companies have better potential to grow shareholder value over the long term.
The Numbers
Devon Energy Corp (NYSE:DVN) does not pull in revenue anywhere near mega cap levels, but Devon is still a respectable investment. In the last quarter the company increased production to 698 thousand barrels of oil equivalent per day (Mboed) and it is looking to continue increasing its production. In the Canadian oil sands it is expanding lower cost steam adjusted gravity drainage or SAGD production to achieve a 16% to 19% CARG through 2020. Due to the lower cost of SAGD compared to traditional strip mining and increased flexibility, Devon should be able to make money in the oil sands even in the face of midstream constraints.
Year over year EOG Resources Inc (NYSE:EOG) increased its quarterly production to 505.9 MBoed in the second quarter from 480.5 MBoed, thanks to strong Eagle Ford results. Its acreage in the Bakken and the Permian basin are other important growth drivers. By putting more wells in the Eagle Ford, EOG is further increasing its recover rates by 2%. With more than 12 years of drilling inventory in the Bakken/Three Forks shale, EOG Resources is in a great place to continue growing production and shareholder returns. Further technological advances will only further boost its recoverable reserves.
The Big Boys
BP plc (ADR) (NYSE:BP) has significantly more revenue than small upstream producers, but that comes with a high cost. BP has been forced to go into risky countries like Russia to continue growing its reserves. BP is proud to announce that thanks to its Russian production it produced 3,190 MBoed in Q2, 2013, but there is no guarantee that its Russian assets are safe.
Political pressures and good old resource nationalism helped force BP plc (ADR) (NYSE:BP)’s hand and make it give up a 50% stake in TNK-BP in exchange for a minority stake in Rosneft. If Russia’s relations with the west take a substantial downturn, BP has a giant bullseye on its head. Russian oil production is around 30% of BP’s total production, making resource nationalism a serious threat.
Petroleo Brasileiro Petrobras SA (ADR) (NYSE:PBR) produced an average of 2,378 MBoed in June, 2013, a 4.8% increase over May’s production. Looking at the big picture, Petrobras is facing many difficulties.
Its presalt wells are horribly expensive to drill. Even though the company recently stated that its presalt fields are sustainable with oil trading around $40 to $45, this ignores the cost to bring this oil to shore and the possibility for the government to increase its take. It is already normal for Brasil to get a 70% or greater take of the profits in larger fields. Brazil’s recent protests have shown that it is more convenient for the government to lower the price of gasoline and force Petroleo Brasileiro Petrobras SA (ADR) (NYSE:PBR) to take losses, than it is to see 300,000 protesters on the streets of Rio.
Also, Petrobras faces challenges in its refinery operations. In Brazil the price of gasoline is not set by the market, but the government. In the most recent quarter, Petroleo Brasileiro Petrobras SA (ADR) (NYSE:PBR)’ refineries are running at 99% utilization, forcing the company to import gasoline at a loss. Given the sensitive political environment about transportation costs, do not expect Brasilia to have a change of heart any time soon.
Investment takeaway
By investing in smaller upstream companies it is easier to find long term growth potential. EOG Resources Inc (NYSE:EOG) and Devon Energy Corp (NYSE:DVN) are both great examples of how a company can grow shareholder value with shale oil plays.
Big firms like BP plc (ADR) (NYSE:BP) and Petroleo Brasileiro Petrobras SA (ADR) (NYSE:PBR) have hundreds of billions of dollars in revenue, but have been forced into risky ventures. BP is stuck in Russia where the government is increasingly hostile to western interests. Petrobras is owned by Brazil. Recent populace protests over transportation costs make it clear that it is easier for Brazil to compress Petrobras’ margins than it is to face the populace ire. Also, the probability that Brazil will increase the tax burden on oil extraction is higher than ever, due to the need to compensate for loss of tax revenue in the face of falling Chinese demand.
The article Are Big Oil’s Best Days Gone? originally appeared on Fool.com.
Joshua Bondy has no position in any stocks mentioned. The Motley Fool recommends Petroleo Brasileiro S.A. (ADR). The Motley Fool owns shares of Devon Energy.
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