Smart Cost-Cutting at Statoil Leads Me to Raise My Target Price

06/05/2014 5:33 pm EST

Focus: ENERGY

Jim Jubak

Founder and Editor, JubakPicks.com

Unlike other oil companies that plan to cut costs by cutting back on capital spending on exploration and development, this Norwegian company is taking a different approach and, so far, investors have been impressed. As of today, June 6, MoneyShow's Jim Jubak is raising his target price.

Internal documents from Statoil (STO), seen by Bloomberg, have put details on the cost-cutting targets set by Norway's state-owned oil company in February.

Statoil said back then that it intended to make cuts that would add $5 billion a year to pretax cash flow by 2020.

The common way these days for oil companies to achieve those goals—when faced with stagnant oil prices and demands from restive shareholders to generate extra cash—has been to cut back on capital spending on exploration and development.

What we know of Statoil's plans, however, says that the company thinks it can achieve most of its cost savings through efficiencies while leaving its exploration and development plans intact. That's good news for Statoil shareholders who own this stock for its big pipeline of promising assets outside of the company's traditional operating area on the Norwegian continental shelf. Especially positive for shareholders is the company's belief that it can find enough efficiencies to enable it to cover dividends from organic cash flow by 2018. Recently, Statoil has been meeting its dividend payouts through asset sales. (Statoil is a member of Jubak's Picks portfolio.)

According to those internal documents, Statoil's cost-cutting program is made up of reducing operating costs (by 15%), reducing technical staff (by 20%), and decreasing capital expenditures (by 25%) by 2020.

It's the reductions in capital expenditures outlined in these documents that are particularly interesting. Statoil plans to achieve that 25% reduction, not by cutting its exploration and development activity, but by finding ways to reduce drilling costs in Norway, the most expensive place in the world to drill and the source of about two-thirds of the company's oil and natural gas production.

For example, Statoil oil wants to lower the cost of putting new platforms into production by 25% by 2020 and to reduce the cost of updating existing platforms by 30%. Drilling costs per meter have climbed by 240% in ten years, Statoil has said—which should leave plenty of room for the plan's goal of reducing well-related costs by 25%.

I've got my doubts about some parts of Statoil's plan—the company says it wants to open discussions with Norway's government on safety regulations and worker rotations requirements. Norway has some of the toughest oil drilling safety regulations in the world and I'm not sure how much the government is willing to bend. More to the point, I'm not sure that looser regulations are to Statoil's long-term advantage. With oil companies moving into more and more fragile and harsh environments in search of oil, opposition to drilling in regions such as the Arctic has climbed. A company with a record of meeting tougher-than-average regulations has a competitive edge in that kind of setting.

Investors have been impressed with Statoil's plans and the company's position as “the” major alternative (to Russia) supplier of natural gas to Europe. The ADRs were up 30.04% for 2014 to the June 4 close.

That means at today's (June 5) close of $30.93, the New York traded ADRs are pressing up against my target price of $31 a share.

As of June 5, then, I'm raising my target price for Statoil's ADRs to $37 a share.

Full disclosure: I don't own shares of any of the companies mentioned in this post in my personal portfolio. When in 2010 I started the mutual fund I managed, Jubak Global Equity Fund, I liquidated all my individual stock holdings and put the money into the fund. The fund shut its doors at the end of May and my personal portfolio is now in cash. I anticipate putting those funds to work in the market over the next few months and when I do I'll disclose my positions here.

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