A Global Bidding War for Oil

10/21/2011 8:00 am EST

Focus: COMMODITIES

Jim Jubak

Founder and Editor, JubakPicks.com

As the costs of producing oil grow and the places to hunt for new reserves shrink, Big Oil is willing to pay more for oil and gas resources. Investors, take note.

In June, Australia’s BHP Billiton (BHP) bought US tight shale oil and gas producer Petrohawk.

In July, China National Offshore Oil Corp. (CEO, or 883.HK in Hong Kong) bought Canadian oil-sands producer Opti Canada.

This week, Norway’s Statoil (STO, STL.NO in Oslo) bid to acquire US oil-shale producer Brigham Exploration (BEXP).

See a pattern here?

Global oil companies and oil-consuming countries are looking past the current soft demand for oil created by today’s global economic slowdown and lower oil prices. They see a future of rising demand and higher energy prices—and of limited opportunities for adding to reserves and production.

They also see an opportunity created by today’s lower oil prices and oil-producer share prices to buy reserves and exploration opportunities. And these global oil producers and oil-consuming countries are moving aggressively to seize that opportunity.

Oh, and let’s not forget that money is cheap right now (if you’re a global oil producer, that is). Many of these offers are all-cash deals to buy shares of the acquired companies at depressed prices.

What are you doing about seizing this opportunity for your portfolio? Let me give you a few suggestions.

First, a Look at Statoil
Statoil, Norway’s state-controlled oil company, is an example of the larger story in microcosm.

For decades, Statoil has been a leading producer of oil and natural gas from the waters of the Norwegian Continental Shelf. But, like the neighboring North Sea fields, these Norwegian fields have shown declining production as they’ve aged.

In its most recent capital plan, Statoil announced a combination of spending on enhanced oil recovery in older fields and new exploration and production. These efforts are projected to stabilize the decline in production from the Norwegian Continental Shelf, and actually lead to a slight uptick in production to 1.40 million barrels of oil equivalent in 2020 (from 1.38 million barrels in 2010).

Stabilizing production in older fields is just part of Statoil’s plan. It has also been spending big time to buy into areas that promise rising future production. That has included buying into joint ventures in unconventional resources in the US Marcellus natural gas shale and Eagle Ford gas and liquids plays.

And most recently, it includes the purchase of Brigham Exploration, a leaseholder on 375,000 acres of the Bakken and Three Fords tight oil formations in North Dakota and Montana.

Current production from that area for Brigham amounts to 21,000 barrels of oil equivalent a day. But oil industry analysts say Statoil will easily be able to increase production to 60,000 barrels a day over the next five years.

Statoil has offered to buy Brigham Exploration in an all-cash offer for $36.50 a share. That’s less than the stock’s close on Thursday, but then Brigham is trading near its 52-week high of $37.87.

But what’s of most interest to investors—unless you happen to already own Brigham—is the big jump in the price per acre that Statoil is paying for Brigham Exploration’s Bakken acreage.

The deal price works out to about $12,000 for each Bakken acre that Brigham has under lease. That’s the most ever paid in a major Bakken deal, according to Bloomberg, and at least 50% more than Occidental Petroleum (OXY) and Hess (HES) paid for their Bakken acreage in the last year.

NEXT: Record Prices for Oil Reserves

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Record Prices for Oil Reserves
I’m sure that seems odd to investors who have a short-term view of the financial markets and the economy. Why pay a record price for reserves and potential reserves when oil is selling for just $86 a barrel for West Texas Intermediate (the US benchmark) and just $109 a barrel for Brent (the European benchmark)?

We’re a long way away from the heady days when oil sold for $140 a barrel. And this is before Libya gets back into production, adding more oil to global supply at a time when global demand is soft.

But oil companies aren’t short-term investors, and the long-term picture looks very different. The costs of producing oil are rising—whether you’re a Statoil planning to spend more on enhanced recovery techniques or a Petrobras (PBR) trying to figure out how to get oil from salt formations deep under the South Atlantic.

According to Bloomberg, ExxonMobil’s (XOM) costs of finding and developing oil have climbed to $14.21 a barrel—a tenfold increase in ten years.

Those rising costs justify spending more to secure access to future reserves, especially if those reserves are in politically low-risk countries and come with relatively predictable production costs.

Oil companies know what it costs to produce oil from the Bakken shale and to get it to market. Petrobras has only a guess on production costs and infrastructure needs in the South Atlantic. ExxonMobil has only a guess on costs to produce oil and gas from the frozen Russian Arctic.

Fewer Places to Explore
But there’s something else driving the price of Bakken and other potential production plays. Looking at the world, oil companies see a scarcity of promising areas for exploration and production.

In their estimation—especially when you factor in potential reserves that are off-limits because they’re controlled by a national oil company in Saudi Arabia or Mexico or Venezuela—there just aren’t a lot of places to look for oil if you need to replace, let alone expand, reserves.

And that has produced a kind of global bidding war among oil companies eager to secure potential resources.

As an investor, I think the strategy with the most potential profit is to think long term—like a global oil company—and buy what you think might be on their list of targets.

Invest in Big Oil’s Targets
In the United States, I think that strategy means considering unconventional producers such as Pioneer Natural Resources (PXD) in the liquids-rich Eagle Ford shale formation. (That’s the same formation where Petrohawk did business.) And other plays in the Bakken shale that operate next to Brigham Exploration.

Two stocks that I’d bring to your attention are Oasis Petroleum (OAS) and Whiting Petroleum (WLL). Oasis holds leases on about 303,000 acres in the 200,000 square-mile formation. Whiting has leases on 579,000 acres, mostly in the southern part of the basin.

To date, most production has come from western North Dakota. The US Geological Survey estimated in 2008 that the Bakken formation, the largest contiguous oil deposit in the United States, could contain 4.3 billion barrels of recoverable oil.

Outside the United States, I’d be looking at Talisman Energy (TLM) and Tullow Oil (TUWOY, TLW in London).

Here, the game is big, new offshore discoveries that might be tempting to the international majors or to national oil companies looking to lock up future sources of supply.

Talisman holds unconventional natural gas and oil leases in the US Eagle Ford and Marcellus plays, but a bigger attraction is the company’s 14.6-million-undeveloped-acre position in Southeast Asia.

In 2011, Talisman has increased production in Indonesia and Vietnam, and started new development projects in those countries and in Papua New Guinea. Talisman projects that production in Southeast Asia will grow at an average annual rate of 8% to 10% through 2015.

Tullow’s Jubilee field in Ghana is a major extension of the exploration horizon in western Africa—it’s not just about Nigeria anymore.

As acquisitions, both Talisman and Tullow would be bigger mouthfuls than an Oasis or a Whiting. But with cash so cheap, oil prices down, and oil companies casting worried looks at the future, I don’t think they’re outside the current deal envelope.

And at the worst, you’d be buying stock in oil companies that are themselves expanding production, and that can expect the future price of oil to be higher than it is in today’s soft global economy.

Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. The mutual fund I manage, Jubak Global Equity Fund, may or may not now own positions in any stock mentioned in this post. The fund did own shares of Brigham Exploration and Oasis Petroleum as of the end of June. For a full list of the stocks in the fund as of the end of June, see the fund’s portfolio here.

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