Putting a Price on Big Oil – How to Valuate Oil Inventories

Big Oil shares – BP, Chevron, ConocoPhillips, Eni, Exxon Mobil, Royal Dutch Shell and Total – collapsed at the start of the pandemic and have remained in disgrace even as the market rallies. BP and Shell (both down 35% since the start of 2020) are particularly weak, but Eni, Exxon, Chevron, Conoco and Total (down 15 to 25%) are also lagging behind, despite the rebound in the oil at the level of three years ago. .

The obvious fear among many investors is that these companies are operating in a dying industry. The world will move away from oil and they will be out of work. This is a very real uncertainty, but as earnings rebound it is worth remembering how much cash these companies can generate and what their options are.

Melt the reserves

The seven oil majors had reserve-to-production (R / P) ratios of between 8.3 years (Shell) and 15.5 (Exxon) at the end of fiscal 2019 (I’m using 2019 because the collapse of oil prices in 2020 meant some of them have depreciated reserves which should be viable with oil returning to higher levels). Free Cash Flow (FCF) also varies widely: Shell averaged nearly $ 25 billion a year in 2018 and 2019 (when oil was $ 65-75 a barrel), while Exxon was in average of nearly $ 11 billion. Just because Exxon has lower underlying cash flow doesn’t just mean Shell is reinvesting less money in finding new reserves instead.

We can do a crude calculation of how much cash each company could generate during those years set aside in reserves if oil stays around $ 70 (the average over 2018 and 2019). Assuming each company is repaying its net debt steadily over this period and using a 5% discount rate, I would estimate the present value of future free cash flow to be around 80% of market capitalization. of Shell and BP, or around two-thirds for Total and Eni, but rather 40% for Chevron and Conoco, and 30% for Exxon.

I emphasize that this is very rude. For example, Shell will not close its doors in seven years: the reserves will not be used uniformly and production will be long. All the majors, even those with low R / P ratios, continue to invest in the search for new resources. The breakdown between oil and gas varies from company to company, as does the cost and complexity of their projects. FCF in 2018 and 2019 may not be an ideal indicator of long-term cash flow. You could easily build a much better model.

Still, it’s hard to avoid the feeling that BP and Shell are almost priced as if they were in liquidation, with the market placing little value on their long-term prospects in oil and gas or renewables. Meanwhile, others – for example, Exxon – are being assessed to suggest that their new investments in oil and gas will have long-term value and not end up stranded. The difference at least partly reflects how much BP and Shell dividend cuts have alienated income investors. With payouts starting to rise (up 38% at Shell and up 4% at BP), as long as the world doesn’t give up oil faster than it seems likely, the two seem extremely cheap games in the industry. a cheap sector.

The seven oil majors
Market capitalization. Net debt R / P 2019 Avg Free Cash Flow 2018/19
PA $ 62 billion $ 33 billion 14 $ 8.3 billion
Chevron $ 199 billion $ 35 billion ten $ 15 billion
Conoco 76 billion dollars $ 11 billion 11 $ 5.3 billion
Eni $ 44 billion $ 12 billion 11 $ 4.5 billion
Exxon $ 244 billion $ 57 billion 16 $ 10.9 billion
Shell $ 115 billion $ 66 billion 8 $ 24.6 billion
Total $ 100 billion $ 25 billion 12 $ 10.3 billion
Sources: Bloomberg, Morningstar

About Myra R.

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