A Needless Alarm Over Oil Reserves
Ever since the beginning of the current shale oil and gas boom, there have been doubters who have maintained that companies are exaggerating their reserves and borrowing heavily in order to develop what they do have. Some of these doubters characterize this boom as a bubble just waiting for a pinprick to burst.
A recent Bloomberg News article — We’re Sitting on 10 Billion Barrels of Oil! OK, Two — played into this story of exaggerated shale reserves. The gist was that the resource numbers that oil and gas companies present to investors are often many times higher than the reserves reported to the US Securities and Exchange Commission (SEC). For example:
Lee Tillman, CEO of Marathon Oil Corp., told investors last month that the company was potentially sitting on the equivalent of 4.3 billion barrels in its US shale acreage. That number was 5.5 times higher than the proved reserves Marathon reported to federal regulators.
Such discrepancies are rife in the US shale industry. Drillers use bigger forecasts to sell the hydraulic fracturing boom to investors and to persuade lawmakers to lift the 39-year-old ban on crude exports. Sixty-two of 73 US shale drillers reported one estimate in mandatory filings with the Securities and Exchange Commission while citing higher potential figures to the public, according to data compiled by Bloomberg.
But note that in the following Bloomberg graphic, both reserves and resources are presented.
Source: Bloomberg News
These “discrepancies” aren’t really so much discrepancies, but rather a function of SEC requirements for classification of proved reserves. Proved reserves, under the SEC’s definition, are those that can be “estimated with reasonable certainty, from the analysis of geologic and engineering data, to be recoverable from well established or known reservoirs with the existing equipment and under the existing operating conditions.”
Proved reserves can be further subdivided into proved developed (PD) and proved undeveloped (PUD). PD means the resource can be produced with existing or minimal investment, typically because the well above it has already been drilled. PUD reserves are typically not yet accessed by wells, but may be booked as “proved” if the development plan is for drilling within five years.
In contrast, companies are not required to focus solely on proved reserves when presenting to investors. These presentations are protected by the Private Securities Litigation Reform Act of 1995, which provides a “safe harbor” for some forward-looking statements. As a result, what is presented to investors is usually more speculative (e.g., “potential reserves”) than what is reported to the SEC in the annual report on Form 10-K.
Development of reserves is largely determined by oil and gas prices. Some reserves that can be profitable to develop when crude is at $100 per barrel may turn out to be uneconomic to tap should oil drop to $60/bbl. So you sometimes see reserves go on and back off the books as oil and gas prices rise and fall, even in cases where the company still owns the rights to the resources and may develop them should prices rise. Many investors assume that writing off reserves simply means a company didn’t find oil where it looked. That can be the case, but isn’t always so.
As for the Bloomberg article’s claim that companies are inflating the amounts of oil and gas they expect to develop, it’s true that some companies may be more speculative in what they expect to develop than others, but it doesn’t necessarily mean they are wrong.
Ultimately, the safest bet is to seek out companies that are good values based on proved reserves, and then look for sources of potential upside. I will do this for a number of oil and gas stocks in the next issue of The Energy Strategist.
(Follow Robert Rapier on Twitter, LinkedIn, or Facebook.)
Portfolio Update
Goodbye, Teekay
There are worse near-term risks in the energy sector than a 7%+ yielding MLP operating liquefied natural gas (LNG) carriers under long-term charters.
But there are also longer-term risks a yield can’t cover, as well as long-term rewards Teekay LNG Partners (NYSE: TGP) is not in a position to produce given the burden of its rising debt load.
That’s why we’re calling TGP a Sell after a more-than-respectable return of 115% since it joined the Conservative Portfolio in 2008. As always, holders of profitable long-time recommendations should consider personal tax consequences that cannot be a part of our analysis.
Given net debt at more than 7 times its recent annualized EBITDA, no cushion in the distribution coverage and the toll of incentive distribution rights owed to its parent, TGP’s yield is clearly the main attraction of this investment. Yet the same stretched leverage metrics could also endanger it down the road, should LNG trade volumes five or more years out fall short of the market’s aggressive current expectations.
We much prefer recent portfolio addition Delek Logistics (NYSE: DKL), whose lower yield is growing fast and with a much greater margin of safety. Within the LNG shipping space, alternatives include Aggressive Portfolio holding GasLog (NYSE: GLOG), now 20% cheaper than it was when we recommended selling half the stake in April, as well as TGP parent Teekay (NYSE: TK), the GasLog MLP affiliate GasLog Partners (NYSE: GLOP) and Dynagas LNG Partners (NASDAQ: DLNG).
— Igor Greenwald
Stock Talk
Peter
You recommend selling TGP because of associated risks and suggest TK as an alternative. However, Igor wrote on 12 Jun 2013 : “Investors with relatively high risk tolerance may do well by following the money into TK shares, which have more upside and more risk than TGP. “
Wouldn´t that imply accepting an even higher risk by switching from TGP into TK? Has Igor´s then assessment of TK´s risk changed or is it just not the same as yours? To what extent is TK hedged against potential declines in oil tanker rates which have proved very volatile and should be major determinant of TK´s earnings?
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