Late last week crude oil prices surged through a key technical resistance level at USD83 a barrel and trades at close to double the level of a year ago. Oil touched this level in October 2009, again in January 2010 and a third time in mid-March before finally breaking higher.

This is oil’s highest level since October 2008, when prices fell rapidly amid the financial crisis and recession.

I’ve long predicted that oil will touch USD100 a barrel this year and will reach record highs in 2011. I stand by that view and would add that I expect crude prices to reach USD90 before the end of this month; demand in emerging markets–and, to a lesser extent, the developed world–continues to show signs of recovery. I expect the oil market’s balance between supply and demand to tighten gradually over the next year, pushing prices steadily higher.

Against that backdrop, I’ve already recommended stocks issued by producers, oil-services companies and equipment firms that should benefit from higher oil prices. In this issue, I’ve gone a step further and sought out small and midsize independent producers with the potential to substantially increase their oil production in coming years.

I looked for one major attribute in all of these plays: a near-term catalyst. Broadly speaking, a catalyst is any event that’s likely to generate interest in a stock and push it higher. In the case of these oil-focused producers, catalysts primarily involve major exploration programs scheduled for 2010 that have a good chance of success. Alternatively, key development programs are another catalyst as producers bring new fields on-stream and generate impressive production growth.

Many of the stocks I’m covering trade in London because the UK exchange is home to a sizeable list of small and medium-sized producers with exposure to some of the hottest oil plays in deepwater, the Arctic, Africa and the South China Sea.

Although many of these foreign stocks also trade in the US over-the-counter market, I recommend buying the London-traded shares. Please be advised that stocks trading in London are quoted in pence (1/100 of a pound) per share, not pounds per share; a stock quoted as trading at 100 doesn’t trading for GBP100 ($150) per share but for GBP1 ($1.50) per share.

This issue won’t include as much theory and background analysis as usual but will focus on detailed discussions of a relatively long list of stocks.

In This Issue

The Stories

I examine several small and midsize exploration and production firms that stand to benefit from higher oil prices and increased output in the near term. The best of these names make it into the model Portfolios as new additions. See The Hot List.

My investment thesis for a short-term trade in refiner Valero Energy (NYSE: VLO) has paid off. Here’s my latest advice. See Refined Advice.

Here’s the skinny on why revisions to a key report from the Energy Information Administration could be an upside catalyst for natural gas stocks. See Natural Gas.

Want to know how the model Portfolios or a particular holding fared in the first quarter? Here’s a synopsis of the quarter that was. See First-Quarter Results.

Subscribers have asked for a listing of my upcoming speaking events–here it is. See Join Me.

The Stocks

Cairn Energy (London: CNE; OTC: CRNCY)–Buy in How They Rate
SOCO International (London: SIA, OTC: SOCLF)–Hold in How They Rate
Afren (London: AFR; OTC: AFRNF)–Buy @ GBP1.15
Tullow Oil (London: TLW)–Buy in How They Rate
Anadarko Petroleum Corp (NYSE: APC)–Buy @ 80, Stop @ 63
Occidental Petroleum (NYSE: OXY)–Buy @ 95, Stop @ 75
EOG Resources (NYSE: EOG)–Buy @ 110, Stop @ 75
Petrobras A (NYSE: PBR A)–Buy @ 50, Stop @ 28.50
Petrobras (NYSE: PBR)–Buy @ 56, Stop @ 32.50
Suncor Energy (Toronto: SU, NYSE: SU)–Buy @ USD43, Stop @ USD25.25
Valero Energy (NYSE: VLO)–Hold, Stop @ 16.95

The Hot List

Based in Scotland, Cairn Energy (London: CNE; OTC: CRNCY) is an oil-focused exploration and production company with two main upside catalysts: growing production from its projects in India and exploratory activities in Greenland.

Cairn Energy’s Indian plays are in an advanced stage of development, and the company expects strong cash flows from its Indian projects to support exploration underway in Greenland. The firm’s Indian fields are located in Rajasthan, depicted in the map below.


Source: Indian Embassy

Cairn Energy’s main fields in Rajasthan are Mangala, Bhagyam and Aishwariya (MBA). Management estimates the MBA fields hold 1.3 billion, 468 million and 293 million barrels, respectively.

Of the three, Mangala is far and away the largest and most developed; as of mid-March, the company had drilled about 50 wells, 38 of which are prepared for production. The current production rate runs around 20,000 barrels per day (bbl/day) and should expand to 30,000 bbl/day as the remaining wells are completed.

The second two phases of MBA’s expansion should be completed by the end of the second quarter and will add a total of another 100,000 bbl/day of production. Finally, the fourth phase of expansion is slated for next year and is expected to add 75,000 bbl/day of oil production. This MBA’s output to about 205,000 bbl/day of oil.

Cairn Energy has negotiated long-term sales arrangements with a number of major refiners, including India’s Reliance Industries (India: 500325). Crude from MBA is low in sulfur, and under the terms of the company’s sales contracts, management expects the output to fetch an average price of 10 to 15 percent less than light, sweet benchmark crude grades.

And Cairn Energy has finished a considerable build out of infrastructure related to the MBA project. Specifically, the company has completed a 600 kilometer (375 mile) pipe from the Mangala area of Rajasthan to the coast near Jamnagar and Salaya (the general area is labeled in the map). From there, tanker ships can transport the crude oil to India’s many coastal refineries.

During the firm’s mid-March conference call, management provided some upside revisions to the potential size of the MBA project. The company also raised its estimates for the size of Barmer Hill, a low permeability field that likely will require horizontal drilling and fracturing to produce the field economically.

An upward revision to Barmer Hill’s reserves and increased confidence in further output from MBA leads management to believe that peak production from its Rajasthan projects could reach 240,000 bbl/day. The Indian government would need to sign off on the expansion, but this approval shouldn’t face many obstacles; the country needs to maximize domestic production to meet the needs of its fast-growing local economy.

Whereas Cairn Energy’s Indian operations offer fairly reliable upside, its endeavors in Greenland represent more of a speculative growth story. Management readily acknowledges that the firm’s significant Greenland plays involve higher risks–exploration success in any particular well is around 1-in-10.

However, Cairn Energy owns significant acreage, and these holdings include some exciting prospects for a major discovery. Here’s a map of Greenland to give you a better idea where these fields are located


Source: Microsoft Map Point

Cairn Energy has won several offshore blocks located primarily along Greenland’s southwest and west coasts. And the company is bidding for additional blocks in the Baffin Bay area off Greenland’s northwest coast; bids are due May 1, and the company expects the licensing results in August. Cairn Energy operates in all of the blocks and has partnered with Malaysia’s Petronas on its planned drilling projects in these regions.

Another licensing round is scheduled for 2012 tat will cover blocks off Greenland’s northeastern coast. Cairn Energy has a license to do some basic prospecting and seismic work along the country’s east coast.

Greenland isn’t a well-explored region. According to Cairn Energy, five wells were drilled off Greenland’s west coast in the 1970s and one well was sunk in 2000. But don’t discount the subsequent technological advances in exploration and production.

Remember, for example, that from the 1950s through the 1980s producers regarded the gas in the Barnett Shale of Texas as inaccessible; later the geological formation became the largest producible gas field in the US. And the region where these six previous wells were drilled is geologically separate to the northern areas in which Cairn Energy plans to drill this year.

Cairn’s Greenland program will begin this year with four exploration wells in the Disko area off the west coast of Greenland, just north of the Arctic Circle (see the map).

Evidence suggests the region could contain oil. In this part of Greenland there are oil seeps, where crude flows naturally out of the earth. And Cairn Energy performed a three-dimensional seismic survey of the area, using sound and pressure waves to map underground rock formations. This process has identified a number of rock structures that could harbor hydrocarbons; thus far seismic data has enabled the company to identify roughly 30 drilling targets. Shallow-core analysis–taking a sample of the seafloor geology above the intended drilling targets–confirmed the presence of hydrocarbons, a common indication that oil persists in deeper formations.

It’s also worth noting that Cairn Energy isn’t alone in these endeavors; ExxonMobil (NYSE: XOM), Proven Reserves recommendation Chevron (NYSE: CVX) and Canada’s Husky Energy (Toronto: HSE, OTC: HUSKF) are also in on the hunt.

Exploring for oil and gas in areas that are largely unexplored is a decidedly risky business; Cairn Energy estimates the probability of sinking a successful well in this area is just 9 to 14 percent. These odds are actually better than average for a reservoir this unexplored and remote. And the upside is enormous: Cairn Energy has estimated that the area might contain over 4 billion barrels of recoverable oil if it proves out. 

The firm plans to drill three or four wells 1,000 miles to the south in 2011. Management indicated that its understanding of the geology of these blocks is roughly 18 months behind that of the Disko area.

All told, Cairn Energy has a three-year horizon for its exploration activities in Greenland. I expect the company to produce a steady stream of well results over the next year and a half. Don’t expect the stock to get crushed if the wells come up dry; most investors have already factored in the play’s high risk. But any exploration success could have huge upside implications because it would raise the value and odds of Cairn Energy’s success across all of Greenland’s acreage.

Share prices would also get a boost if the company wins significant acreage at the upcoming Baffin Bay licensing round. Although reports indicate that the bidding is highly competitive, Cairn Energy’s existing knowledge of the area in question and position in the Disko region to the South may give the firm an edge.

The stock’s valuation is a bit rich at current levels, but leverage to higher crude oil prices and the aforementioned upside catalysts in 2010 justify its higher-than-average valuation. I am adding Cairn Energy to my How They Rate coverage universe as a Buy and will consider graduating this stock to the Gushers Portfolio if share prices dip.

London-based SOCO International (London: SIA, OTC: SOCLF) is an oil-focused exploration and production (E&P) company with two areas of operation worth watching: Southeast Asia and Africa.

In Asia, the firm’s most interesting prospects are found in Vietnam, a country that’s opened up significantly to foreign investors in recent years and has enjoyed rapid economic expansion. Prior to the financial crisis, Vietnam’s gross domestic product (GDP) was expanding 8 to 10 percent per year; now the country’s real GDP growth clocks in at slightly less than 6 percent annualized–an impressive rate, given the circumstances.

Vietnam is also rich in natural resources and is a significant regional producer of coal, oil and natural gas.

SOCO International’s Vietnamese operations are all in an area known as the Cuu Long Basin (CLB), roughly located offshore and to the south of Ho Chi Minh City in the South China Sea.

Source: Google Images

SOCO International has three main fields in the CLB: Te Giac Trang (TGT), Te Giac Den (TGD) and Ca Ngu Vang (CNV) development areas. In 2009, the company did some seismic work in both TGT and TGD, and the Vietnamese government gave the go-ahead to begin production in TGT, a field that primarily contains oil. The TGT project is slated to commence in mid-2011 and produce about 50,000 barrels of oil equivalent per day.

The firm announced a discovery in TGD in 2008 and plans to sink an appraisal well in the latter half of 2010. The field appears to contain a mixture of oil, natural gas and natural gas liquids (NGL).

CNV is one of SOCO International’s two producing fields. The company has drilled a total of six wells in the field, and its share of production amounted to about 2,900 bbl/day. But that figure is misleading because the firm scaled back output while drilling a series of water-injection wells designed to maintain underground pressures in the field. Management feared that, in the absence of these precautionary measures, the full-scale production would sap the formation’s naturally occurring pressures, damaging its longevity and total output. Expect production to ramp up once the project is complete.

The Bualuang Field off the east cost of Thailand is SOCO International’s second producing property; the company doesn’t operate this field but does hold a working interest of 40 percent. The company’s share of production was 3,567 bbl/day in 2009, and the addition of horizontal wells–plus potentially producible areas identified on seismic surveys–could boost output from the play.

When you consider that SOCO International’s total production from Vietnam and Thailand amounted to less than 6,500 bbl/day, an increase to 50,000 bbl/day from TGT and TGD alone would represent an enormous jump in output. Successful execution of this project–the largest in firm’s history–would likely prove a major upside catalyst for the stock.

SOCO International’s Vietnamese fields are an appraisal and development program; having discovered oil, the company is working just to delineate the size of the play and ramp up production. The real exploration upside will come from its plays in the Democratic Republic of Congo (DRC) and the Republic of Congo. 

Source: World Sites Atlas

As you can see, there are two “Congos,” both located on the west coast of Africa, north of Angola and south of Gabon and Cameroon. In acknowledgment of their respective capitals, the northern Congo is sometimes known as the Congo Brazzaville, while the southern Congo is sometimes called the Congo Kinshasa.

Both countries occupy a relatively small amount of coastline that’s interrupted by Cabinda, a tiny province which is technically part of Angola despite its physical separation. The area is the scene of nasty territorial disputes.

SOCO International has two major blocks in the Republic of the Congo: the Marine XI and the Marine XIV. In the second half of 2009, the E&P firm drilled two wells in the Marine XI license. The first well targeted a formation that turned out to hold primarily water and was subsequently abandoned and plugged. The second was a vertical well containing hydrocarbons; the well flowed a maximum of 2,600 bbl/day of oil and about 7 million cubic feet of gas. SOCO International is examining additional seismic data to determine whether the structure warrants additional exploration and development.

The company also acquired a 29.4 percent interest in the adjacent Marine XIV Block in 2009 and took over operations. The firm is performing a three-dimensional seismic survey before proceeding with its first well. This block has yielded previous oil discoveries, and in some parts, the geological formations complement those in SOCO International’s Marine XI license.

In the DRC, the company has an 85 percent share of the Nganzi block, an 800 square-kilometer section onshore. SOCO International has identified several potential targets and plans to drill exploratory wells in the back half of this year. The firm may also choose to partner with another outfit to defray the development costs. In total, the company estimates that the targets it plans to drill in Nganzi could hold as much as 665 million barrels of recoverable oil.

In addition, SOCO Internationals owns a 38.25 percent interest on Block 5 in the eastern part of the DRC, which borders an area of Uganda that has yielded some noteworthy discoveries.

Finally, Cabinda also contains some regions prospective for oil. Soco holds a 17 percent interest in Cabinda North, an onshore block operated by Sonangol, Angola’s national oil company (NOC). Although this Angolan province contains significant resource wealth, it’s a security nightmare. The Portuguese established the province during the colonial era because the local inhabitants sought protection from the Belgians in the Congo. Now, local residents are unhappy because most of the oil wealth in Cabinda flows back to Angola. To make a long and complex story short, security issues have halted work on SOCO Internationals blocks in Cabinda.

For investors seeking upside catalysts, the Nganzi property in the DRC is the best bet; SOCO International has identified several promising targets in this area that could prove to contain substantial reserves.

That being said, this catalyst wouldn’t come into play until the back half of 2010, as that’s when the firm plans to drill exploratory wells in the block.

Investors should regard SOCO International as a more speculative play than Cairn Energy because it’s a smaller company both in terms of its market capitalization and production base.

I’m adding SOCO International to How They Rate as a Hold, but it could make a profitable trade in the second half of the year as well results from Nganzi come in.

Afren (London: AFR; OTC: AFRNF) is primarily an oil-focused independent producer and represents a pure play on Africa. To date, the company’s strategy has focused on acquiring proven fields in West Africa that remain largely undeveloped. These overlooked gems may not be able to move the proverbial needle for a major integrated oil company like ExxonMobil but can be huge successes for a relatively small firm like Afren whose market capitalization is $1.5 billion.

Afren already produces oil, and the company’s output should grow tremendously in coming quarters. In fact, its production is already expanding at an impressive clip: In 2009 Afren averaged 22,100 bbl/day of oil, up from 3,800 bbl/day in 2008. Management estimates that the company will produce over 60,000 bbl/day of oil by the first half of 2011–roughly triple the rate of production in 2009.

Fields off the coast of Nigeria form the center of Afren’s operations. The map below should help you visualize where the firm’s fields are located.

Source: mapsoftheworld.com

Much of Afren’s current production comes from Okoro, an offshore field located near the Ebok Field labeled on the map. It’s an offshore field in the southeastern part of Nigeria, not far from the border with Cameroon. 

This field was discovered in the early 1970s but remained undeveloped. The company now generates 18,000 to 19,000 bbl/day of oil from the play but has identified several infill drilling targets–wells drilled between known producing wells. Afren plans to undertake these low-risk infill drilling projects in May and June of this year and expects production to reach roughly 21,000 bbl/day of oil.

But the company’s most important development and upside catalysts are the Ebok, Okwok and OML 115 developments labeled on the map.

Of the USD430 million the company has slated for capital spending in 2010 (up from less than USD200 million in 2009), USD310 million will go to the Ebok development; the firm has allocated USD30 million to activities in the Okwok and OML 115 plays.

Afren scored a major success in March when Netherland, Sewell & Associates (NSAI), an independent oil and gas consulting firm, largely corroborated management’s reserve estimates for Ebok and the potential of some of the company’s planned exploration and appraisal projects. NSAI revised its estimates of Ebok’s proven and probable (2P) reserves from around 20 million barrels to 107.5 million barrels–just shy of management’s own estimates.

The company plans to develop Ebok in two stages. The first stage, which targets 15,000 bbl/day of oil by October 2010, is already underway; the second stage is slated for completion by year-end and will add another 20,000 bbl/day. In other words, management expects the output from the Ebok field to go from zero to roughly 35,000 bbl/day of oil in 2010–a huge surge in production for a firm that generated a little more than 21,000 bbl/day in 2009.

On top of these development projects, Afren has identified additional areas of interest in the Ebok Field that are deeper than the reservoir it plans to produce this year. Appraisal drilling on what management imaginatively has dubbed “Ebok Deep” will get underway this year.

The company estimates that Ebok Deep could contain roughly 30 million barrels, while NSAI pegged the upside at 43 million barrels. This relatively low-risk project could act as a meaningful catalyst for the stock.

Located adjacent to Ebok, the geologies of the Okwok and OML 115 plays resemble that of their neighbor, and exploration and appraisal projects slated for this year should involve relatively little risk. In the third quarter, Afren will do appraisal work in Okwok to formulate how it will develop the field; the announcement of a development plan would provide a clear path to further production upside and would be a catalyst for the stock.

Still in the exploration stage, OML 115 is the least developed of the three fields. But OML 115 features the same basic reservoir its brethren, reducing the likelihood of complications. And management has noted that the company’s engineers have identified deep targets beneath that reservoir. The company will initiate a single-well exploration program for OML 115 in the third quarter.

Outside of this core, Afren has several exploration prospects that could offer significant upside in coming years. The most advanced is the OPL 310 play off the coast of western Nigeria, adjacent to the Aje Field–a proven, oil-producing field with similar geology.

Based on three-dimensional seismic data covering a significant portion of the play, NSAI estimates that the area could contain as much as 329 to 521 million barrels of oil equivalent. Note that these figures indicate the play’s potential and should not be misconstrued as reserves.

Afren plans to “farm out” this play, or offer an interest in the field for help funding the drilling. That being said, the company has also indicated it would consider undertaking the project on its own if need be–a highly unlikely scenario given the overtures from third parties. One way or another, exploration on OPL 310 is likely to start in late 2010 or early 2011–yet another potential catalyst for the stock.

The stock also offers exposure to catalysts further down the line. Afren also has interests in blocks off the coasts of Ghana and the Cote d’Ivoire, some of which are located along the same trend as the Jubilee, Twenboa and Venus finds that have attracted so much attention from producers in recent months. I wrote extensively about these plays in the Oct. 7, 2009, issue The Golden Triangle and will discuss them in the next section as well.

Afren has exactly what I look for in an exploration-focused firm: multiple near-term catalysts, strong production growth, and a book of planned prospects with different risk levels.

I’m adding Afren to the Gushers Portfolio as a buy under 115 pence (USD1.75). I recommend that all investors buy this stock on the London exchange rather than purchasing the US over-the-counter stock–the latter lacks sufficient liquidity.

I’m grouping Tullow Oil (London: TLW) and Anadarko Petroleum Corp (NYSE: APC) together because both stocks stand to benefit from further success in emerging deepwater plays off the coast of West Africa. I’ve written about both names extensively in previous issues of The Energy Strategist, and Anadarko already appears in the Wildcatters Portfolio.

With gross domestic product (GDP) of just USD1,500 per capita, Ghana is among the poorest countries in the world. For most of its history, the West African nation’s most important industries and sources of foreign reserves have been cocoa production and gold mining.

Although Nigeria, Angola and Libya have garnered significant attention and economic growth as a result of their oil wealth, Ghana’s proved oil reserves stood at just 15 million barrels at the end of 2008–less oil than the US consumes in a single day, and a far cry from Nigeria’s 36 billion barrels in reserves and Libya’s 44 billion barrels.

But that’s changing. Ghana has become the unlikely setting for a high-stakes oil bidding war that’s pitted global energy giant ExxonMobil against the Chinese giant CNOOC Limited (NYSE: CEO) and a group of powerful private equity firms, including Blackstone Group (NYSE: BX). The object of all this attention: a massive offshore deepwater oil discovery known as Jubilee.

The Jubilee field is located in waters roughly 4,000 feet (1,220 meters) deep, spanning two offshore blocks, the West Cape Three Points and Tano. Each block is owned by a consortium of foreign companies and the state-owned Ghana National Petroleum Corporation (GNPC). The table below shows the ownership structure of both deepwater blocks.

Source: Company Reports, Oil & Gas Journal

The Jubilee field is still being appraised, but early indications suggest the field could contain as much as 1.8 billion barrels of recoverable oil, along with another 800 billion cubic feet of associated natural gas; there is considerable upside to these estimates, as companies continue to drill appraisal wells to delineate the field’s exact size and shape. In addition, producers have announced the discovery of smaller fields in these two offshore blocks, including the Mahogany Deep and Odum finds in the West Cape Three Points Block and the Twenboa find in the Tano Block. Twenboa, in particular, looks promising, and Tullow Oil estimates that the field could be as large as 200 square kilometers and contain total reserve upside of as much as 1.4 billion barrels.

The Ghanian government gave the go-ahead for first phase of producing Jubilee last summer. Tullow Oil will conduct these operations, which call for output to begin in the fourth quarter of this year. Oil will flow onto a floating production platform capable of handling 120,000 barrels per day of oil and 160 million cubic feet per day of natural gas. The importance of the Jubilee discovery becomes apparent when you consider that the nation’s current oil output stands at just 7,400 barrels per day.

The massive oil find has become the subject of considerable international controversy and instigated backroom maneuvering reminiscent of the early days of the Texas oil boom. For more than a year, rumors have swirled that Kosmos Energy was keen to sell its stake in Jubilee. The rationale for such a move has nothing to do with the quality of the reserves; Kosmos Energy will be required to put up significant sums of cash as part of Jubilee’s development plan, and in early 2009 there were real concerns that an entity backed by private-equity firms wouldn’t be able to raise the necessary capital.

As it turns out, Kosmos Energy obtained a USD750 million loan via the International Finance Corporation, part of the World Bank. Nonetheless, it’s been an open secret that Kosmos Energy is willing to sell its significant stakes in both offshore oil blocks for a reasonable price. Several buyers were rumored to be interested, including India’s Oil and Natural Gas Corporation (ONGC), ExxonMobil and, of course, CNOOC Limited.

ExxonMobil offered to buy Kosmos Energy’s stake for USD4 billion last October. Let’s put that amount into perspective for Ghana: The country’s total GDP in 2009 was about USD14.8 billion; the offer equals nearly one-third of the country’s total economy.

Given the strategic importance of Jubilee to Ghana, it’s no surprise that GNPC blocked the sale and indicated that it might pursue the acquisition of Kosmos Energy’s stake on its own. It’s clear that the Ghanaian government never expected West Cape and Tano to bear such fruit and is now dissatisfied with just a 10 percent stake in each field, plus any royalties and taxes earned. It appears that if Kosmos Energy sells, GNPC will buy the stake and look to partner with another firm–possibly ExxonMobil or another integrated oil company such as ONGC or CNOOC–to develop the field.

The level of interest from so many top integrated oil companies and national oil companies, coupled with the sheer size of ExxonMobil’s bid, offers a good indication of the play’s potential long-term. And whatever the outcome of the Jubilee sale, two companies stand out as winners: US-based Anadarko Petroleum Corp and Britain’s Tullow Oil. Even if another publicly traded company such as ExxonMobil or CNOOC Limited were to secure a stake in the field, neither stock represents much of a pure play on West Africa’s oil boom or the African oil sector as a whole given–both firms boast diversified and far-flung operations.

As the operator of the Jubilee field, Tullow Oil offers the best direct exposure to growth in Ghana’s oil production. With a market capitalization of around GBP10 billion (USD15 billion), Tullow Oil is less than half the size of Anadarko, and its future growth potential is more closely tied to success with the Jubilee and Twenboa finds.

But the bullish case for Tullow Oil isn’t confined to its offshore finds in Ghana. Tullow Oil is an aggressive exploration-oriented firm that’s had considerable success drilling in other parts of Africa. Topping the list is the Lake Albert Rift Basin, an area where the company has already drilled 27 wells, 26 of which were prospective for oil or gas. The firm has announced 700 million barrels worth of discoveries across several plays and estimates the area could contain over 2 billion barrels in potential recoverable reserves. The Ugandan plays in this field are slated for development in three phases, the first of which will supply 20,000 to 30,000 barrels per day, primarily to the domestic market. The program will culminate in production of 100,000 barrels or more per day, much of which will be exported via pipeline.

We sold Tullow Oil from the Gushers Portfolio last year, booking a profit in excess of 100 percent. The stock corrected earlier this year and has traded sideways for about six months. Given how hot West Africa is becoming, I am raising Tullow Oil to a buy in How They Rate.

At this point, the sole reason I’m not adding it to the model Portfolio is that Anadarko Petroleum Corp offers similar exposure. For those of you who prefer a bit more upside leverage, however, Tullow Oil would be a solid choice.

The market has traditionally regarded Anadarko Petroleum Corp as a US-focused gas producer with heavy exposure to fields in the Rocky Mountains. Although the firm has considerable US natural gas assets, the stock’s valuation is increasingly driven by announcements concerning its deepwater finds in West Africa and the US Gulf of Mexico.

Anadarko Petroleum owns significant stakes in the major Ghana offshore blocks. In addition, Anadarko continues to pursue the theory that Ghana’s Jubilee find is just one bookend of a much larger deepwater oil and gas producing region that extends west into neighboring countries.

Source: Anadarko Petroleum Corporation

In September 2009, Anadarko announced the discovery of Venus off the coast of Sierra Leone, about 700 miles (1,100 kilometers) to the west of the major Ghana discoveries. Exploratory wells in Venus encountered about a 45-foot thick layer of oil and natural gas. Further appraisal will be necessary to estimate the size of the find.

The discovery of Venus lends credence to the idea that there’s more oil and gas to be found between the Ghana and Sierra Leone discoveries; the deepwater region off the coast of Liberia and the Ivory Coast shares similar geological characteristics with the Ghana and Venus finds.  

Although Tullow Oil also owns interests in some of these blocks, Anadarko has the largest position in this potentially massive offshore oil region. The company has already identified 30 drilling targets that have characteristics similar to Jubilee. If even a few of these prove to be major finds, it spells huge potential upside for Anadarko Petroleum.

Anadarko was one of the best-performing E&Ps in my coverage universe in the first quarter, and I see enough additional upside to warrant raising my buy target price to 80. I am also raising my recommended stop to 63, locking in a small gain on this position.

Occidental Petroleum Corp (NYSE: OXY) is a California-based company with a portfolio of oil- and gas-producing properties in the US, Latin America and the Middle East.

The company will host an analyst day to discuss production growth on May 19. Such events are rarely scheduled to relay bad news; the company appears poised to make positive comments about growth from some of its main plays.

As with all of the picks in this issue, Occidental Petroleum offers favorable exposure to higher oil prices. According to the firm’s most recent presentation, a USD1 increase in crude oil prices–a move of about 1.2 percent at today’s levels–adds about USD34 million to its net income. Meanwhile, if natural gas prices rise USD0.50 per million British thermal units–a move of 12 percent at current prices–the company’s net income increases USD24 million.

Fourth-quarter production growth was up 4.8 percent from a year ago and full-year production was up more than 7 percent in 2009. Occidental Petroleum is expected to report production growth of 1.1 to 2.5 percent when it releases its first-quarter results later this month. Over the long term, management is targeting production growth of 5 to 8 percent. Production growth for the full-year should come from planned projects in California, Oman, Bahrain and the United Arab Emirates (UAE).

With around 64 percent of Occidental Petroleum’s total reserves and 58 percent of total production coming from the US, the firm’s domestic operations are a good place to start. The company has about 2.2 million acres in the Permian Basin of West Texas and New Mexico, and these holdings produced roughly 185,000 bbl/day last year. These wells boast low decline rates and maintenance costs, generating lot of free cash. 

Occidental Petroleum also has the potential to boost production from the Permian Basin through bolt-on acquisitions and enhanced oil recovery (EOR). A mature region for oil production, the area contains a large number of relatively small producers. Over time, Occidental Petroleum can purchase additional land from these operators and leverage its existing infrastructure to earn a higher return.

The company is also building out its carbon dioxide production facilities. The gas is injected into ageing play to increase field pressures and aid production.

Occidental’s discovery in Kern County, CA is an even more exciting prospect. The company had four producing wells in the first quarter of 2009, 10 by mid-year and 15 by year-end. Over this same one-year period, total oil equivalent production soared from 7,700 bbl/day to about 31,700 bbl/day.

Management estimates the play’s reserves at 150 to 250 million barrels of oil equivalent. It appears that the play comprises roughly two-thirds natural gas and one-thirds liquids. The field likely contains plenty of oil and gas; Occidental noted that it had discovered a 1,000-foot thick segment of productive rock with 600-feet of wet gas and 400-feet of oil in a deeper section. A thousand feet is considered to be a very large productive area for a field.

Management also noted that the field is permeable and resembles an offshore field, though it’s located onshore. This suggests that the field is under high pressure and produces at a fast rate. Occidental has also indicated that for now it will focus on producing oil from the field–partly because of pricing and partly because the region lacks the gas-processing infrastructure to handle the output.

During its fourth-quarter conference call, management offered few additional details about the discovery in Kern County; however, this comment from Occidental’s President and CFO Stephen Chazen leads one to believe that the analyst meeting on May 19 won’t disappoint:  

Analyst: …you’ve given an indicator of 5 to 8 percent for this year for production,  but I have to confess, Steve, I’m kind of struggling here because Bahrain is a big slug, California is a big slug and then you’ve got the ramp up in Oman and various other things, obviously the Century gas plant. Just help us now–why is 5 to 8 percent the right number? It just looks like you might be sandbagging a little bit here.

Stephen Chazen: We would never sandbag. But, I would remind you that at your request, I think, we’ll have an update in May.

This exchange requires little explanation. Despite Chazen’s protestations, it appears as though the company is underpromising on growth and plans to over deliver on May 19. In my view, that’s a specific and short-term catalyst for the stock.

And the company began field operations on the Bahrain Oil and Gas Field on Dec. 1, 2009. It’s looking to triple the field’s production to around 100,000 bbl/day over the next seven years.

Occidental has partnered with a consortium led by Proven Reserves holding Eni (NYSE: E, Italy: ENI) to produce the Zubair oilfield in Iraq. As I’ve written before, most of the Iraqi government’s production growth estimates are pure fantasy. But Zubair produces just 200,000 bbl/day of oil these days; it’s not out of the question that production could increase significantly over the next three to six years.

Finally, Occidental is producing the giant Mukhaizna oilfield in Oman using a steam flood. This means that steam (heated) is injected into the reservoir to add pressure to the field and facilitate the flow of oil. As of the end of last year, Occidental had increased production from the field ten-fold compared to 2005 levels. And management expects to production to grow incrementally going forward.

With some impressive oil-levered assets and a definable catalyst in the analyst meeting on May 19, Occidental Petroleum rates a buy. I am adding the stock to the Wildcatters Portfolio as a buy under 95 and recommend instituting a stop at 75.

I am lumping Wildcatters Portfolio recommendations EOG Resources (NYSE: EOG), Petrobras (NYSE: PBR A, NYSE: PBR) and Suncor Energy (Toronto: SU, NYSE: SU) into a single section simply because I have written extensively about all three in recent issues of TES. All three stocks offer hefty exposure to oil.

As I explained in the March 3, 2010, issue The Explorers, EOG Resources was traditionally a gas-focused producer but in recent years has shifted its exploration and development program in favor of crude oil. The company is targeting two main areas for oil: the Bakken Shale of North Dakota, where it has one of the largest acreage positions of any producer; and the Barnett Combo play, the northern part of the Texas Barnett Shale, where wells tend to produce two-thirds oil and natural gas liquids (NGLs) and just one-third natural gas.

I would also remind readers that EOG Resources is hosting an analyst day today and should offer new data on some of its newer oil plays; I identified this meeting as a likely upside catalyst for the stock in the March 3 issue. I’ll issue a Flash Alert as needed later this week to cover anything of interest that transpires in the analyst meeting.

EOG Resources rates a buy under 110. Note that I’m raising the stop to 75 to lock in a break even on this position. 

I outlined the development plan for Brazilian National Oil Company Petrobras in the Oct. 7, 2009, issue The Golden Triangle. Brazil is home to some of the world’s most exciting deepwater discoveries in recent years, and Petrobras has its hands in all of those finds. Unlike many NOCs, Petrobras is a well-run outfit. Plus, the government has maintained a fairly stable regulatory structure for Brazil’s energy industry that encourages foreign investment.

One recent development of interest is that Petrobras has decided to accelerate the development of its massive Tupi oil find by a few months. Instead of starting up production from the next phase of the field’s development in December 2010 or January 2011, it’s now targeting October of this year. 

This shift might not sound like much of a change, but consider that big projects of this nature are notorious for delays. It’s encouraging to see Tupi proceeding ahead of schedule. Petrobras has two share classes that trade on the New York Stock Exchange: “PBR” and “PBR A.” Both are basically identical, save for the voting rights–not a major concern for investors because the Brazilian government has majority control of the NOC.

We hold PBR A in the Wildcatters Portfolio as a buy under 50 with a stop at 28.50. For those who prefer to buy PBR, it’s a buy under 56 with a stop at 32.50.

Suncor Energy’s lackluster performance from the beginning of the year through late February is a bit of a mystery given the stock’s strong leverage to oil prices. Some of this weakness undoubtedly stems from concerns about the company’s ability to sell non-core assets acquired in the purchase of Petro-Canada last year. But those divestments continue apace; Suncor recently announced the sale of its Rosevear and Pine Creek natural gas assets to Bonavista Energy Trust (Toronto: BNP).

Another factor was a fire at Suncor’s Fort McMurray facility disrupted production for two months–about 125,000 bbl/day. Suncor won’t get all of that lost business back in insurance. But one-off incidents like that really shouldn’t affect Suncor’s long-term growth plans or the valuation of the stock.

The stock has recently started to take off on heavy volume, a sign that investors are gaining confidence in the company’s fundamentals. Suncor rates a buy under USD43 with a stop at USD25.25. I assume readers will purchase the US-traded shares; however, the US dollar and Canadian dollar are basically at parity, so it doesn’t really matter.

Refined Advice

Finally, Gushers recommendation Valero Energy (NYSE: VLO) is not a producer but a refiner. I outlined the rationale for this trade in the Feb. 17, 2010, issue A New Dark Age for Refiners.

Refining margins have recovered off their lows, and refinery utilization remains weak–a sign that many facilities are either idled or not operating at full capacity. This should keep a floor under margins through spring. And there’s reason to believe the 2010 summer driving season could be strong given recent improvements in the economy and consumer spending.

Bottom line: I see Valero moving higher through this seasonally strong period and believe we have a few more points of upside left in the stock. I am cutting Valero Energy to a “Hold,” as it has been trading above my “Buy Under” price. I recommend maintaining your stop at 16.95 for now.

Natural Gas

Earlier this week, there was a major development for natural gas when the US Energy Information Administration (EIA) admitted that its widely watched EIA-914 survey is flawed.

As I’ve written before, EIA-914 is part of the EIA’s monthly natural gas report and is released near the end of each month. The report estimates US natural gas production with a two month lag; EIA based these figures on a survey of the largest US E&P companies and then estimates production from smaller firms based on the data it collects.

One of the major arguments made by the natural gas bears is that US gas production has actually risen even as the US active rig count–the number of rigs actively drilling for gas–has declined. The most common rationale is that although US conventional gas drilling activity is declining, firms are actively drilling in gas shale plays such as the Haynesville and Barnett. Strong production growth from these plays means that the US can produce more gas with far fewer rigs.

Long-time readers know that I am a believer in the importance and scale of the shale gas revolution. That’s why I think gas will become a more important fuel in coming years; it already appears to be gaining share as a fuel for power plants.

But the EIA has now indicated that EIA-914 is significantly overestimating production. The main problem is that the agency’s model was created before the shale gas revolution really took off; it’s just not particularly applicable in the current environment.  

One of the easiest ways to illustrate the growing inaccuracy of the EIA data is to look at the “balancing item”–a sort of error term the EIA uses to explain the difference between US production growth and the agency’s other surveys covering demand, gas imports and storage. Here’s a graph showing this balancing item as a percentage of total US gas demand.

Insert chart USbalancingitem.gif
Source: EIA

Suffice it to say, a negative balancing item indicates that the EIA is overestimating production; when it overestimates production it needs a negative balancing item to bring estimates in-line.

Historically, the EIA’s balancing item has, for lack of a better term, balanced over time. A big positive number would be offset a few months later by a significant negative item; over the course of a year, the sum of all balancing items would be insignificant relative to total US gas production.

But this historic pattern began to deteriorate in 2006-07. As I attempted to illustrate in the above graph, there’s a very definable downtrend in the size of any positive balancing items. Meanwhile, the size of negative balancing items has been running at near record levels. The error terms here consistently indicate an overestimation of US gas production.

The EIA plans to revise recent data lower when it releases its April report. And it will recalculate historic data as well, releasing those revisions later on this year. What’s interesting is that this could actually totally reverse the picture on gas production in the US; it’s quite possible, as many producers have indicated, that US production is actually falling, not rising. Such a change in sentiment could boost gas prices from current depressed levels.

US storage levels have still been rising of late due to unseasonably warm weather across the country; however, this data has the potential to change the sentiment on gas significantly–especially with sentiment so uniformly bearish right now. I am looking for the revisions to be an upside catalyst.

First Quarter Returns

Last but not least, the table below presents returns for all three model Portfolios in the first quarter of 2010. I have excluded the “field bets,” which I will examine in an upcoming issue.

I’ve traditionally accounted for returns on a portfolio level inside TES, but going forward, I will provide a stock-by-stock table of quarterly and year-to-date performance to give subscribers greater granularity. We’re planning some major revisions to the website that will allow us to show returns on a real-time basis.

Source: Bloomberg, The Energy Strategist

A few points are worth noting. First, some of these recommendations, such as Williams Partners (NYSE: WPZ), are no longer in the portfolio because I recommended selling them during the quarter. However, they still have a bearing on our quarterly return and are included in the table.

There are two columns: “1Q Return” is self-explanatory, while “Over (Under) Performance” shows the performance of each pick relative to the S&P 500 Energy Index over equivalent holding periods. Positive numbers show that the stock outperformed the benchmark.

As you can see, Wildcatters picks outperformed the S&P 500 Energy Index by an average of 2.1 percent; Proven Reserves plays outperformed by an average of 7.3 percent; and Gushers beat the benchmark by an average of 1.9 percent. The extreme outperformance of the most conservative TES Portfolio, Proven Reserves, can be explained largely by the strong returns posted by income-oriented MLP recommendations such as Enterprise Products Partners (NYSE: EPD) and Teekay LNG Partners (NYSE: TGP).

These income-oriented picks have benefited from strong access to capital that’s allowed them to undertake new acquisitions and fund organic expansion products. Investors are beginning to recognize that this adds up to distribution growth in coming quarters.

Join Me

Many subscribers have asked me to announce my upcoming appearances at conferences and events; this will be a regular feature at the end of each issue.

The Las Vegas Money Show: May 10-13, 2010 at Caesar’s Palace in Las Vegas.

I’ll be speaking on three occasions and participating in a panel discussion with my colleagues Gregg Early and Roger Conrad. For more information, click here.

The KCI Investing Cruise: Oct. 21 – Nov. 1, 2010 aboard the Seabourne Odyssey.

One of my fondest memories in recent years was a cool evening in June 2007 aboard the MS Deutschland as the ship cruised through the Stockholm archipelago.

After dinner that evening, I enjoyed a few glasses of cognac and several hours of conversation on the back deck with subscribers and fellow editors on the first KCI Investing cruise. As anyone familiar with the Baltic Sea region at that time of year will tell you, the nights are short, and it’s easy to lose track of time.

Since then I’ve been on two KCI Investing cruises, one down the Danube River in central Europe, another around the Caribbean and through the Panama Canal. The best endorsement of these trips that I can think of is that we’ve had several repeat cruisers.

This October, it’s time for the fourth KCI Investing cruise. This time we’ll be cruising from Istanbul, Turkey, to Athens, Greece, aboard the Seabourne Odyssey. We’ll spend additional nights onshore in both Istanbul and Athens. And this time we’re bringing along a bit of local knowledge in the form of my longtime friend and colleague Yiannis Mostrous, editor of The Silk Road Investor and a native Athenian.

I hope you’ll join me this October. Click here for details. And the first round of after-dinner drinks aboard the Odyssey is on me.