Shifting commodity prices are a given in the oil and gas industry, but sometimes the industry landscape changes in unexpected ways. In this interview with The Energy Report, Oppenheimer & Co. Managing Director and Senior Energy Analyst Fadel Gheit discusses the effect of Middle Eastern geopolitical issues on oil production, dissects the changing oil and gas production situation in the U.S. and explains how the shift in natural gas prices has turned the refinery business from the industry's perennial ugly duckling into a beautiful swan.
The Energy Report: During your last interview in March, you said that oil prices were inflated by about 30% based on replacement costs of about $70/barrel ($70/bbl). Do you still believe that or are prices more realistic today?
Fadel Gheit: Nothing really changed over the course of the year. Oil prices are still inflated. I still stand by my estimate that oil should be trading between $70 and $80/bbl, not $90 or $100/bbl.
TER: What are your top picks among the large-cap exploration and production (E&P) companies in the oil and gas space?
FG: There are three or four categories of companies. The large, integrated oil companies are Chevron Corp. (CVX:NYSE), Exxon Mobil Corp. (XOM:NYSE), Royal Dutch Shell Plc (RDS.A:NYSE; RDS.B:NYSE), Total S.A. (TOT:NYSE) and the like. This is a shrinking universe because most of these companies are breaking up. ConocoPhillips (COP:NYSE) used to be a major integrated company and it split into two separate companies. But of all the major integrated companies, Chevron has been the best-performing stock. It's highly leveraged to oil prices. It has a strong balance sheet and has really outperformed its peers and the S&P 500 in the last 10 years, so Chevron would be our top pick among the large-cap companies.
The large independent E&P companies are Anadarko Petroleum Corp. (APC:NYSE), Apache Corp. (APA:NYSE), ConocoPhillips and Occidental Petroleum Corp. (OXY:NYSE), and of all these companies, we like Occidental a lot because of its restructuring potential.
We like to pick stocks for investors, not make bets on oil and gas prices, because I've been in this business 30 years and I believe no one can accurately forecast oil and gas prices. We're trying to pick stocks that have a catalyst, or for which we expect a catalyst, that will increase valuations. Occidental is a good example. It had massive changes on the board; the chairman was not reelected and the lead member did not stand for reelection. Now the CEO is trying to break up the company and create much higher value for shareholders.
TER: You have suggested that Apache exit Egypt because of growing instability. What should the company do instead with the funds?
FG: Egypt is a problem that Apache or any other company cannot solve. The International Monetary Fund is trying to help Egypt, and Egypt's problems are daunting. The political, economic and civil situation in Egypt is likely to deteriorate even further. The main problem in Egypt probably is economic. It is a poor country with high unemployment, and it has lost the biggest revenue generator—the tourism industry.
Apache has the highest earnings exposure to Egypt; a big percentage of its profit is generated from the country. Although its operations have not been interrupted and Apache is getting paid its share of profit regularly with no delays, the market has concluded that Egypt is a big risk for Apache and therefore it is better for Apache to leave Egypt.
Apache would be better off selling its Egyptian assets to another company that has the appetite for this political risk and using the proceeds to buy back its stock. That will do two things: remove the risk, which means the shares will receive higher multiples of earnings and cash flow, and shrink the number of shares outstanding, thus improving earnings and cash flow per share and ultimately boosting the valuation. It's a win-win situation for Apache and for its shareholders.