The latest reporting season is under way in the US, where listed companies update the market on trading figures for the first quarter of 2011.
This will include updates from a number of the oil majors. These integrated businesses, with upstream (exploration and production) and downstream (refining, processing, and distribution) interests, typically provide impressive cash generation with dividend yields being well covered by current earnings.
However, with oil at around $120 a barrel, shareholders may justifiably ask why the levels of shareholder returns from the majors such as Conoco Phillips, Exxon Mobil, Shell, and BP – to name but a few – are not higher.
The answer in no small part may be attributed to the fact that for these huge organisations, operating costs remain high and are consistently rising with an ever increasing regulatory burden.
In July 2008, the oil price peaked briefly at $147 a barrel, before bottoming out at $32 in December 2008, when it seemed that the global economy had ground to a halt.
Oil once again is trading nearer the top end of this range, yet the share prices of the majority of oil majors trade below the ratings of three years ago. Integrated oil companies tend to trade between roughly seven and 14 times current earnings, while for pure exploration and production or oil-service groups, multiples trade into the 20s.
There have been a number of asset disposals by the integrated majors through 2010, with BP contributing in no small part following the Gulf of Mexico disaster which led to a number of non-core asset sales totalling around $30billion in value.
In addition, Conoco Phillips has been selling off some of its North American assets and Italy’s ENI has indicated that it wishes to sell its stake in Portugal’s Galp.
A recent note from Credit Suisse highlights that such moves often unlock a market value on under-appreciated assets.
Such disposals may be high value in dollar terms, but against the total value of the sector in terms of stock market capitalisation, they remain marginal.
As such, an argument could be made for more radical restructuring whereby “big oil” could seriously boost investor returns. Deutsche Bank estimates that European oil companies trade on average at around a 30% discount to their sum of the parts valuations.
Could such discounts be converted to premiums through a process of break-up or managed divestment?
Consider Marathon Oil as a case in point, when its board decided to separate upstream from downstream assets.
Marathon is the fourth-largest integrated US oil & gas company, and has decided to split out its refinery and pipeline operations from its exploration & production activities.
The move, when announced earlier this year, sent Marathon’s price ahead by close to 10%.
Encana carried out a similar operation in 2009 which was equally well received.
Early last year, support services concern Petrofac spun out its North Sea E&P interests, now trading as Enquest.
At issue, the stock traded at 100p and now sits around 140p. This exercise has clearly been a success in unlocking hidden value.
In reality, the larger integrated operators would find it difficult to split their assets out due to the sheer scale of their operations and it would be the mid tier, such as Encana and Marathon, who would be better placed to undertake such reorganisations.
Even further down the market cap scale, this process would seem to make sense.
Back in March, the Press & Journal reported that AIM-listed North Sea operator Encore would potentially split out its riskier, cash intensive exploration activities from the development of its significantly de-risked assets in the Catcher and Cladhan fields.
Encore has now announced that it is indeed to proceed with this divestment, thereby assigning a value to the exploration part of the business, for which there has been little in the share price to date.
Back in 1962, Neil Sedaka sang that Breaking Up Is Hard To Do.
While that may well be the case, it could be a real option for any chief executive of small, mid and even large cap oil companies to look at unlocking shareholder value from their asset portfolios: time perhaps to dust off the vinyl and get this one back on the turntable?
David Barclay is a divisional director at investment management and financial planning specialists Brewin Dolphin.
Past performance of shares is not a guide to future performance.
The opinions expressed in this article are not necessarily the views held throughout Brewin Dolphin Ltd.
No Director, representative or employee of Brewin Dolphin Ltd accepts liability for any direct or consequential loss arising from the use of this document or its contents.
Recommended for you
