Tuesday, December 9, 2014

Are Energy Investments Today a Once in a Lifetime Opportunity?

In part one of this series, we discussed a few risks that are present in oil today. We also provided some arguments against those risks. Today, we will discuss how investors could capitalize on opportunities available today.

I believe that the time to start buying securities is when there is blood on the streets. One pays a dear price for cheerful consensus, which is bad for returns. However, if everyone is bearish on a security or a sector, chances are that prices are depressed, which increases the potential for good returns for the investor. Therefore, I am considering two oil companies and one pipeline company on further weakness.

Oil Prices are volatile, and could go easily to $35/barrel or $105/barrel easily through the end of 2015. However, investors should have a long-term horizon when making any type of an investment. I always make investments in a way that I would not care even if they closed the stock market for one decade. An investor who did their research should know oil and gas prices are volatile, Which is why it is important to select a blue chip company like Exxon Mobil (XOM), Chevron (CVX) and ConocoPhillips (COP) and get paid dividends along the way. Heck Exxon Mobil, Chevron and ConocoPhillips didn’t cut dividends even when prices were flat 1981-2001. They actually managed to raise them. Thus it would be prudent to hold shares in companies that pay them to hold, and ignore price volatility.

I want to keep building my position in ConocoPhillips and Exxon Mobil slowly over the next several months. I already have too much in Chevron, which prevents me from adding further to this company. Therefore, if my ideal position size is say $10,000 per company (just using numbers to illustrate my point), and my purchase size is $1,000 per time, it would take me approximately 10 purchases to build that position out. However, given the fact that there are other interesting opportunities out there, it might reasonably take an investor approximately 3 – 5 years to build that position out. Hence, the main idea is not to pile everything up at one time, but to keep accumulating stocks slowly and spread purchases over time. This is to protect the investor in case their timing is suboptimal. It is important to spread out purchases to gain diversity in time as well ( dollar cost averaging). Most of you are in the accumulation phase, and have a certain dollar amount to put to work every month. Thus, your course of action is business as usual to dollar cost average into a few companies each month, and you might find energy shares very appealing today.  However, try to not buy only energy shares for the foreseeable future.

I will look at Chevron, ConocoPhillips, and Exxon-Mobil however, for comparative purposes. Chevron and Exxon-Mobil have integrated operations, including exploration and production and refining, while ConocoPhillips only has E&P operations.

ConocoPhillips (COP) explores for, develops, and produces crude oil, bitumen, natural gas, liquefied natural gas, and natural gas liquids worldwide. This dividend achiever has managed to increase distributions for 14 years in a row. The ten year dividend growth rate is 15.70%/year. The company is estimated to earn $4.69/share in 2015, down from expected 2014 earnings of $5.75/share. The stock yields 4.30%. The dividend looks sustainable, but will likely not grow by much in the near term if oil prices stay low. Check my analysis of COP.

Exxon Mobil Corporation (XOM) explores and produces for crude oil and natural gas. This dividend champion has managed to increase distributions for 32 years in a row. Yes, this includes periods of rising oil and gas prices, falling oil and gas prices, and flat oil and gas prices. The ten year dividend growth rate is 9.60%/year. The company is estimated to earn $6.29/share in 2015, down from expected 2014 earnings of $7.61/share. The stock yields 2.90%. The company has very good coverage of its dividend, which would likely grow slightly better than peers. Check my analysis of XOM.

ExxonMobil has managed to consistently repurchase shares. This is why low prices and low share prices could allow the company to retire a lot more shares than previously expected, thus further turbocharging returns to remaining shareholders.

Chevron Corporation (CVX), through its subsidiaries, is engaged in petroleum, chemicals, mining, power generation, and energy operations worldwide. This dividend champion has managed to increase distributions for 27 years in a row. Yes, this includes periods of rising oil and gas prices, falling oil and gas prices, and flat oil and gas prices. The ten year dividend growth rate is 10.60%/year. The company is estimated to earn $8.63/share in 2015, down from expected 2014 earnings of $10.10/share. The stock yields 3.90%. Check my analysis of CVX.

You can judge management by results within their control, not what prices did over a period of time. Good management can deliver good results even when things are not going as well for the industry. Good management can deploy cash to projects that can deliver high return on investment even if prices are low, they can also acquire companies or they can also repurchase shares and thus make other shareholders wealthier.

For oil and gas companies, I evaluate management based on costs to explore for, develop and acquire oil and gas BOE. I also evaluate energy companies based on their ability to replace production through exploring for, producing and acquiring reserves in a cost effective way.

I looked at costs to acquire reserves, finding and development costs and reserve replacement costs to evaluate the companies I own. The source behind this is EY research:

• Proved reserve acquisition costs (PRAC) are calculated as proved property acquisition costs and identified related asset retirement obligation costs, divided by proved reserves purchased.

The 3 year average PRAC per BOE for ExxonMobil, Chevron and ConocoPhillips are $1.61, $6.59 and $10.07. The average for US PRAC’s per BOE is $10.42.

• Finding and development costs (FDC) are calculated as unproved property acquisition costs, exploration costs, development costs and identified related asset retirement obligation costs, divided by extensions and discoveries, revisions and improved recovery of proved reserves. The calculation excludes the effect of proved reserves purchased.

The 3 year average FDC per BOE for ExxonMobil, Chevron and ConocoPhillips are $25.14, $36.35 and $16.96. The average for US PRAC’s per BOE is $22.92.

• Reserve replacement costs (RRC) are calculated as total capital expenditures divided by extensions and discoveries, revisions, improved recovery and purchases of proved reserves.

The 3 year average RRC per BOE for ExxonMobil, Chevron and ConocoPhillips are $20, $30 and $16.92. The average for US PRAC’s per BOE is $19.44.

I also looked at reserve replacement ratios. It is important for companies to replace oil and gas pumped out from the ground, by either purchasing reserves or finding and developing for them.

The 3 year reserve replacement ratios for oil (gas) for Exxon Mobil were 183% (104%); for Chevron were 111% (212%); for ConocoPhillips were 181% (56%). The average 3 year production costs for BOE in $ for ExxonMobil, Chevron and ConocoPhillips were $17.51, $19.52 and $24.56.  Based on the data, I could see why Warren Buffett bought Exxon Mobil.

Besides the traditional oil companies listed above, I am also closely looking at pipelines. I also want to initiate a position in Enterprise Products Partners L.P. (EPD) at entry yields closer to 5%. This translates into a unit price closer to $29 - $30. If things get really out of control, like they did in October, I would not be surprised to see the units go as low as $30. The likelihood is low, although you never know, especially if interest rates start ticking up in 2015. Enterprise Products Partners L.P. is an MLP and a dividend achiever, which has managed to boost distributions for 17 years in a row. The ten year distribution growth is 6.50%/year. I sold out my units last year, and purchased Kinder Morgan Management (KMR), Kinder Morgan Inc (KMI) and ONEOK Partners (OKS) with the proceeds. Later on, Kinder Morgan Management was acquired by Kinder Morgan Inc, and I replaced ONEOK Partners (OKS) with ONEOK Inc (OKE). I do want to get back in Enterprise Products Partners (EPD), and I am willing to wait for the right entry price that offers the best prospects for returns going forward.

Full Disclosure: Long XOM, CVX, COP

Relevant Articles:

Accumulating Dividend Stocks is a Long Term Process
Dividend Stocks For Long Term Wealth Accumulation
Five Dividend Paying Companies with Consistent Share Buybacks
Why did I sell Enterprise Product Partners (EPD)
How to Increase Current Yields with Master Limited Partnerships


  1. i agree 100%
    you can also check refineries, they are getting hit wit the sector eve thou they are not directly impacted by oil price (my pick in NTI- which is a refinery+gas station chain+small pipeline)

  2. Wow!.....you really crunch your numbers. I suspect most dividend investors don't go to the same lengths you do, rather they probably just look at the usual metrics. It seems overwhelming that you would need to know something about each sector of the economy (investible universe of securities) to do that kind of in depth analysis. As usual, great writeup, lots to consider. Thanks for your efforts!

  3. thanks for the article. Why the switch from OKS to OKE?

  4. Great job! I intend to take advantage of this nosedive and scoop up plenty of energy over the next several months, too. I just posted my "Accomplishment and Celebration" post to mark the second rental house paid off and the long awaited adjustment to DGI investing over at the "PayoffmyRentals" blog. Some of the names here are on my buy list.

  5. DGI,
    I enjoy both part 1 and 2 of your articles on the energy topic, very educational. When you mentioned about the $10,000 ideal position per company I felt as if you were talking to me. Thats my current target for now, I will be comfortable with 10K on CVX, XOM, KO, JNJ, and other big companies as my top primary holdings to complete a position. Again thank you very much!

  6. DGI,
    Another great analysis. Thanks!

    Funny, my recent purchase moved CVX into top spot in my portfolio at 3.3%. I would definitely like it to move back down, but the companies that I would like to add to, such as JNJ and PEP, are just too expensive. But like you, I won't add to CVX any time soon.
    Best wishes,

  7. I myself prefer not to fill out the paperwork for MLPs during tax time but I am also considering EPD if it falls like it did in October. Compared to other sectors, it is much easier to find well valued buys in the Energy sector. XOM and CVX are both very solid companies with proven histories and strong financials.

  8. Also look at that free cash flow. I know it is something you should look at for every company but with energy companies in the oil/gas area this is very important. They have to be able to survive $60 barrel and under for long periods of time. They only way to survive and continue to pay/increase dividends is with lots of cash (and not loans.)

  9. Thank you for this article and all that you share on your website everyday. In light of the recent news regarding oil, what are your thoughts on buying stock in some of the larger pipelines and others in the energy space based on the recent dip, e.g., KMI, PAA, ETE, BPL, PSX and ETP?

    Thank you.

  10. I already own XOM quite a lot compared to my small portfolios size. But the energy companies shares are going down thus opening me some really nice buying opportunities.

    Is it too stupid to open new position in CVX or add XOM because now is the chance for it, in my opinion? That would add energy companies' value to almost 30% of my portfolio.

    Other dividend champions are priced pretty expensive for me since I already own some of the ''cheaper'' ones such as AT&T and Unilever.


Questions or comments? You can reach out to me at my website address name at gmail dot com.

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