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Black stuff arb

10 October 2011 By Christopher Swann

Economic fear has taken a heavier toll on U.S. oil company shares than on crude itself. Either there are bargains among the stocks of oil explorers, or commodity investors are too bullish. The difference of opinion ought to mean there’s room to make money.

True, crude speculators have not been totally impervious to worries over a global slowdown. Both the WTI and Brent benchmarks are sharply down from the peaks reached at the end of April. But compared with the start of the year, oil has fared relatively well. WTI is down just 10 percent and Brent is actually up close to 9 percent. Nor are futures markets bracing for any price plunge over the coming two years.

By contrast, investors in U.S. oil and gas exploration companies are taking the threat of a global slowdown far more seriously. The S&P exploration and production index is down by almost a fifth since the start of 2011. As a result, many of these companies now look cheap. These wildcatters are now typically trading at an enterprise value of around 4.8 times estimated 2012 EBITDA – well below the average of 5.8 that has held since 2005, according to energy investment bank Tudor Pickering.

The sector, which includes Apache, EOG, Devon Energy and Occidental Petroleum, is also trading on enterprise values that reflect a 20 percent discount to the market value of proven reserves, Tudor Pickering reckons.

Of course, the stocks only look like a steal if crude traders are right to be relatively sanguine about oil prices. Another 15 percent fall in crude, and they look less like bargains. Futures markets are pricing Brent at $100 in a year’s time. That doesn’t appear to allow for the demand weakness that could accompany future accidents for the global economy, for instance further jolts from Europe.

But investors might not need to make that call to profit from the arbitrage opportunity. Whatever happens to the oil price, the gap in the outlook between commodity and stock markets should narrow. A bet that oil explorers’ shares will rise relative to the price of the black stuff looks like a smart one.


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