The joint monthly web chat for subscribers of The Energy Strategist (TES) and MLP Profits (MLPP) took place two weeks ago. The chat is conducted by Igor Greenwald, who is managing editor for TES and chief investment strategist for MLPP, and myself.  

We got to most of the questions during this session, but there were a few that required an extended answer, or a bit more research. This week I will answer the two final questions: One on Argentina’s expropriation from Repsol in 2012 and one on Shell’s massive floating liquefied natural gas project.

Q: YPF and Repsol, now forcibly divorced, are both recovering. Do you follow either?  

As a former employee and current shareholder of ConocoPhillips (NYSE: COP), I watched the Venezuelan government expropriate our projects in the country in 2007. (An expropriation that an international tribunal has ruled unlawful.) As a former shareholder of Petrobras (NYSE: PBR), I watched as the Brazilian government forced the company to sell fuel below cost to Brazilian citizens at a cost of billions to Petrobras shareholders. And since I believe Chevron (NYSE: CVX) is one of the key companies to watch for those interested in investing in oil companies, I have closely watched as Ecuador has attempted to extract billions of dollars from the company for environmental damage caused mostly by Ecuador’s national oil company.

So I do have a keen interest in oil and gas operations in South America, especially when governments get involved. As a result, I did follow the Repsol/YPF saga as it unfolded. Let’s review what has happened to this point, and how that might affect their prospects going forward.

Repsol (OTC: REPYY) is a Spanish oil and gas company. It operates in three segments: Exploration and Production, Refining and Marketing, and New Energy, which is involved in renewable energy for transportation. Repsol is the world’s 15th largest refiner.

In 1999 Repsol bought nearly 98 percent of the Argentine oil and gas company YPF (NYSE: YPF), the largest oil-and-gas company in Latin America at that time. The acquisition proved to be a huge success for Repsol, and the company expanded across Latin America.

One of Repsol-YPF’s biggest successes was the discovery of the Vaca Muerta basin, a huge shale gas formation that moved Argentina into third place for largest recoverable natural gas resources in the world. At 774 trillion cubic feet, Argentina’s estimated recoverable reserves now trail only China and the US. The Vaca Muerta basin was discovered by Repsol-YPF in 2010, and announced in May 2011.

Nearly a year later in April 2012, Argentine President Cristina Fernandez de Kirchner  announced that “hydrocarbon self-sufficiency” was “in the national interest”, and she sent a bill to Congress expropriating 51 percent of Repsol-YPF. As rationale, she accused Repsol of underinvesting in the country and sending profits overseas by way of dividend payments. This was very similar to the rhetoric the late Venezuelan strongman Hugo Chavez used to expropriate not only oil companies, but businesses in a wide variety of industries.

The US and the EU condemned the expropriation, and Repsol asked for $10.5 billion as compensation, but Argentina responded that it would make its own determination and then subtract environmental damages to come up with compensation value. Last June, Argentina offered $5 billion as compensation, which Repsol rejected. Reports this past week indicate that Repsol is near an agreement to final compensation with Argentina over the expropriation, which would guarantee Repsol at least $5 billion, and possibly more based on the performance of the discounted Argentine bonds in which it would be paid.

From the day of the expropriation announcement to June 1 2012, Repsol saw its shares decline 36 percent. Since then shares have rallied 65 percent, but are still not back to where they stood before the expropriation news.

YPF similarly saw its share price plunge, as there are numerous examples in the region that attest to government incompetence at managing oil companies. In 2011, YPF’s share price exceeded $50, but following the expropriation announcement and a deep dividend cut the price briefly fell below $10. The share price rallied from there, exceeding $30 before pulling back into the $20s.

If I were to invest in one of these companies, based on what I have seen from other oil and gas companies operating in South America, I would opt for Repsol. Argentina’s shale gas prospects appear to be very good, but the history of South American governments not letting oil and gas companies reap the rewards of their risks will keep me out of South America for the foreseeable future.   

Q: Given the high cost of land based LNG facilities, how viable and at what price nat gas can the floating pipeline of AUS be competitive?

I didn’t answer this question during the chat because I wasn’t sure I understood what you were asking. I wanted to do a bit of research and make sure there wasn’t some new development that hadn’t yet garnered my attention.

I believe you are referring to the development of floating liquefied natural gas (FLNG) facilities. Royal Dutch Shell (NYSE: RDS.A) is building the world’s first FLNG facility, which will allow the company to develop offshore gas reserves that would otherwise be uneconomical.

Shell’s Prelude floating LNG ship. Source: Shell

The Prelude will chill natural gas produced at the field to -260°F, liquefying it so ocean-going carriers can load the LNG, condensate, and liquefied petroleum gas (LPG) for delivery to customers around the world.

The ship will remain at the location for 20 to 25 years before it docks for inspection and overhaul. Shell expects the Prelude to process at least 5.3 million metric tons per year (mtpy) of liquids: 3.6 mtpy of LNG, 1.3 mtpy of condensate, and 0.4 mtpy of LPG. This is a drop in the bucket relative to the natural gas the world consumed in 2012, but it marks an entrance into a potentially lucrative growth area for the company.

Shell’s profitability on the project will mainly be a function of the price they can get for LNG, condensate, and LPG. Shell’s gas costs are likely to be very low, so barring a collapse in Asian LNG prices, Shell will probably do well with this project. But the bigger payoff may come from being a first mover in this space, as Shell seeks to improve upon and replicate the Prelude in order to be the first to access resources that others aren’t technically equipped to pursue.

There is precedent here, as Shell’s massive Pearl gas-to-liquids (GTL) facility in Qatar was designed based on knowledge from a smaller facility the company had operated for several years in Bintulu, Malaysia (a facility I visited in 2010). The massive Pearl project cost an estimated $20 billion, but Shell’s contract gave it the gas inputs for free. Qatar reaps the benefits from jobs created and tax revenue from the plant output.

Shell is certainly no stranger to mega-projects, and we will be paying close attention to its progress on Prelude. It could be just the tip of the iceberg for the company. Throw its stake in the massive Australian Gorgon LNG project into the mix, and this could solidify Shell’s status as as a leader in LNG for many years.

(Follow Robert Rapier on Twitter, LinkedIn, or Facebook.)

Portfolio Updates

Cabot on Sale the Best of Best Buys    

Ho-hum, another great year in the books for Cabot Oil & Gas (NYSE: COG) the dry-gas champion of the Marcellus that increased production 55 percent in 2013, grew cash flow 57 percent, drove down cash unit costs 26 percent and began aggressively repurchasing its shares.

But the market’s response was anything but ho-hum as the stock dropped 8 percent on disappointing forward guidance. While production is still forecast to rise 25 to 45 percent in 2014, much of that growth will be back-end loaded. In the first half of the year, output will be flat vs a year-ago as the company shifts to pad drilling with longer lead times and copes with the effect of the recent weather-related disruptions.

Even current production levels have outrun the available takeaway capacity, forcing Cabot to sell its gas at recently widening discounts to the NYMEX benchmark, now running at 60 to 65 cents per thousand British thermal units (MMBtu). Continuing shortage of regional export capacity and hedging means that Cabot is planning to sell its gas for between $3 and $4 per MMBtu throughout this year, a far cry from the current spot price near $6 per MMBtu. Still, even at $3 per MMBtu, the company has an internal rate of return of more than 100 percent on new wells. So its decision not to add a rig to the current six it’s running in the formation has a lot to do with extracting the maximum value from its resource base over the long haul, rather than worrying about earnings in a given quarter.

Over the long haul, Cabot’s export capacity and therefore pricing should improve with the completion of the Constitution pipeline in 2016, alongside deals to sell gas to Dominion’s (NYSE: D) Cove Point LNG export project and into the Transco system. So it may well be that in the short term Cabot is better off buying more of its stock, and leaving more of those 100-percent-return wells until later, when pipelines come online and regional prices firm.

Cabot began repurchases in the most recent quarter at an aggressive pace equivalent to a 5 percent annual buyback yield, and its free cash flow position will only improve from here even in the absence of higher sale prices. The firepower Cabot has to keep buying the dips places an effective floor under the valuation, while protecting the long-term upside. With this dip, Cabot moves to the forefront of our Best Buys. Buy COG below $42.50.

ARII on Right Track, But We’re Hedging    

Unlike Cabot, American Railcar Industries (Nasdaq: ARII) actually posted a revenue dip year-over-year, but appearances proved deceiving as the decline reflected a greater share of the tank cars made by the company for its leasing affiliate, which effectively defers revenue over the term of the leasing agreement.

More to the point, cash from operations expanded 36 percent in 2013 over 2012, as the long-prophesied slowdown in ARII’s bread-and-butter tank car business still hasn’t materialized. The company reported fourth-quarter earnings well above estimates, and raised its quarterly dividend from 25 to 40 cents a share, good for a 2.5 percent annualized yield even after the share price has rallied 27 percent in the three days since the announcement.

The huge short interest (25 percent of the float as of Jan. 31) likely had a lot to do with the price spike, but ARII is currently enjoying rich tank car margins and early stages of growth in its lower-margin hopper car line, while still trading at a reasonable 8 times trailing Enterprise Value/Ebitda.

New safety rules for tank cars could provide another long-term boost by increasing demand ahead of the adoption and margins afterward. But in the longer term the more efficient pipelines are a real risk, and subscribers who’ve stuck with this investment on our advice through thick and thin should consider taking profits here, with the position up more than 40 percent for us since March. We recommend selling half of your initial ARII position.    

 — Igor Greenwald

Stock Talk

We encourage you to engage with our analysts and your fellow subscribers on our website. To ask a question or post a comment related to a particular article, please do so in the Stock Talk field at the bottom of that article.

Or, to ask a general question, please go to the main Stock Talk page found under the Resources menu for each publication.