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O&G Reserve and the 6/1 NG/Oil Conversion


usdtor05
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Hi all,

 

Have a question on how you think about the NG/Oil 6/1 conversion. I understand why it is done from an energy equivalency perspective but in terms of valuing reserves after a conversion to oil or vice versa this would not appear to be the right way to go about it unless I am missing something.

 

Basically I am just trying to come up with a quick and dirty metric to guide me in terms of valuation to see if something is screaming cheap, especially after the moves lately.

 

Would love your thoughts on this if you have a moment.

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There's different types of oil.  Some refineries will work best for a particular type of oil.  Often, the oil is being produced in a location far away from the relevant refineries.

 

For natural gas, there's "dry" gas and "wet" gas.  Wet gas burns hotter because it contains ethane.  If the gas exceeds 1100 btu, it can't be sold in most markets because a lot of equipment isn't designed to burn gas so hot.  In many places, shale development has led to too much wet gas.  In rare cases, wells are being shut-in because the gas can't be sold.  There are different types of processing plants that can remove ethane from wet gas.  Some technologies remove more than others (e.g. cyrogenic).  Nowadays it's mostly cyrogenic plants (they remove the most) that are being used for shale gas because there's so much wet gas.

 

I don't think that the energy equivalency is that relevant at the moment.

 

Basically I am just trying to come up with a quick and dirty metric to guide me in terms of valuation to see if something is screaming cheap, especially after the moves lately.

Net present value.  (Or standardized measure, which considers tax.)

 

However, most companies lie about their reserves.  So I would *not* rely on that metric.

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Thanks Glenn

 

@yadayada yes I've seen you post that a number of times over the board and totally get your position. I am just trying to get my mind around a valuation. Agree they feel like black boxes but is nice to know how to think about them at the least.

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Look at VIC, there is a thread where a lot of people name companies in this sector. If i invest there I would probably make a bucket of like 20% in my portfolio. Wouldn't try too hard to value them. And then just select them on proven reserves or something, and also based on inside ownership and insider buying.. And try to follow some smart managers. And avoid the ones that are clearly being bled by management. I wouldn't put too much faith in what management says about costs. Just buy reserves.

 

Also a lot of companies with gas reserves in north america can't make money with current gas prices. To see an increase in gas prices you would need an increased amount of export terminals for gas to Asia. I think gas there trades like 3x higher at least. I think this is pretty likely to happen. A lot of research already shows that we can export quite a bit more without seeing prices really skyrocket. So you will probably see a somewhat increased price and improved exports in the future.

 

I think in the next 10 years the costs of getting oil out of the ground will only go up. If I went for oil companies I would probably go for Lukoil or Dragon oil or something, and wouldn't bother with those exploration companies.

 

If you want some reading material on gas and oil market in general, this is a good place to start:

https://doc.research-and-analytics.csfb.com/docView?language=ENG&source=emfromsendlink&format=PDF&document_id=1019317461&extdocid=1019317461_1_eng_pdf&serialid=LmQFSGKrHItrp246eOqExIInv7I3xq5fm4%2BY5WWCHuk%3D

 

https://doc.research-and-analytics.csfb.com/docView?language=ENG&source=emfromsendlink&format=PDF&document_id=1023125461&extdocid=1023125461_1_eng_pdf&serialid=9EIFh5wGMbrXUOFyyhvTsJLi%2fxb2aKN9Saj95oKCxko%3d

 

https://doc.research-and-analytics.csfb.com/docView?language=ENG&format=PDF&document_id=1005321471&source_id=em&extdocid=1005321471_1_ENG_pdf&serialid=0sD72ky5PVE69YdSxRIsei9L5gnDVssxzgAuLedlEiQ%3d

 

 

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Look at VIC, there is a thread where a lot of people name companies in this sector. If i invest there I would probably make a bucket of like 20% in my portfolio.

 

They managed to name most of my oil and gas shorts.  :o

 

Um... you should probably avoid any resource stock written up on VIC as a long.  For whatever reason, VIC is very good at identifying the worst stocks as longs- ATPG, Yukon Nevada / Veris Gold, ?Goldgroup? GGA.TO, Baja Mining, MILL, etc. etc.

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Look at VIC, there is a thread where a lot of people name companies in this sector. If i invest there I would probably make a bucket of like 20% in my portfolio.

 

They managed to name most of my oil and gas shorts.  :o

 

Um... you should probably avoid any resource stock written up on VIC as a long.  For whatever reason, VIC is very good at identifying the worst stocks as longs- ATPG, Yukon Nevada / Veris Gold, ?Goldgroup? GGA.TO, Baja Mining, MILL, etc. etc.

 

I would guess that it's people stretching outside their circle of competence, maybe trying to fill their quota of two ideas per year?

 

To the OP, the 6:1 ratio has no value for an investor. I would ignore it, and deal with oil and gas reserves/production separately in your analysis.

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Why short any of these things. I mean let's be honest they are mostly black boxes. Some sudden rise in oil prices, or something wasn't as bad as you thought and there's a hole in your portfolio. Like a reverse lottery ticket. I read valuetrap's comments, and they make sense, and then I hear a bullish write up, and that sounds convincing too.

 

If two people argue opposite sides and they both make sense, nobody probably really understands what is going to happen.

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Thanks Bizaro, that's how I have it modeled out but nice to know I wasn't thinking about it incorrectly.

 

Still trying to wrap my head around what the netbacks are on the oil vs. the gas for some of these players. They seem to mix it all together and by the time they are done reporting you can't tell what they are really making without taking a pretty big swag at it.

 

It would seem like if you were to be able to get at those margins you could back into a pretty reasonable valuation if you had solid numbers on the EURs and the true wells costs and operations. I understand the PV-10 theoretically does this for us but half the time when I try to do a high level recalc of the pv-10 using their stated EUR and well costs I don't even get close which tells me either I am way off or they are doing something shady in there...

 

In the end I think it's safest to stay away unless you are a true expert as many of you have pointed out...the hurdle is likely too high for me.

 

I was just trying to find something glaringly obviously mispriced. I went back and took a look at Petrochina in 2002 and looks like Buffet bought at roughly $3/barrel EV/Proved Reserves of which 90% were oil. That's basically what I was looking to do.

 

Thanks to all for your help

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