Dan Amoss

The world oil market is hardly free and frictionless, with supply responding seamlessly to high price signals. U.S. oil production gains from shale are just a tiny part of the global oil market. Evidence mounts that the per-barrel marginal cost of oil is higher than advertised. Inefficient government-run oil companies and high oil taxes are one big problem; paper currencies, deficits, and other demand-boosting factors are another problem.

Production disappointments in Russia, Nigeria, and Venezuela cannot be ignored.

It seems Russian oil millionaires ‘n billionaires need their tax breaks to spur lagging Russian oil production, and even Putin himself has a hard time getting his tax reform proposals to turn things around. Ouch, this according to Bloomberg:

“The impact of the production and mineral-extraction taxes when crude is selling for $100 a barrel means that, after paying pipeline fees, producers in Russia are left with about $22 a barrel to lease rigs, pay workers, rent equipment and service debt before recording any profit, said Wolcott… The production tax is the larger of the two, accounting for about $50 of the per-barrel levy when crude trades for $100. That would remain unchanged under Putin’s proposal.”

Focusing on Africa, Nigerian crude production is back at 2009 lows thanks to pipeline sabotage. According Bloomberg:

“Nigeria’s oil thieves are back in action, sabotaging pipelines to rob Africa’s biggest crude producer of more than a 10th of its daily production. In the first two months of this year alone, Royal Dutch Shell Plc (RDSA) and other oil companies have declared three force majeures, a legal clause that allows them to miss contracted deliveries due to circumstances beyond their control.”

As for Venezuela? For now let’s the dust settle with the aftermath of Hugo Chavez. But it’s safe to say that there’s plenty of uncertainty for the oil producer’s future.

Today, with uncertainty filling the streets in foreign oil-producing nations, I’ll update you on a drama playing out at an asset-rich, American oil company. Let’s take a look at where two parties compete to unlock hidden value…

Investor Drama At Hess (Share Price Rises!)

No matter the state of the broad stock market, you can find value-enhancing or value-destroying events underway at specific companies. On Feb 1st, I wrote to you about an event unlocking value at a stodgy oil company with great assets: Hess Corp. (HES).

DRH_Hess_030713

To recap: activist hedge fund Elliott Management acquired a 4% ownership position in HES. It announced proposals to change Hess’s unfocused strategy, and unlock billions in shareholder value in the process. Elliott argues that Hess should spin off its Bakken shale acreage into a separate company. This acreage is an attractive, but poor focus and execution had led to high production costs.

A month has passed, and Elliott Management is already getting results. HES stock was up this week on news that it plans to sell unattractive, noncore assets, replace some board members, and increase the annual dividend to $1 per share. CEO John Hess calls these initiatives “the culmination” of his multi-year transformation process.

In a letter to shareholders, the CEO attacks Elliott’s proposals: Elliott “ignores credit implications”; “ignores tax consequences”; and “uses flawed valuation benchmarks.” He quotes a handful of Wall Street analysts arguing that the cash-producing offshore assets should be used to fund growth in the cash-consuming Bakken.

This, however, has been the situation for years. The result: HES trades at a “conglomerate discount.” A conglomerate discount is when the market values a sprawling, unfocused company at a discount to the sum of its parts.

Here’s my question, which reflects why I agree with Elliott management’s thesis: Why would portfolio managers want to own two poorly managed exploration and production companies when they can simply buy the best-of-breed companies in each category: no-growth cash cow and high-growth resource play? Management, in my view, hasn’t adequately answered this question.

Hess’s actions are a step in the right direction, but fall “dramatically short of what is needed,” Elliott believes. In a written response, Elliott makes two strong points in the conflict over breaking up the company:

  •  “Hess’s conventional portfolio did not fund the development of the Bakken, rather it funded $4.5 billion of exploration failure and over $4 billion of acquisitions of conventional assets and downstream investments. Hess mismanagement resulted in the company issuing more debt, issuing similar amounts of equity, and selling more assets than Bakken pure-play Continental to achieve similar production growth in their build out of the Bakken.”
  •  “Pure-play Bakken operators all have ready access to credit markets. Continental has similar Bakken production to Hess and has $2.9 billion of bonds that yield less than 4.0%.”

In other words, the proposed spin-off of Hess’s Bakken assets into a new company would hardly be starved of capital, especially in an era of low corporate bond yields and high oil prices.

Hess will hold its annual meeting on May 16. Regardless of which party wins its slate of board nominees, it’s refreshing to see an undisciplined, asset-rich oil company getting leaner and more focused.

HES stock is a good-looking play on oil prices, with upside into the $100s.

Best regards,
Dan Amoss, CFA

Original article posted on Daily Resource Hunter

Dan Amoss

Dan Amoss, CFA, is a student of the Austrian school of economics, a discipline that he uses to identify imbalances in specific sectors of the market. He tracks aggressive accounting and other red flags that the market typically misses. Amoss is a Maryland native, a graduate of Loyola University Maryland, and earned his CFA charter in 2005. In spring 2008, he recommended Lehman Brothers puts, advising readers to hold the position as the stock fell from $45 to $12. Amoss is our macro strategist and guardian of The 5 Min. Forecast PRO.

Recent Articles

Modern Monetary Theory (MMT): How Fiat Money Works

Chris Mayer

From time to time, the curious economist in you may wonder, "How does a fiat currency system actually function?" and, further, "Why don't more countries default on their debt?" Well, it turns out there as a nifty little theory that explains exactly why these things happen. And the answers may surprise you. Chris Mayer explains...


Bill Bonner
The Surprising Reason QE Lives On

Bill Bonner

QE3 officially came to an end today, with the Fed stopping its $15 billion monthly bond purchases. But what does that mean for the US economy going forward? Today, Bill Bonner explores that question, and why you probably haven't seen the last of QE just yet. Read on...


Video
Why Lower Gas Prices Are NOT “Bullish Indicators”

James Rickards

As U.S. gas prices continue to head lower, U.S. consumers are getting a little bonus to their disposable income. Some economists like to tout this as a "bullish indicator" for the overall economy. But as Jim Rickards explains in this interview with RT's Erin Ade, nothing could be further from the truth...


Extra!
Why You Need to Pay Attention to the Swiss Gold Initiative

Grant Williams

The Swiss Gold Referendum is set to take place on Nov. 30, 2014 - just six weeks away. And depending on how the vote turns out, the world could wake up on Dec. 1 with a very different outlook for the rest of the year... and beyond. In fact, it could be one event that helps trigger a major financial collapse. Grant Williams explains...


Amazon Is A Big, Fat “Sell” – Here’s Why…

Greg Guenthner

Just one short year ago, investors were rejoicing at Amazon's huge bounce. But thanks to a blundered foray into the smartphone market and a drone delivery service that never materialized, Amazon has had a fairly rocky 2014. Today, Greg Guenthner explains why this stock is a sell, AHEAD of the holiday season. Read on...