Oil and gas companies key metrics and stock performance

The research projectidentifies the primary metrics used in executive compensation plans, overall and byindustry, company size, and valuation premiums, and then tests these metrics todete

Oil and Gas Companies: Key Metrics and Stock Performance

Group sciences: Nguyễn Hà Phương

Nguyễn Thu HiềnHoàng Nhật HạClass: AC2015D

Science advisor: Dr Lê Đức Thịnh

Chapter 1 – Introduction

1 The necessity of topic

The US State Board of Administration (SBA) sponsored an executivecompensation research study by Farient Advisors LLC, covering 1,800 companies, 24Industry groups, and fourteen years of data (from 1998-2011) The research projectidentifies the primary metrics used in executive compensation plans, overall and byindustry, company size, and valuation premiums, and then tests these metrics todetermine whether the metrics used have the highest impact on total stock returns Thestudy found that, in aggregate, performance metrics are generally well-aligned withshareowner value Earnings growth, followed by returns and revenue growth, has thegreatest impact on stock prices

The review also found that many industries have a number of metrics to choosefrom; with half of the 24 industry groups studied having at least three metric categorieswith strong correlations to total shareholder returns However, the optimal use ofmeasures differs considerably by industry This research aims to find out metrics thathave strong correlations with total shareholder returns for companies in oil and gasexploration and production industry

The petroleum or oil and gas industry, also known as the oil industry or the oilpatch, includes the global processes of exploration, extraction, refining, transporting(often by oil tankers and pipelines), and marketing of petroleum products The largestvolume products of the industry are fuel oil and gasoline (petrol) Considered to be thebiggest sector in the world in terms of dollar value, the oil and gas industry is a globalpowerhouse employing hundreds of thousands of workers worldwide as well asgenerating hundreds of billions of dollars globally each year In regions which housethe major national oil companies, these oil and gas companies are so vital they oftencontribute a significant amount towards national GDP

The industry is usually divided into three major components: upstream,midstream and downstream The Upstream component is also refereed to as the E&P(exploration and exploration) This involves search for underwater and undergroundnatural gas fields or crude oil fields and the drilling of exploration wells and drilling

into established wells to recover oil and gas.Downstream refers to the filtering of theraw materials obtained during the upstream phase This means refining crude oil andpurifying natural gas The marketing and commercial distribution of these products toconsumers and end users in a number of forms including: natural gas, diesel oil, petrol,gasoline, lubricants, kerosene, jet fuel, asphalt, heating oil, LPG (liquefied petroleumgas) as well as a number of other types of petrochemicals Midstream is generallyclassified under the downstream category.

In recent years there has been a growing negative sentiment towards the oil andgas industry and "big energy" Major environmental disasters such as the DeepwaterHorizon Gulf Of Mexico Oil Spill have cast a negative spotlight up on the industry.The trend towards Renewable and Alternative energy is also another threat totraditional oil and gas companies Coupled with the rise in pro-eco legislation andgovernmental pressure has meant the oil and gas industry is under more scrutiny thanever

However the Oil and gas industry is still extraordinarily successful and stillexperiences massive growth Petroleum is vital to many industries, and is ofimportance to the maintenance of industrial civilization in its current configuration,and thus is a critical concern for many nations It's estimated that 30 billions barrels areconsumed globally each year - primarily by developed nations Oil also accounts for asignificant percentage of energy consumption regionally from 32% for Europe andAsia, 40% for North America, 41% for Africa, 44% for South and 53% for the MiddleEast.Petroleum is also the raw material for many chemical products, includingpharmaceuticals, solvents, fertilizers, pesticides, synthetic fragrances, and plastics

For all of these reasons, studying oil and gas companies is quite necessary and

an interesting topic In this research, we focus on biggest companies operating in theupstream area

Source: [1], [2]

2 The goal of topic

- Key metrics of oil and gas exploration and production companies

- Annual financial and operating data of key metrics and stock prices from somebiggest oil and gas companies around the world

- Multiple regression model

3.Research questions, methodology and scope of research

 Methodology and Scope of analysis:

- Qualitative: Study featured key metrics for oil and gas exploration and productioncompanies (includingProduction to Reserves, Reserve Life Index, Reserve-Replacement Ratio, Finding Cost (Technical) per Barrel of Oil Equivalent (boe), andProduction Costs per boe), and some standard metrics in corporate finance (such asEarnings per Share Growth, Revenue Growth, Return on Equity, etc.)

Source: [3], [4], [5], [6], [7], [8], [9], [10]

- Quantitative: Analyze data from 14 big oil and gas companies in North America,South America, and Europe (mostly in the US)

Source: [11], [12], [13], [14], [15], [16], [17], [18], [19], [20], [21], [23], [24], [25]

4 Facilities and the difficulties of the researching process

 Facilities: We obtain data from financial reports of fourteen oil and gas companies,and stock prices from Yahoo Finance

 Difficulties:

- Companies record data in various types of currencies

- Some companies do not have enough data to analyze

Chapter 2 -Key metrics

1 Total Shareholder Returns (TSR)

TSR for a given period= Adjusted closing price at the end of the period−Adjusted closing price at the beginning of the period

Adjusted closing price at the beginning of the period

(We obtain stock prices from Yahoo Finance.)

2 Featured Metrics for Oil and Gas Exploration and Production Companies

a) Production to Reserves

Reserves are the amount of resource still in the ground Production is the average

amount of resource being pulled from the ground This ratio is used to determine if a

company is replacing the reserves depleted through production To perform this

calculation,first the amount of natural gas reserves needs to be converted from cubic

feet (cf) to barrels of oil equivalent (boe), usually at a ratio of 6,000 (or 5,800) cfto1

boe

Production¿Reserve= Production

Reserves b) Reserve Life Index

The RLI is the reciprocal of the Production to Reserves Ratio, showing how long

reserves will last at the current production rate with no additions to reserves

Production RLI ( years)=1¿ Reserves Ratio¿

c) Reserve-Replacement Ratio

The Reserve-Replacement Ratio is used to see if a company is replacing production

Basically, it shows whether a company is increasing reserves or depleting them.The

main objective of any oil and gas company is to maximize profit while increasing the

value of the company year after year In order to do this, the company must generate

more revenue while cutting costs To achieve this, the company must enhance its oil

and gas production year after year This is to say that a company needs to continually

invest its financial resources in exploration and development activities to broaden their

portfolio The greater the proved oil and gas reserves added to the company’s resource

base, the greater the value of the company

Reserve−Replacement Ratio= Increase∈Reserves+Production

Production

d) Finding Cost (Technical) per boe

Finding cost is used to estimate a company’s cost to find new reserves, measuringtechnical efficiency of that company

Reserves changed FindingCost (Technical) per boe= Exploration Cost¿ extensions∧discoveries¿

e) Production Costs per boe

Production costs for the period are divided by combined oil and gas productionvolumes, to be analyzed on a per boe basis

Production Costs per boe= Production Costs

Total Oil∧Gas Production

3 Standard Metrics in Corporate Finance

a) Diluted Earnings per Share (EPS)

Diluted EPS is a very important performance metric used to gauge the quality of acompany's earnings per share (EPS) if all convertible securities were exercised.Companies usually report both primary and diluted EPS, but the focus is generallymore on the diluted EPS, as it is more conservative and indicates a worst-case scenario

in terms of EPS

b) Diluted EPS Growth

EPS Growth is defined as the percentage change in EPS over the previous 12-monthperiod to the latest year end It gives a good picture of the rate at which a company hasgrown its profitability

Diluted EPS Growth= Current yea r

' s diluted EPS−Previous yea r ' s diluted EPS Previous yea r ' s diluted EPS

c) Revenue Growth

Revenue Growth is the percentage increase (or decrease) in a company's sales fromone period to the next

Revenue Growth= Current yea r ' s revenue−Previous yea r ' s revenue

Previous yea r ' s revenue d) Return on Equity (ROE)

ROE is the amount of net income returned as a percentage of shareholders equity.Return on equity measures a corporation's profitability by revealing how much profit acompany generates with the money shareholders have invested

Income attributable Returnon Equity=¿ shareholders ¿

Total shareholder s ' equity e) Free Cash Flow (FCF) Growth

FCF growth is the percentage change in FCF from year to year

Free cash flow=Net cash provided by operating activities−Capital expentures

FCF Growth= Current yea r ' s FCF −Previous yea r ' s CFC

Previous yea r ' s CFC f) Earnings Margin

We calculate this ratio as net income divided by revenue This ratio measure howmuch out of every dollar of sales a company actually keeps in earnings

Income attributable

Earnings Margin=¿ shareholders ¿

Revenue

Chapter 3 - Analyzing correlation between each metrics and TSR

We will analyze data of the following fourteenoil and gas exploration andproduction companies:

- Tenof the biggest oil and gas companies in North America: ExxonMobil,Chevron, ConocoPhillips, EOG Resources, Occidental Petroleum, Marathon Oil,Anadarko Petroleum, Murphy Oil, Noble Energy, and Hess (all are Americancompanies)

- Three of the biggest oil and gas companies in Europe: Royal Dutch Shell(Netherlands), BP (UK), and Total (France)

- One of the biggest oil and gas companies in South America: Petrobras (Brazil)Our choices are restricted, since the multiple regression model requirescosts perboe figures (the 4th and 5th featured metrics) accounted in the same currency

We analyze both featured and standard metrics to find out correlation with totalshareholder returns.We also run Pearson test in some cases to see if the data supports alinear relationship between two populations

1 ExxonMobil

Among featured metrics of this company, only Production/Reserves and RLInotably have linear relationship with TSR, because correlation with TSR ofProduction/Reserves and RLI are approximately 0.525 and -0.515, respectively

None of the standard metrics has significant relationship with TSR Out ofthese, Revenue Growth is the most related with correlation of about 0.410, still lowerthan that of Production/Reserves It is followed by FCF Growth (0.307) and EPSGrowth (0.237).Therefore, in this case, Production/Reserves and RLI are the mosteffective metrics.

2 Chevron

Chevron shares the same patterns with ExxonMobil regarding the first twofeatured metrics, that is, Production/Reserves is positively related with TRS (0.517)and RLI is negatively related with TSR (-0.530) This indicates that Chevron hassimilar production and reserves management strategy to ExxonMobil’s.They bothproduce a large amount of oil and gas compared to reserves each year, and this ispossibly a sign of prosperity for the two largest oil and gas companies in the US

Similarly, none of the standard metrics of this company has strong correlationwith TSR However, some slight relationships can be identified: FCF Growth ispositively related with TSR because correlation is0.212; Earnings Margin and DilutedEPS are negatively realated with TSR, as correlation are -0.186 and -0.180,respectively.

3 ConocoPhillips

For ConocoPhillips, in contrast with previous two companies,Production/Reserves has a negative (although weak) relationship with TRS, while RLIhas a positive relationship This suggests that these two ratios can vary in meaning Itwould seem a long RLI in years would be better as resource would be produced over along period of time However, if a company is lacking the ability to develop this

resource, it would have a long RLI, so investors should also see whether the companyhas the abilitys to produce this particular resource.

Standard metrics appear to be good metrics to measure this company’scorporate finance Five out of six metrics have moderate to strong positive linearrelationship with TSR, with p-values small enough to infer for the population at 95%confidence level

4 EOG Resources

The only relationship revealed in this case is the weak positive linearrelationship between Reserve-Replacement Ratio and TSR, with correlation ofapproximately 0.357

Similarly, FCF Growth is weakly positivelyrelated to TSR, with correlation of 0.473.

5 Occidental Petroleum

For this company, Production/Reserves has a weak, negative relationship, andRLI has a positive relationship with TSR Reserve-Replacement Ratio is moderatelypositively related with TSR at correlation of 0.553, while Production Costs/boe ismoderately negatively related with TSR at correlation of -0.626 The small p-valuesshow that these are both effective metrics to measure stock performance

The relationships between the standard metrics and TSR are insignificant,except for EPS Growth and FCF Growth These two metrics are both weaklypositively related to TSR at correlation of 0.305.

6 Marathon Oil

The first two ratios of this company show the same tendencies asConocoPhillips’: Production/Reserves has a negative relationship, and RLI has apositive relationship with TSR However, both of them are weak

The relationships between the standard metrics and TSR are insignificant,except for EPS Growth and FCF Growth There is a weak positive relationshipbetween EPS Growth and TSR at correlation of 0.445 Meanwhile, FCF Growth isstrongly related to TSR at correlation of 0.742, and is effective to evaluate oil and gasstock in population (p-value = 0.007).

7 Anadarko Petroleum

The signs of the coefficients of correlation show that all five featured metricsabove are following normal reasoning: Costs and Production/Reserves are negativelyrelated with TSR, while RLI and Reserve-Replacement Ratio are positively relatedwith TSR However, three of them are too small to take into consideration The notablerelationship arethose between Reserve-Replacement Ratio and Productiontion