TOP CONTRIBUTORS

Anthony Citarrella

PXP AT A GLANCE

P/E ► -3.09   EV/EBITDA ► -5.33   ROA ► -12.2% AVG ROE ► -33.5% AVG Debt to Equity ► 1.42 AVG Current Ratio ► 1.24 AVG Interest Coverage Ratio ► -15.7 AVG

 

 

 

 

 

 

With proved reserves almost exclusively on and offshore California, Plains Exploration and Production Co. is somewhat of a misnomer. At the end of the 2006 fiscal year, approximately 99% of proved reserves were located both on and offshore California, and 95% of total reserves were heavy crude oil,^[1] which traditionally sells at a discount to lighter, sweet crude. Furthermore, during the three year period ended December 31, 2006, only six percent of their total successful projects were exploratory in nature. ^[2]

Despite their historically selective approach, the company has recently been implementing a more aggressive growth strategy. Their exploration related spending has spiked from 15% in 2005 to 50% (or $300 million) in 2007.^[3] In May of 2007, the company acquired 60000 acres in Colorado that has proved reserves equal to 15 million barrels of oil in which 97% is natural gas.^[4] After the Colorado acquisition, the company acquired Pogo Producing Company (PPP) in November of 2007 with a blend of cash and equity.^[5] These moves highlight management's efforts to expand their portfolio beyond the mature Californian sites.

Business Overview and Financial Operating Metrics

The majority of PXP's production is a low-grade, heavy crude oil. In order to extract this oil, it first must be heated in order to improve its viscosity. Naturally, this is bad news for any company's bottom line because it translates into higher operating expenses (see how their operating margin compares to its competitors in the table below). On the other hand, the near term growth prospects for the existing wells are commendable and management has been taking strides to geographically expand their operations. Recently, they have even gone as far as to initiate exploration and production in the deepwater oil exploration arena offshore in the Gulf of Mexico.

Below are some of the relevant operating metrics for Plains Exploration and Production Co. over the past three years. In late 2006, the company successfully divested properties for a total of $1.6 billion in cash proceeds. One of the larger transactions was the sale of some of their non-producing assets to STATOIL ASA (STO) in which the company realized a $638 million pre-tax gain. Furthermore, they contracted future negotiation rights to potentially sell off some of their more risky Gulf of Mexico assets. ^[6]

Trends & Drivers

PXP's Movement into Deepwater Oil Exploration

Traditional oil producing basins have matured, particularly for PXP, and oil exploration and production companies have started to look for new reserves in more challenging, deep-water environments. Plain's recent offshore acquisitions and movement into the Gulf of Mexico marks their entrance into unfamiliar territory and highlights their shift towards a more aggressive strategy.

PXP's movement into the more risky deepwater environment can prove unprofitable for several reasons. First, offshore Mexican wells are generally expensive and they usually have relatively low success rates along with a high level of physical risk. Furthermore, to date, Plain's has been heavily focused in California where the majority of their infrastructure exists and it may be costly to transport equipment and develop a new infrastructure at a new location. On the other hand, in order to hedge some of the inherent risks associated with managerial inexperience and increase the likelihood of success, management has partnered many of these offshore projects with companies such as Exxon Mobil (XOM), ChevronTexaco (CVX), and Royal Dutch Shell (RDS'A).

PXP's Dense Geographic Concentration and Narrow Customer Base

Although being so heavily concentrated in one area has administrative and expertise building benefits, it also leaves the company subject to an array of other risks. California, where the vast majority of PXP's proved reserves are located, is notorious for coastal earthquakes. Therefore, risk of natural disaster is prominent to the existing Californian reserves and the threat of hurricanes is prevalent to the exploratory initiatives in the Gulf of Mexico. In addition to the the risk of natural disasters, management also acknowledges other concerns stemming from dense operations such as increased state regulation (such as pollution limitations), regional price fluctuations, and a lack of product marketability due to the low grade of oil they produce.^[7] Furthermore, the company has contracts to sell the majority of their oil production to only two customers; CONOCOPHILLIPS (COP) and PMLP. Although these contracts may decrease some marketability risk, it also exposes them to a significant external credit risk from each of the two counter parties.^[8]

Rising Oil and Gas prices as Revenue Driver

PXP is highly dependent on favorable market prices for oil, which tend to fluctuate significantly over time.^[9] Recently, the price of oil has surged, and PXP's average realized price per Bbl jumped $38.81 from first quarter of 2007 to $87.03 in 2008. ^[10] Furthermore, the company usually hedges the prices at which it can sell oil & gas. By use of derivatives, the company locks in a price or a range of prices, which limits downside but also presents an opportunity cost if oil prices rise significantly over the lives of contracts.^[11]

Hybrid and Alternative Energy Technology

Rising oil prices have led both consumers and companies to seek out alternative sources of energy and to invest in renewable energy such as nuclear, solar, wind, biofuels, and ethanol technologies. As global consumer demand shifts toward renewable energy sources and incentives to develop long-term solutions to the world's dependence on oil and gas become stronger due to recent environmental concerns over climate change, consumer consciousness and the entrepreneurial profit motive may adversely affect the oil and gas industry. With the advent of hybrid and fuel cell vehicles and the cost of gasoline becoming quite high, consumers have become less inclined to purchase gas guzzling SUVs as opposed to more fuel-efficient cars. As a result, the company stands to face long-term materially adverse effects if the oil and gas industry encounters a decrease in demand.

Competition

Although PXP has been geographically concentrated, they have not been able to take advantage of managerial efficiencies by minimizing administrative expenses. In addition to this, the nature of PXP's extraction processes yields a comparatively low operating margin relative to their competition. However, in order to remain competitive, PXP has been becoming more exploratory in nature, hoping to expand their holdings and production beyond the rapidly maturing Californian reserves.

Below is a table comparing several metrics from some of the main players in the independent oil & gas industry.^[12]

Footnotes

1. ↑ PXP 2006 10-K "Business" pg 6
2. ↑ derived from PXP 2006 10-K pg 7
3. ↑ PXP 2006 10-K "Business" pg 10
4. ↑ PXP 10-Q (third quarter) "Property Acquisition" pg 22
5. ↑ http://investor.plainsxp.com/phoenix.zhtml?c=132091&p=irol-newsArticle&ID=1073453&highlight=
6. ↑ PXP 2006 10-K "Management's Discussion and Analysis of Financial Condition and Results of Operations" pg. 33
7. ↑ PXP 2006 10-K "Risk Factors" pg 22
8. ↑ PXP 2006 10-K "Risk Factors" pg 23
9. ↑ PXP 2006 10-K "Risk Factors" pg 20
10. ↑ PXP 2008 10-Q "Managements Overview of Operations" pg 24
11. ↑ PXP 2006 10-K "Business" pg 6
12. ↑ All data compiled from company annual reports and 10-K's
13. ↑ MMcfe/day, or millions of natural gas cubic feet equivalent, is a measure of the level of production per day that converts oil into the energy-yielding natural gas equivalent using a ratio of 6 to 1 (natural gas to oil)