Saturday, September 6, 2008

Really Big Oil

The Financial Times had a good story a while back on how the role of Western oil majors has been replaced by state-owned firms.  With reserves in places such as the North Sea in rapid decline, the new seven sisters, such as Gazprom, Petrobras, or PetroChina, are holding the largest viable reserves of oil and gas.  The failure of some of these firms to ramp up production due to political pressures has sparked a Political Peak Oil that's probably more responsible than Peak Oil for higher energy prices.  

Buffett's purchase of PetroChina was an early recognition of the these firms' investment potential.  Since then, Buffett has exited his position; but a fall in energy prices and political risk has given these companies an attractive valuation.  PetroChina's extensive refinery operations, along with state-set pricing, has lowered their margins, but the Russian companies are doing better business than ever.  Gazprom and Lukoil are trading at about a third off recent highs.

Of course, there are a few concerns.   First, commodity prices are lower.  But these firms are a bargain even with lower oil and natural gas prices.  Second, there is political risk in investing in Russia.  Though this risk is considerable for a company such as Mechel (full disclosure: I am long MTL), it's hard to imagine companies as well connected as Gazprom or Lukoil taking another hit.  The war with Georgia, to the extent it matters at all, increases Russian energy grip over Europe.  Last, state-owned firms may be unlikely to invest in new production.  But current valuations compensates for low growth, and the Russians seem to know what they're doing.  

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