Total Has More To Lose With Falling Oil Prices

By Stephen D. Simpson, CFA | June 29, 2012 AAA

Major oil and gas companies are clearly suffering as oil prices decline. While some investors look at this situation as a bargain-in-the-making on the basis of a never-ending demand for oil around the world, the truth is a little more nuanced. Oil demand does indeed look solid on an intermediate-term basis, but many majors are finding that they have to spend enormous amounts of money to harvest their reserves. Consequently, today's oil prices do start to change the expected path for project development and dividend payouts.

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Total (NYSE:TOT) is one of those companies that looks vulnerable to the squeeze play. Not only does Total have a sizable downstream (refining) business that drags on results, but the upstream operations have some questions around them as well. With so much expected production tied to areas with political risks and/or advanced technological needs, Total has a has a problem with sub-$90 oil.

SEE: What Determines Oil Prices?

Reserves Look Good ... or Do They?
At over 12 years of reserve life, Total would seem to be in good shape, relative to companies like Royal Dutch Shell (NYSE:RDS-A, RDS-B), Eni (NYSE:E), Statoil (NYSE:STO) and Chevron (NYSE:CVX). Unfortunately, it's not quite that simple.

Total has a decent amount of oil in its reserve base (more or less in line with its current production profile), but more than 40% of these reserves lie in Africa and a substantial portion of the ex-Africa reserve base involves the Mideast and Russia. At the risk of stating the obvious, operating in Uganda, Nigeria, Iraq and Russia is not like operating in the North Sea or Texas - there are substantial political risks, as well as issues tied to adequate material and labor supply.

But wait, there's more. Total is also looking at a much larger future contribution from heavy oil, unconventional plays and technologically demanding resource basins. In other words, Total is going to have to spend a lot more to get that oil; good news for companies like Seadrill (NYSE:SDRL) and Schlumberger (NYSE:SLB), but not for Total shareholders. For a company that already has a higher-than average per-barrel finding and development cost, that's not good.

SEE: A Guide To Investing In Oil Markets

Is There any Good News?
It's not all doom and gloom for Total. The company is poised to become a major global player in LNG, as it is already the second-largest natural gas player (behind Royal Dutch). Although LNG is still an immature market, odds are good that this will be an attractive market in the years to come, as energy-users cope with increasing oil prices by switching to cheaper natural gas.

SEE: What Determines Oil Prices?

Total may also be poised to get more aggressive with its downstream operations. Total is a major refiner in Europe, but the returns from this business have been decidedly lousy. The hope here, then, is that the company either substantially restructures these operations or jettisons them entirely.

Last and not least, the acquisition of SunPower (Nasdaq:SPWR) has been a dud so far, as the company paid over a billion dollars for a not especially well-run solar company. I don't think too highly of how SunPower has been run, but the company's panels are quite efficient and I think this business should offer some upside once the solar industry emerges from what has been a prolonged sector recession.

SEE: Analyzing An Acquisition Announcement

The Bottom Line
My biggest worry with Total is that the current oil prices simply don't support the company's plans. As I see the math, Total needs oil prices in the range of $90 to $100 per barrel to support its development pipeline and dividend plans. With Brent crude prices hovering around $90, that's getting pretty dicey.

What's more, while falling oil prices may encourage other companies to cut development plans, Total's breakeven costs are on the higher end of the scale, so they will be among the first to suffer from lower anticipated production growth rates. At the same time, service and development costs never seem to fall as fast as crude oil prices.

Even on the basis of a below-average forward EV/EBITDA multiple, Total looks really cheap. The problem is that so do companies like Statoil, Eni and Apache (NYSE:APA), and there are arguably better reasons to own those three companies before Total. Still, there will be investors who are attracted to the sizable dividend at Total and, although I believe Total has unappealing exposure to falling oil prices, investors who believe in a quick oil price rebound might see this as a more leveraged play to that rebound.

At the time of writing, Stephen D. Simpson did not own shares in any of the companies mentioned in this article.

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