With turmoil in Ukraine, investors should consider looking for opportunities in the energy space. Geopolitical tension of almost any sort tends to be a near-term catalyst that drives the price of oil higher, as not only do investors fear that people in these areas (in this case Ukraine) might have trouble getting energy, but they fear contagion and the possibility that we could have several regions throughout the globe where oil is difficult to come across.
This fear should be especially heightened given that in the ongoing conflict, Russia — one of the world’s largest oil producers — is being threatened with economic sanctions, and the government could respond by limiting oil exports to the United States, the European Union, and their allies.
Given this situation in particular, I think investors should consider owning oil companies that not only profit when the price of oil rises but that have been shifting their portfolios to assets in safer jurisdictions. Apache (NYSE:APA) is one company that comes to mind.
Apache has a very long history of generating shareholder value by growing its oil and gas production. However, over the past several years, shareholders were frustrated by the fact that Apache operated a lot of oil wells in Egypt and Argentina. Recently, the company decided to reduce its exposure to Egypt from 20 percent to 13 percent of its portfolio, and it decided to divest its Argentinean assets. Going forward, Apache is going to be a North American oil and gas producer.
Furthermore, it is going to be a leader in the infamous Permian Basin. The Permian Basin is a region in Texas in which a lot of oil has been discovered recently. Much of this oil has been or will be extracted using the controversial method of hydraulic fracturing, or “fracking.” This controversial method of oil and gas extraction consists of a company using water in order to fracture large rocks in the ground in order to get to the oil between them.
While its environmental impact has led to opposition and controversy, there is little doubt that oil companies operating in regions such as the Permian Basin will be fracking in order to substantially increase their oil and gas production. Apache is a leader in this, and it plans on spending billions of dollars in the Permian Basin in order to increase its oil production. Going forward, the company’s management projects that it will see double-digit increases in its Permian Basin oil production.
Despite this projected growth and the drastic steps that management has taken to de-risk its portfolio in geopolitical terms, the shares have not been performing well. In 2007 and 2008, the stock spiked up to $140 per share only to collapse later in 2008 with the oil price to just over $50 per share. Since then, it has been consolidating within this wide range. However, throughout the past five years or so, Apache has been growing production, growing its earnings power, shifting its assets out of high-risk jurisdictions, and increasing the amount of capital it is returning to shareholders.
Furthermore, the stock roughly trades at the company’s net asset value, which is extremely appealing given that the S&P 500 in the aggregate trades at over 4 times net asset value. While the consolidation may very well continue, I think the next major move is going to be higher, and a crisis such as the one going on in the Ukraine is a potential catalyst that can drive oil and Apache shares higher.
Before investing, I highly recommend that you take a look at the company’s latest analyst day presentation, which was released toward the end of February. It is a wealth of information, and while any company’s perception of itself is going to be biased, I see very little exaggeration of any in this document.
Furthermore, investors need to consider a couple of potential risks. First, the company still has some assets in Egypt, which continues to be a relatively risky place to mine. Second, the company’s emphasis on investing in the Permian Basin could end up failing if the U.S. Environmental Protection Agency comes out with more stringent regulations that make it harder for the company to operate there.
Finally, while political tension in Ukraine can drive the oil price higher, keep in mind that we are seeing weakness in the global economy, especially in developing markets. Weakness in the earnings of some American bellwethers such as Wal-Mart may indicate that we are seeing economic weakness in the U.S., as well. A weak economy means lower oil demand, which could push prices lower. Lower oil prices will be reflected in Apache’s bottom line.
But aside from these three risks, Apache shares appear to be very compelling in both the short and longer terms.