Rising Oil Prices Make E&P Profitable

The Energy Report: Your area of coverage is exploration and production. Do small caps and large caps trade similarly? Do they follow similar patterns?

Phil McPherson: Yes. In the exploration and production (E&P) space as a whole, it's a pretty simple business model. The size of the company is basically a reflection of the ability to accelerate that business model. And your ability to execute and meet timelines usually has just as much of an impact on your market cap as the success or the failure of the actual oil and gas (O&G) play. I'm covering many California companies, including Berry Petroleum (NYSE:BRY), Plains Exploration & Production (NYSE:PXP) and this small oil producer that I stumbled across, NiMin Energy Corp. (TSX:NNN). I think they all have the same type of idea. But in terms of how they trade, every company is in some ways going to trade as does the commodity. So you're going to go up and down on certain days because oil's up and oil's down. I used to joke with people that you could announce the best well in the world, but if oil prices are down, your stock is going to go down. A small cap of $100 million to $500 million trades more on the net asset value (NAV) or the value of the perceived potential of your properties. When you get to that $500 million– $2 billion area, you start looking at a multiple of EBITDA (earnings before interest, taxes, depreciation and amortization) or cash flow multiples. When you get to be large cap, you're really more of an earnings story; then you start thinking about P/E ratios and cash flow ratios.

TER: Do inflationary pressures point towards higher oil prices?

PM: With the economy recovering, and as more people feel that the double-dip recession is not going to happen, oil prices are tending to stay stronger. However, it seems to me the tail is wagging the dog right now, with the U.S. dollar going down and the price of bonds being up, and the yield being extremely low. To me, it has more to do with the price of oil than necessarily the pure supply and demand fundamentals, because we still have excess supply of oil via OPEC. If you're bullish on oil or bullish on the economy, then you use those dips as opportunities to gain more exposure. (more)