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Finding the Right Oil Plays Is Easier than You Think

Written by Keith Kohl
Posted September 22, 2009

It's a mistake that too many people make.

I'm not immune, by any means. In fact, one of the first trades I ever made proved to be an important lesson.

The mistake was simple. Several years ago, I was star-struck by a big name in natural gas and thought buying this company would prove a win-win deal for me.

A few months later, I swallowed my pride and ended up taking the big loss.

Believe me, it's a mistake I won't make again, and the good (if any) that comes from a loss is that the bad deals end up being the ones we learn from.

So what has me thinking about a painful trade from the past?

A reader of mine recently shared what he called, in his words, a 'hugely successful trading story.'

At first, I was elated. . . I'm always in the mood to hear a good story from one of my readers. Yet the moment he told me the name of the company, I couldn't help but let out a knowing sigh.

His play was none other than Exxon Mobil Corp. (NYSE: XOM).

I recognized his mistake as my own from the past, and knew my reader had been star-struck with the bright lights surrounding this play.

With a monster market cap around $336 billion, Exxon is one the largest publicly traded corporations in the world. I had a feeling he had simply seen the name Exxon and assumed it was his best chance to take advantage of $70/bbl oil.

Of course, my reader seriously misunderstood the situation. . .

A Case of Mistaken Identity

This reader told me about three companies that were bound to perform well, especially considering the fact that 'they have all the oil' — his words, not mine. He recognized the names Exxon Mobil, Chevron, and ConocoPhillips. . . and he jumped in prematurely.

Just so there is no confusion, I immediately want to clarify: these companies don't even crack the top ten in terms of their piece of the world oil reserves pie. Rather, the huge national oil companies from the world's largest producing companies, like Saudi Aramco (Saudi Arabia's national oil company), are leading the pack from a reserves standpoint. Saudi Aramco comfortably sits on top with 260 billion barrels.

In fact, about 95% of the world's oil and gas reserves are held by state-owned oil companies, not the publicly-traded Exxon, Chevron, and ConocoPhillips. These companies are included in the group of the six largest non-state-controlled energy companies (known as supermajors) only control about 5% of global oil and gas reserves.

According to Exxon's 2008 annual report, the company has approximately 12 billion barrels of net proved developed and undeveloped reserves — but I'll get to their reserves in just a second.

Even if OPEC's oil reserves suddenly increased during the 1980s, the fact remains Exxon still wouldn't come close to a company standing like that of the state-owned oil companies. If you haven't heard about their suspicious reserve growth, I suggest checking it out for yourself. As you might be aware, OPEC members keep their data closely guarded. So until more acute data is released, the world will just have to take their word for it.

Not a comforting thought, is it?

Trusting Your Money in Exxon

Unfortunately, the deck is stacked against the supermajors like Exxon.

You've probably heard about how much trouble these companies have when dealing with foreign governments.

I've covered the feud between Venezuela and Exxon before. During the 2007 May Day takeover, Chavez nationalized all of Exxon's holdings in Venezuela. It took nearly a year before a U.K. court issued an order freezing $12 billion worth of assets taken from Exxon. A month later, a judge canceled the freeze order.

If you need recent proof of just how guarded countries are over their oil resources, look no further than Iraq. In an effort to develop its giant oil fields, Iraq set an auction up for six bids. The auction resulted in just a single successful bid. The problem was that Iraq was unwilling to give up their oil fields for such low bids.

I wouldn't be surprised to see more resistance from foreign governments, especially as oil prices inevitably move higher.

And then there is the confusion with the reserves reported by Exxon. Last year, the company said it had replaced 103% of its reserves. However, we're not talking about the light sweet crude pumped out of Texas. . .

Taking a closer look at their reserves, you would notice right away that 2.7 billion barrels are from Canada and South America.

Depending with whom I'm talking, developing the oil sands can cost up to $75 per barrel, meaning that any future shock in oil prices could be disastrous.

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Are You Satisfied with Single-Digit Gains?

Look, I'll let you make your own call on Exxon's operations, but I'll ask you the same question I did to my star-struck reader: "Do you honestly feel like you're getting the best bang for your buck?"

His silence spoke volumes.

More importantly, I wanted to know how the stock has performed so far. Since he bought into Exxon, he's up less than 3%.

At first, I had thought this was a recent trade. After the sell-off from late last week to yesterday, I could understand his gain. He mentioned how he made the trade three months ago, anticipating a demand jump in July.

One thing's for sure — the numbers don't lie.

I noticed something else, too. Even if my reader managed to buy Exxon at the very bottom during the first week of March, he'd only have walked away with a 9% gain in seven months. The news wouldn't have been much better if he picked one of the other supermajors. In the last three months, ConocoPhillips and Chevron posted gains of 15% and 10%, respectively.

Perhaps he would have been better off taking a bit of advice from these pages. If anything, he'd have realized that there are much better investments to be made.

Back during the first week of March, for example, I gave readers a heads-up on a few of my favorite oil stocks approaching their 52-week lows. One was Whiting Petroleum (NYSE: WLL). Had he decided to act at the time, he would be walking away with a gain of 195%!

Compare that to his 3% gain. . .

And even if he was late to the party and made the trade in June, at the time he bought Exxon, he would still be up much more than he is currently — nearly 60% today.

Not everyone is lucky enough to pick the exact bottoms, but my point here is to show him that there are much better opportunities out there. You just have to look past the big names that dragged their feet this year. After all, Exxon's total revenue fell 47% in the second quarter, compared to a year ago.

But I'll let you make your own call on whether or not 3% is worth your time.

Until next time,

Keith Kohl Signature

Keith Kohl

follow basic@KeithKohl1 on Twitter

A true insider in the energy markets, Keith is one of few financial reporters to have visited the Alberta oil sands. His research has helped thousands of investors capitalize from the rapidly changing face of energy. Keith connects with hundreds of thousands of readers as the Managing Editor of Energy & Capital as well as Investment Director of Angel Publishing's Energy Investor. For years, Keith has been providing in-depth coverage of the Bakken, the Haynesville Shale, and the Marcellus natural gas formations — all ahead of the mainstream media. For more on Keith, go to his editor's page.

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