Safe Bets in an Unsafe World

The first six months of 2014 are nearly in the books and it has proven to be a rocky ride for the oil markets.

Back in January, analysts predicted that the world was heading into a period of oversupply and lower prices. Iraq's oil production was surging, and was expected to quickly top 4 million barrels per day (bpd), after averaging just over 3 million bpd for 2013.

Libya had been experiencing political infighting, holding back its oil sector. But, 2014 was expected to bring brighter days and see a return of some of Libya's 1.8 million bpd of production capacity. Iran too was demonstrating an ability to revive parts of its oil production, and a warming of sorts with the West held promise that Iranian oil could soon return to market.

Against this backdrop, the U.S. shale patch continued to post remarkable gains in oil output.

Six months later, there seem to be more geopolitical flashpoints than ever. Russia annexed Crimea, and cut off natural gas supplies this week, raising concerns about supply disruptions to Europe. Although the standoff had seemed to be pushed to the back burner in recent weeks, the sudden escalation could renew questions about the exposure of western oil companies in Russia. ExxonMobil (NYSE: XOM) is betting big on the Russian Arctic. BP (NYSE: BP) signed an agreement with Rosneft to explore for shale oil in the Urals. Total (NYSE: TOT) signed a similar agreement with Lukoil.

If natural gas flows to Europe are disrupted because of Gazprom's action against Ukraine, the West could turn its attention back to sanctions. For now, it still seems likely that the oil majors will escape unscathed, but there is some risk there.

In a more urgent (and bloody) disaster, we discussed last week about the brewing crisis in Iraq, and the threats to oil companies operating in affected areas. After the second week of the chaos, the state looks no closer to resolving the calamity. Indeed, the splintering of the country along sectarian lines seems to be hardening, with a full on civil war in the works.

Investors can never predict where fires will suddenly spring up, and operating in key regions of the world that have high growth rates but suffer from political risk have long been a part of doing business. But the events so far this year may have many investors suffering from whiplash as they have seemingly had to turn their attention to a new crisis each week.
In a world of geopolitical upheaval, the smart investor plays it safe.

That means keeping your money in steady companies operating in safe parts of the world. The growth rates may not be eye-popping, but a coup won't upend your portfolio either.

And the bonus is, higher oil prices due to instability elsewhere could help your mom and pop oil company that is going about its business safely at home. That may sound cynical, but it is merely a hedge.

Take a renewed look at the following companies, which are not only operating in regions largely free of political risk, but could even stand to benefit from a spike in oil prices from turmoil in the Middle East and beyond.

EOG Resources (NYSE: EOG) is one of the best managed companies that focuses exclusively on North American oil and gas. Importantly, it is one of the leading producers in the two formations principally responsible for America's shale revolution - the Bakken and the Eagle Ford. EOG has posted impressive growth rates for its oil production assets. In 2011, production jumped by 51% from a year earlier, and in 2012 and 2013 EOG successfully lifted production by another 39% each year, respectively. It now produces over 220,000 barrels of oil per day, and has some of the most impressive initial flow rates in the Bakken and Eagle Ford.

EOG also holds assets in the Marcellus, the Permian, and Canada's oil sands. The only downside for EOG is that it has performed so well in the stock market - its share price is up 33% on the year, so investors may want to wait for a good entry point. But EOG is a fine stock to own in today's crazy world.

Continental Resources (NYSE: CLR) is another North American option. It has just over 1 billion barrels of proved reserves in its portfolio, with a heavy slant towards the oil-rich Bakken. Continental has succeeded in boosting both reserves and production each year since 2008. In the first quarter of 2014, Continental produced 152,000 barrels of oil equivalent per day, a 6% jump over the previous quarter. This year Continental plans on drilling more than two dozen wells in the Three Forks formation, which lies below the Bakken. While Continental depends upon the Bakken for 55% of its production, it is also producing in Oklahoma, Colorado, and Montana - all far from the violence in the Middle East.

Pioneer Natural Resources (NYSE: PXD) is another company safe from political risk, as it has most of its operations in drilling-friendly state of Texas. It successfully boosted its oil production across its 230,000 acres in the Eagle Ford, from only 2,000 bpd in 2010 to 38,000 bpd in 2013. More interestingly are Pioneer's assets in the Sprayberry field in the Permian Basin. Pioneer recently estimated that the Sprayberry field could hold more than 50 billion barrels of oil equivalent, making it the largest U.S. oil field and the second largest in the world. How much of that oil can Pioneer extract profitably is uncertain at the moment, but it is sitting on some acreage with high potential.

On the smaller side, there is Penn Virginia Corporation (NYSE: PVA), an independent operator with a market cap of just $991 million. It operates largely in the Eagle Ford, Haynesville Shale, and the Marcellus Shale. It produces just over 11,000 bpd in South Texas, and in 2013, it spent 97% of its capital budget on the Eagle Ford. The company is a riskier bet than the previous companies, due to its small size, but it is showing great promise. It used to be a predominantly natural gas producer, but in 2010, it shifted towards oil. Over the last year, its stock price has more than tripled, from just under $5 per share at this point last year, to $15.11 per share as of June 18.

Major oil and gas companies are often rewarded by taking risks and moving into underexplored territory. Sometimes they hit it big because other companies are unwilling to operate in such risky environments. But, at this point in 2014, with so many oil companies getting punished because of "above-ground" issues, some investors may be growing wary of political risk, and just want to focus on the fundamentals of producing oil and gas. North Dakota and Texas are well-trodden areas, but sometimes it pays to play it safe.