The returns are coming in, and it’s safe to say 1998 was a year the energy industry – particularly producers – would like to forget. Not all energy sectors suffered equally, but shareholders in every energy province have something to grouse about judging from earnings releases and analyst reports.
Low prices clearly hit producers square on the nose while others were relatively spared, noted Jofree Corp. analyst Carol Freedenthal.
The median stock in a universe of 279 publicly traded oil and oil service firms tracked by Energy consulting firm John S. Herold Inc. returned a negative 36.1% to investors. Herold’s “Oil Share Market Performance 1998 Year-End Review” analyzed and ranked companies by stock market performance. Losers overwhelmed gainers by a margin of 238 to 40 with one issue unchanged. While in 1997 nine issues doubled in price and 30 did so in 1996, not a single energy company’s share price doubled in 1998.
“The exploration and production groups were devastated worldwide, especially those with large future capital costs associated with their undeveloped properties,” said Robert E. Gillon, John S. Herold vice president. E&P companies dominated the Herold survey with 147 producers represented. “Results were as dismal as one might expect from the commodity price behavior, perhaps worse. Only 12 E&P shares managed to gain on the year, seven of which were Canadian-based and, as such, drew some benefit from the weakening local currency. Notably, all 12 gainers are principally focused on natural gas, by far the stronger of the commodities. That might imply that battered oil producers have substantial recovery potential.”
Particularly discouraging is that producers who grew production, in some cases substantially, were just spinning their wheels, making less money than the year before because of depressed prices. Despite record fourth-quarter production, Vastar Resources reported 1998 earnings that are down 43% from the previous year. Last year’s earnings were $136.4 million, compared to $240.5 million in 1997. During the full year, Vastar total production increased by nearly 9% to 1,289 MMcfe/d. Gas production was 988 MMcf/d, up from 882 MMcf/d in 1997. Average wellhead prices were down, though, to $1.85/Mcf from $2.03/Mcf in 1997.
“Gas realizations for the full year of ’98 were down 18 cents from the prior year. This is in spite of about a 48-cent deterioration in the benchmark Henry Hub price,” said Vastar CFO Steve Shapiro during an analyst conference call. “The difference between the 48 cents and our 18 cents realized is primarily derived from a tighter basis, particularly in the San Juan [Basin] and improvement in our hedge positions year over year. Of that differential, about 20 cents came from the hedge, and about four cents from the basis.”
Despite Vastar’s performance, the company was one among a handful of E&P companies worldwide to achieve respectable market returns. Vastar gave investors a nearly 22% total return, driven by Gulf of Mexico discoveries, noted Herold, and was one of only two E&P companies worldwide to better the return of the Dow Jones Industrial Average. The other was Alberta Energy Ltd. with a more than 20% total return.
Similar to Vastar, Enron Oil &Gas Co. (EOG) 1998 net income was less than half what it was in 1997 despite higher volumes, which could be considered additional evidence Enron really is considering an “unsolicited offer” to buy the company.
In December Enron notified the Securities and Exchange Commission it received an unsolicited offer for its 53.5% share of EOG (see NGI Dec. 21, 1998). The unnamed third party would acquire Enron’s shares in EOG and make an offer for all the outstanding shares. The third party also would require Enron to dispose of certain other assets. In a research note following an Enron analyst conference last week, PaineWebber said Enron believes any EOG sale would be effectively balance sheet neutral. Unlike Vastar, EOG total return to investors was negative 18%, according to Herold.
In 1998, EOG had net income of $56.2 million, compared to $122 million for 1997. The company posted record 1998 delivered volumes of 417 Bcfe, up 13% on a per-share basis over 1997 volumes of 377 Bcfe. EOG North America wellhead gas delivered volumes averaged 776 MMcf/d in 1998, up from 758 MMcf/d during 1997. North America wellhead gas prices decreased 15% to $1.86/Mcf in 1998 compared to $2.20/Mcf in 1997.
Freedenthal said a continuing drop in oil prices could lead to supply-demand equilibrium and price stability sooner than some people in the industry seem to think. “Let’s say we get back to some normal weather. I think that could be sooner than some people think.” He’s heard others projecting oil supply-demand equilibrium as far away as three to five years off.
While commodity prices are down, though, Freedenthal said he expects more producer properties to come on the market. “I don’t think there’s any question those that have the money will be out there buying things.. There’s no question that at these prices reserves are worth a lot less and you’re going to have to write them down.”
Pipelines, Diversified Companies Fare Better
Not all the news coming from year-end reports is bad. While producer earnings were off sharply, pipelines and diversified companies generally fared much better.
El Paso Energy earnings hit a new record for 1998, and each of the company’s operating segments was credited for the success. El Paso diluted earnings per share rose 16% to a record $1.85 in 1998 from $1.59 in 1997. Consolidated earnings before interest expense and income taxes (EBIT) for 1998 increased to a record $644 million compared to $578 million in the year ago period.
“Each of El Paso Energy’s operating segments had an outstanding year in 1998, enabling the company to deliver substantial, high quality earnings growth,” said CEO William A. Wise.
El Paso’s Tennessee Gas Pipeline, and El Paso Natural Gas Co., reported 1998 EBIT of $358 million and $217 million, respectively. Tennessee’s earnings increased 13% from 1997, while El Paso reported record throughput on its system. Earnings from the company’s non-regulated businesses — El Paso Field Services Co., El Paso Energy Marketing Co., and El Paso Energy International Co. — totaled $110 million compared to $48 million in 1998. Strong gains in both the energy marketing and international segments contributed to the significant increase. Full-year EBIT for El Paso Field Services was $75 million. El Paso Energy Marketing’s EBIT was $9 million for ’98, compared to a $28 million EBIT loss in 1997, while EBIT for El Paso Energy International rose to $25 million compared to $2 million in 1997. El Paso Natural Gas gave shareholders a 7% total return in 1998, according to Herold.
Spurred on by strong operations that fought through an arduous fourth quarter, Duke Energy posted a 36% increase in annual earnings to $3.41/share in 1998 from $2.51/share in 1997. Duke’s revenues increased to $17.6 billion compared to $16.3 billion in 1997. Earnings before interest and taxes (EBIT) rose $540 million from the previous year, reaching $2.65 billion.
Duke gas transmission operations had to work hard to beat the fourth quarter blues. For the year, EBIT was up 13% from 1997 to $702 million. This total was bolstered by a pre-tax $39 million gain due to the resolution of gas supply costs. Operating revenues fell $54 million dollars to $1.54 billion in 1998, but expenses also fell from $964 million in 1997 to $864 million in 1998. Duke’s sale of Panhandle Eastern Pipe Line Co. and Trunkline Gas were not included in the earnings report because it hasn’t been completed yet. Duke said it expects the deal to close this quarter.
Despite the warmest year since 1921 in Michigan and a lackluster fourth quarter, CMS Energy reported net income rose to $284 million in 1998 from $244 million in 1997. CMS total return to shareholders was 12.8% in 1998.
William McCormick, CEO, called 1998 “a year of tremendous business development.” Some new assets McCormick thinks will help the company’s future growth include the Panhandle Eastern Pipe Line and Trunkline Gas, which it is buying from Duke Energy for $2.2 billion; the construction and operation of a 550 MW, $240 million cogeneration power plant in Dearborn MI; the acquisition of Tulsa, OK-based Continental Natural Gas for $153 million; and various international operations and purchases.
CMS’ oil and gas exploration unit and its Consumers Gas Group were the only two subsidiaries to experience declines. The oil and gas exploration unit lost 76% of its net income compared with 1997 to finish at $6.4 million. Consumers Gas Group reported a total net income of $51.6 million, down from the 1997 totals of $60.1 million.
Unlike others in the group, Williams’ performance faltered last year. None of the company’s three main subsidiaries matched 1997 earnings levels. Total 1998 net income was $140.7 million, down from $368.3 million in 1997. Williams total return to shareholders in 1998 was 11.5%.
Williams’ gas pipeline businesses reported 1998 profit of $610.4 million, down from $614.7 million for 1997. Expansions on the Transco and Texas Gas systems combined with lower operating and maintenance expenses to bolster earnings, and a fourth quarter $58 million charge for long-term supply contracts hurt year-end results. Williams Energy Services registered the largest year-to-year decrease of the subsidiaries, posting a 1998 profit of $407.3 million, down more than $150 million from 1997.
Despite the disappointing results at affiliate EOG, Enron Corp. reported a 16% increase in 1998 earnings per diluted share, led by wholesale energy marketing operations. Earnings rose to $2.01/share from $1.74 in 1997. Corresponding net income increased 36% to $698 million from $515 million during the year. The comparisons are before non-recurring items and last year’s gain of $61 million, related to the sale of a 7% interest in Enron Energy Services. Enron total return to shareholders was a strong 39.6% in 1998.
“Across Enron, 1998 was an excellent year,” said Kenneth L. Lay, CEO. “Our Wholesale Energy Operations and Services business led the company’s growth during the year, achieving record levels both in volumes of energy marketed and in earnings. In addition to positive developments in our established businesses, Enron Energy Services has advanced to a fully developed business with broad new capabilities to provide energy outsourcing products to business customers across the nation,.”
Enron achieved an almost 40% shareholder return during the year, significantly above the very strong returns of the broader U.S. equity market, Lay said.
In 1998, Enron Energy Services (EES) incurred a loss before interest and taxes of $119 million in 1998 compared to a loss of $107 million in 1997, or $(0.24) per diluted share in each year. The losses stem from ongoing efforts to build the business. During the year, EES exceeded its contracting objectives and signed contracts representing $3.8 billion of customers’ future energy expenditures. Based on both the current backlog of contracts and contracting activity, EES expects to double the level of new contracts to be added in 1999. In addition, earnings are expected to be positive in the fourth quarter of 1999.
“Worth addressing,” wrote PaineWebber’s Ronald Barone, “is that the Street often forgets to associate any value creation with the ongoing losses at EES (losses which decrease Enron’s earnings, ‘artificially’ increasing its P/E). In short, this business could evolve into a key growth driver by the turn of the century and should be given value today, despite lingering losses.”
Joe Fisher, Houston
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