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Can Italian Oil Giant Eni SpA Prosper in a Qaddafi-Free Libya? Sure

Oil prices are soaring -- and the share price of Italian energy giant Eni SpA is falling -- on news that political unrest in Muammar Qaddafi's Libya has crippled crude exports from the oil-rich African nation. Contrary to current wisdom, the Italian energy conglomerate can prosper a regime change in Libya, helped by a geo-politically balanced portfolio of upstream production.

American Depositary Receipts of Eni SpA (E) have fallen some five percent since protesters took to the streets of Libya's two largest cities, Tripoli and Benghazi, back on Feb. 13.

Political upheaval has swept across Northern Africa, toppling governments in Egypt (Mubarak) and Tunisia (Ben Ali & family). Regime changes, coupled with violent clashes of "pro-democracy" demonstrators with authorities in the streets from Bahrain to Yemen and Iran, have fueled speculative jumps in crude prices this month -- with contract prices for April delivery hitting two-year highs last Thursday:

  • On the New York Mercantile Exchange, contracts for April delivery hit $103.41, the highest since Sept. 29, 2008
  • In London, ICE Brent for April delivery touched $119.79, the highest level since the Aug. 22, 2008
North Africa accounted for approximately 32 percent of Eni's total worldwide production of 1.81 million barrels per day oil and natural gas (equivalent) in 2010, according to regulatory filings. Of the 13.4 million acres under development in the region, most exploratory operations are being conducted in Algeria, Egypt, Libya and Tunisia - home to many of these falling dominoes!

Libya is Eni's largest source of oil and gas, accounting for approximately 244,000 barrels of oil equivalent a day. With Qaddafi loyalists battling anti-government forces town-to-town, most of Libya's aggregate production of 1.6 million barrels a day has been shut-in, according to Bloomberg and other news sources. Estimates are that about 50 percent of Eni's Libyan production has been curtailed, too.

Angelina Valavina, senior director in Fitch's EMEA Energy, Utilities & Regulation team, recently opined that the long-term credit rating outlook for Eni SpA remained vulnerable to developments in North Africa, in particular Libya:

"They have limited financial flexibility to absorb any material deterioration of cash flow or asset profile as a result of operational and/or market shocks," Ms. Valavina said.
I disagree. The "unpredictable event" is a variable that all of the energy majors always build into their production equations (going forward) -- whether that company be an Exxon Mobil (XOM) or Eni SpA. As it turns out, the health of Eni's balance sheet isn't as precarious as suggested by Ms. Valavina:
  • During 2010, at average Brent prices of between $60 to $80 per barrel, the company generated $2.41 billion (€1.75 billion) in free cash flow -- even after tax payments that ate almost 60 percent of operating profits;
  • Leverage (total liabilities to shareholders' equity) is a manageable 0.47 times. Further, of the $36 billion in net borrowings, only $265 million comes due in the next 18 months.
  • Planned capital budgeting needs for 2011 (about $13.8 billion) assume an average Brent price of $70 per barrel. With Brent crude prices well above $100/barrel, this windfall will likely be used for expanded production development and reductions in net borrowing ratios;
  • Return on average capital employed for the exploration and production division was a respectable 16 percent; and,
  • In terms of reserves, Eni replaced 125 percent of its production. Estimated proved hydrocarbon reserves totaled 6.84 billion barrels of oil equivalent at year-ending 2010. Further, the delivered reserve replacement ratio was 135 percent (10 year index of reserves, at planned capacity output growth of between two and three percent per annum).
Irrespective of what faction "liberates" Libya, there is one certainty: Those in control understand that an uninterrupted flow of oil and gas is the requisite "opium of the masses" (sorry, Karl Marx). Production need be brought back online in short order to ensure the health of whatever rhetoric rules the day in Tripoli.

Without the cash, this "Jasmine" revolution wouldn't survive a fortnight -- for whoever sits on the throne must pay the soldiers and feed the masses. As Eni SpA has roots planted in Libya that predate Qaddafi by more than a decade, it's likely the company will survive when existing contracts arrangements come due for "re-negotiations" (if Qaddafi gets the boot).

Eni also has new fields coming online across the globe -- an expanding footprint that could eclipse dependency on Libyan output by mid-decade. On the company's 2010 fourth-quarter conference call, chief executive officer Paolo Scaroni updated investors on significant progress with near-term production prospects in West Africa and the Americas (23.4% and 13.5% of 2010 production), including:

  • In November, a large gas discovery was spudded in the Perla field (the Cardon IV block, Eni 50% interest), located in shallow waters (210 feet) in the Gulf of Venezuela. Initial flow tests yielded 600,000 cubic meters per day (about 3,700 barrels of oil equivalent/day, or boe/d). The field is estimated to contain a reserve potential of more than 160 billion cubic meters of gas (1 billion boe/d), with an anticipated ramp-up date come mid-2013;
  • The company also signed agreements with the Venezuelan state-owned energy company (PDVSA) for a 40 percent stake to co-develop the giant Junin 5 oilfield, which is estimated to hold reserves of more than 35 billion barrels of oil. The two partners plan to achieve first oil by 2013 at an initial rate of 75,000 barrels per day, targeting a long-term production plateau of 240,000 barrels per day to be reached in 2018;
  • In a timely deal, Eni renewed its strategic partnership with Russian gas giant Gazprom, securing an agreement last week for the future handover to Gazprom of 50 percent of Eni's stake (33.3%) in the consortium developing the Elephant oilfield in Libya (located in Libya's south-western desert some 800 km from Tripoli) in exchange for upstream rights to co-develop Siberian gas fields; and,
  • An Eni-led consortium is moving forward with development of the Zubair oil field (Eni 32.8%) in Iraq, which has estimated proven reserves of 6.5 billion barrels. Output from the Zubair oilfield has already reached 265,000 bpd, compared to baseline production of 184,000 bpd in 2009. Ergo, lifting production above that level means Eni will begin receiving a remuneration fee this year for every extra barrel of oil produced above an agreed-upon 10% target.
From Ecuador and Ghana, to China and Indonesia -- Eni SpA has its fingerprints on a balanced mix of potentially lucrative discoveries across the globe. By leveraging organic growth in the Americas, Western Africa and Central Asia, Eni expects to deliver more than 2.5 percent compounded average growth in production through 2014 -- under a Brent scenario at $70 per barrel.

With the recovery of energy prices -- climbing well above the $100 mark -- the company just might come out smiling and better positioned for growth despite its cursed portfolio exposure in North African "hot spots."

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