A new proposed SEC plan will overhaul oil and gas reporting rules that have existed since the 1970. The new rules will boost the proven reserves reported by oil companies, and in the process boost their shares and potentially increase interest in takeovers (see Financial Week article). The plans will essentially allow companies to book reserves from “unconventional” oil and gas sources, including oil sands and coal-bed methane. Some deep-water projects that to date have not been allowed to be described as “proven” will also now be included. Furthermore, firms will be able to publish data on what are called “probable” and “possible” reserves, where recovery is not as certain. The new rules obviously don't change the amount of oil and gas that is available worldwide, but they will help investors better calculate future cash flows and thereby place a proper valuation on a company. Needless to say, the oil companies are in favor of the new rules.

The plan will affect both U.S. and international companies that report under SEC rules, which often includes most of the larger international firms. Those with the largest non-traditional sources of future production are most likely to benefit. Analysts expect that Royal Dutch Shell is likely to benefit the most among the oil majors given that they are investing capital to retrieve crude from bitumen-soaked soil in Canada, as well as extract natural gas in coal beds in Australia and China, both of which can now be included as reported proven reserves. ConocoPhillips (COP), Exxon (XOM), and BP (BP) have also invested in non-conventional sources of oil. The reporting of non-traditional proven reserves could also have an impact on acquisitions and takeovers. As mentioned by Neil McMahon, analyst from Bernstein:

“We believe that these rule changes could be the catalyst for a wave of acquisitions, with those companies with the largest unproved resource bases making juicy takeover targets for some of the larger cash-rich majors.”

McMahon feels that Marathon Oil (MRO), with investments in oil sands and shale, and British gas producer BG, with its stakes in the deep-water Brazilian fields and a new 25% stake in Chesapeake Energy (CHK) and the Fayetteville shale, are potential targets. In fact, given that the changes will make the SEC rules more in line with European rules, the impact on UK-listed firms, among others, is expected to be positive.

The rule changes are likely to apply to 2009, and not 2008 year-end reporting since the SEC is still in a consultation period and has not committed to a time line for implementation. Given that the market is forward looking, share prices may nonetheless begin to see the impact of the proposed changes which are expected to be approved and put into place quickly.

As reported at Bloomberg.com, George Soros purchased an $811 million stake in Petroleo Brasileiro SA (better known as Petrobras) in Q2. The Brazilian oil company is now the largest holding in his fund, amounting to 22 percent of the total $3.68 billion of stocks and American depositary receipts held by Soros Fund Management LLC. Of course, crude oil has taken a dive in the last month, helping to push Petrobras down 28 percent since his purchase and costing Soros's $235 million. I guess we would all like to be in a position to lose nearly a quarter billion dollars and still be "OK". Then again, if Soros holds tight, he could end up doing well.

While the timing for Soros may not be perfect for this trade, a number of other people are also betting on Petrobras. As quoted by Ricardo Kobayashi from UBS Pactual SA: "Petrobras has something that other oil companies don't have: oil - lots of it and they're going to find more. If you can buy now and hang on, if you have the staying power, it's great.'' As written in a previous post , estimates have the Tupi-area fields in Brazil costing between $200-$240 billion to develop, in part due to deepwater rigs causing $600,000 a day to rent, forcing Petrobras to look for capital. Yet the cost might eventually be worth it given that the offshore fields are expected to hold up to 50 billion barrels. Petrobras has already leased approximately 80% of the deepest-drilling offshore rigs (see post). They are also buying new rigs and production platforms. If oil prices stabilize, companies to consider would be Transocean (RIG), Nobel (NE), and Nabors (NBR), each of which have sold off with lower crude prices, but each of which are also near some key support levels. For longer-term investment, some capital-intensive E&P oil companies such as Exxon Mobil (XOM) should do well, even without direct investment. Of course, this all requires crude oil to stabilize, probably stay over $100 a barrel, and potentially continue its march higher. If not, you may be experiencing the short-term returns of Soro, and not necessarily the longer-term ones.

Cambridge Energy Research Associates is estimating that the Tupi-area fields in Brazil will cost between $200-$240 billion to develop. As reported in Bloomberg, labor and equipment costs are rising as oil prices increase. Recently, deepwater rigs have received rents of $600,000 a day. As a result of the huge project, Brazil and Petroleo Brasileiro SA will need international partners with lots of capital. Nonetheless, the effort and cost might be worth it given that the offshore fields are expected to hold up to 50 billion barrels, or $6 trillion of petroleum at today's prices. If estimates are correct, the wells could help to make Brazil a top 10 oil producer.

As discussed before, Petrobras has already leased approximately 80% of the deepest-drilling offshore rigs. Astonishingly, the company also plans to hire 14,000 engineers, geologist, and drillers to help with the project. They are also buying new rigs and production platforms. As periphery plays in the short-term, this is certainly good news for the drilling contractors, such as Transocean (RIG), Nobel (NE), and Nabors (NBR). For longer-term investment, some capital-intensive E&P oil companies such as Exxon Mobil (XOM) should do well, although these companies may require direct involvement to see any benefit.

UBS is projecting that crude oil will have a yearly average of $156 a barrel by the year 2012, with the price rising steadily over the next four years, even though they see oil averaging $115 a barrel this year, about $10 less than the recent highs. This is a reversal from earlier coverage which predicted a pullback in oil prices as demand fell in the face of a potential U.S. recession. UBS has also stressed that it believes the increase in prices are mainly due to demand growth (not met by equal supply growth), rather than speculation.

Who does UBS see as benefiting from this increase in oil prices over the next four years? As to the major oil companies, UBS believes Chevron (CVX) will benefit, in addition to Occidental Petroleum (OXY), Apache (APA), ConocoPhillips (COP), and Exxon Mobil (XOM), all of which have buy recommendations. In addition to the major oil companies, UBS has also initiated coverage of oil service, drilling, and equipment firms. Current buy recommendations include Transocean (RIG), Diamond Offshore Drilling (DO), Noble (NE), Ensco International (ESV), Atwood Oceanics (ATW), and Rowan (RDC).

Of the group, the oil services and equipment analyst at UBS prefers Transocean, a recommendation that is due in part to the recent news of Petrobras locking up 80% of the deep water rigs, while also attempting to extend contracts with Transocean for over three more years (see earlier post). Current daily rates are topping over $600,000 a day for leasing deep water rigs, almost three times the average rate of $219,700 just a little over 6 months ago. A number of analysts are also picking up on this story.

A lot is being written about Exxon Mobil's Q1 2008 earnings of $10.9 billion, the second largest quarterly profit ever for a U.S. company. What is not receiving as much attention, but more than I expected - at least in the blogs, is how Exxon incurred a tax bill of $9.3 billion. When overall international taxes are consider, the tax figure is even more staggering, and increasing at an alarming rate. Adding in sales and other taxes (countries are defining their own ways to profit from oil), total taxes were closer to $29.3 billion.

Exxon in effect paid $3 in taxes for every $1 of earnings. Even with these numbers, we will continue to hear about how higher taxes, and even windfall profit taxes, are needed for the oil companies. Of course, when you tax something you typically get less of it, which may be the point for some, but certainly not an energy plan. Decreased supply will increase prices at the pump.

As for the stock itself, it was down after missing earnings. The street was expecting earnings per share of $2.14, while Exxon delivered $2.03 per share. While high taxes certainly contributed to Exxon's lower than expected earnings, decreasing crack spreads have hurt refiners and other integrated oil companies, such as Exxon. Oil company margins are also not as large as other industries (such as software), squeezing profit margins when costs, such as taxes and commodities, increase.

Ticker: XOM

Venezuela is preparing a windfall tax that would take 50% of oil revenue above $70 per barrel, and 60% of revenue above $100 per barrel. The country is already in legal battles with Exxon Mobil and ConocoPhilips.

Ticker: XOM, COP