March 4, 2002; Marathon Oil Pursues Integrated Gas Strategy

It is a new era for Marathon Oil.  Chief Executive Clarence Cazalot has been in place for little more than a year and the company has been completely independent of the steel business for just two months.  An important reason that has contributed to lackluster performance for MRO stock the past two decades has been removed. 

As we have suggested, the value of Marathon depends almost equally on three businesses - natural gas, oil and refining/marketing.  Management characterizes its business model in the same three parts.  The company further characterizes one of its three businesses not just as natural gas, but "Integrated Gas".  In a step that coincidentally jibes with our previous discussion, Marathon recently purchased the Equatorial Guinea properties of CMS Energy.  The seller is in our Mid Cap Infrastructure Group with a ratio of debt of 0.62.  MRO's ratio of debt is 0.27. 

The project includes a giant African natural gas field with liquids that will be separated while gas is reinjected in the ground.  Ultimately some of the gas will be turned into methanol for export.  Marathon further eyes an innovative gas to liquids plant that will convert a stranded resource to a sulfur free diesel fuel for example.  LNG exports may be another option.  The long-term payoff of the project remains to be seen.  Yet it is a reasonable project for MRO to undertake and MRO is much stronger financially to handle it than is CMS.

The company also announced two new interesting Integrated Gas projects.  One is an LNG regasification facility for Baja California. The other is a sub sea pipeline for the North Sea.  Both are somewhat non traditional for a producer and reflect a creative view of a changing world.

Marathon has its strongest competitive position in its refining/marketing business concentrated in the Midwest and one of the most efficient networks in the industry.  Among other assets, MRO operates terminals and pipelines where it interfaces with Kinder Morgan.  We doubt that Kinder Morgan is more efficient than MRO.  Yet investors pay 17 times Ebitda for KMP and 5 times Ebitda for MRO.  In our opinion the main difference between MRO and KMP is h y p e.

There has been an apparent negative influence on the stock in recent months - dry holes.  There have been no further discoveries in the Gulf of Mexico.  A well offshore Nova Scotia has been delayed for rig repairs.  Our view is that the amount of exploration risk MRO undertakes, particularly at the newly reduced level, can be supported by the strength of its business.  While we would welcome any unusual success such as in the waters near Sable Island, we don't count on it. 

The reason to own Marathon starts with the fact that it is among the most out-of-favor large oil stocks.  As such it is not likely to become more out-of-favor.  At the same time we believe it is soundly managed.  It is also in strong financial condition, not as strong as the Mega Caps, but far stronger than most infrastructure stocks.  If one owns several low McDep Ratio stocks with low ratios of debt the worst that is likely to happen is that the stocks are dull.  More likely something good is likely to happen to one or more of the stocks that would make the combination perform well on a risk-adjusted basis over time.