Murphy’s Oil (NYSE: WALL) attracted attention with the year-end announcement of generally positive results and a dividend increase. There was also news of major production coming online in the Gulf of Mexico. This is all good news coming from a very solid performer. The added attraction of this potential investment is the Partnership with Exxon Mobil (XOM) who will hunt elephants off the coast of Brazil. This partnership has the potential to be a game-changer for this company as it is much smaller than Exxon Mobil and these offshore discoveries tend to be big projects.

Basically, these types of projects require a lot of oil or natural gas. A commercial well does not justify a commercial platform and an associative production structure unless you are close to a large project on which you can graft.

The caveat is of course that this could all be considered a failure or they find something non-commercial to produce. The coast off Brazil seems to be as prolific as several places in the Gulf of Mexico. So, this particular company seems to have a decent chance.

The first well has dried up. It’s not that unusual. It could take a year or two to find reserves or decide that these blocks aren’t worth it. Any kind of success will likely take years to get to production. But usually, that success means strong production growth in the future for a company Murphy’s size.

The other big caveat is that the time from first oil to actual production is often 5-7 years. So even if there is a trade discovery, it will take some time for the money to start flowing. Any investor who hopes to succeed in Brazil must be patient.

There is always a risk that the stock price will not react to a discovery because the benefits of that discovery are years away. With all of the warnings presented above, a discovery could eventually make Murphy a candidate for acquisition or enable growth at a rate well above the typical growth rate for a company of Murphy’s size.

Current outlook

Murphy not only has a long-term game-changing prospect. But ongoing operations are also making decent progress. Therefore, the company has a way to show improvements every year until a major game-changing elephant has a material effect on the bottom line.

The company has some of the best Eagle Ford acreage in the industry. Often, this Eagle Ford acreage has production and price advantages over competing Permian Basin acreage. Eagle Ford production often receives high prices for production, while Permian production is often caught up in take-out bottleneck issues that lead to discounts on sales prices. At this point in the recovery, there appears to be ample takeout capacity in both basins.

However, the plans of Exxon Mobil (XOM) and Chevron (CVX) decent production increases in their Permian area. It won’t take too many growers to follow this path for another takeout bottleneck to result in reduced prices in the Permian during the current industry recovery cycle.

As noted above, Murphy reduced well costs and increased well production. Every time a well produces 200,000 barrels of oil, that producer has an extremely profitable well. The best part is that Eagle Ford acreage usually costs a lot less than premium Permian acreage. Thus, the cost of locating each well is also lower (on average).

At current prices, Eagle Ford’s production is expected to increase in the current fiscal year. Many companies exhibit disciplined growth. But these same companies report growth in production due to improved technology while claiming that it was unexpected. Restraint in the industry is remarkably low because it is in every company’s interest to increase production even though the industry as a whole needs some discipline. This is the big reason why the cure for high prices is high prices.

Murphy is one of many producers to report an increase in production in the form of much higher initial rates. This has made Canadian dry gas production much more profitable than it has been in years. Improvements like this will likely reach other basins with mixed results. However, these mixed results still mean that technology continues to improve, so production costs go down. This makes the ability to export natural gas very important so that the North American market does not suffer years of price declines in the future, as it has in the past.

Of all the projects underway, the Gulf of Mexico is expected to generate a significant (and usually very profitable) increase in production. Offshore wells tend to have large (and long-lived) production. Murphy brings quite a few offshore wells into production this fiscal year.

The current climate of high commodity prices will likely prompt more than a few producers to “raise” the capital budget. This will likely result in more production than was originally the case. Much of the industry, including Murphy, is eager to pay off some of its debt first. However, fiscal 2023 should find many companies much more optimistic about production increases than is the case this year.

Typically, an industry downturn begins when lenders with little or no industry experience enter the market to offer highly optimistic buyouts or finance projects with unrealistic long-term parameters. These lenders typically pick up the assets during the next recession due to bankruptcy or other financial events only to find that they will lose money. At present, these lenders are far from investing money in this industry. Therefore, the industry is likely to have a few years of decent commodity prices ahead of it. However, greed is a powerful motivator. Sooner or later, there will be this speculative money in the industry (which will be a sign that the next downturn is on the way and it’s time to take profits).

In the meantime, Murphy Oil offers investors excellent current prospects while participating in a potential game-changing partnership with Exxon Mobil off the coast of Brazil. The company is a solid investment proposition for long-term investors, even without the Brazil partnership. Management keeps the company focused on certain relatively cheap and very profitable sectors of the industry. As an upstream investment, this is one of the best deals in the industry.