Big Oil is an all American institution. Dating back to the days of John D. Rockefeller, Black Gold has somewhat erroneously been associated solely as a domain for swashbuckling frontiersmen wildcatters and penny-pinching fat cat financiers. Big Oil investment strategy, of course, is far more complex than aimlessly drilling holes in the ground and slashing costs from the refined comfort of Texas and New York City wood paneled offices.
Big Oil executives are similar to money managers, who actually allocate capital between exploration and production, refining, and the retail sales of finished petroleum products. Big Oil has emerged as a staple of the diversified portfolio because commodity prices are only slightly correlated to domestic economy and stock market performance. As such, analysts, traders, and long-term investors alike often take special interest regarding evaluations for Big Oil stocks. For American oil, the Big Three may be defined and ranked in descending order as ConocoPhillips (NYSE:COP), Chevron (NYSE:CVX), and Exxon Mobil (NYSE:XOM).
On May 1, 2012, ConocoPhillips completed the spinoff of its Phillips 66 (NYSE:PSX) refining, chemical, retail, and pipeline units. At that time, Phillips 66 owned 15 separate refineries and 10,175 different retail outlets and gasoline stations around the globe. Phillips 66 has listed its total refining capacity at more than 2.2 million barrels per day. Phillips 66 shares did open for trading in May 2012 at $31.73 and has since more than doubled to close out the January 27, 2014 trading session at $74.90, for a 136% gain as an independent refiner. For the sake of comparison, ConocoPhillips' stock has advanced from $52.26 to $65.86 per share, for a mere 13.6% gain in price through this same time frame. The stark divergence in performance between the two companies may expose weaknesses within the ConocoPhillips business model.
In effect, ConocoPhillips has deconstructed the vertically integrated oil company, in order to focus its efforts upon the historically more profitable upstream exploration and production side of the business. E&P has been an obvious cash cow when crude oil and natural gas prices rise beyond massive up-front capital spending. Oil prices, of course, are known to track secular cycles of boom and bust, as opposed to the technology sector that changes by the hour. In effect, one large exploration and production project may not generate real returns upon investment for one decade. Refining operations are similar to put options that offer downside protection for Big Oil investors. Refining profits would actually expand, if crude oil prices fell, while demand for gasoline, jet fuel, and the transportation of finished petroleum products to major population centers remained steady. ConocoPhillips, without its refineries, may be the second coming of Apache (NYSE:APA). Apache rode the oil boom wave to establish a $149.23 per share high, on May 21, 2008. From there, Apache stock was to promptly collapse, before heading into 2014 slightly above $85.00.
Again, ConocoPhillips shares changed hands at $65.86, on January 27, 2014. At these levels, Wall Street traders have applied an $81.1 billion market capitalization price tag to the ConocoPhillips business. ConocoPhillips now trades for nine times current estimated earnings, while also paying out a 4.2% dividend yield. On the surface, ConocoPhillips may appear cheap. Going forward, however, ConocoPhillips shareholders would be especially exposed to financial risks, in the event of stagnation, if not outright price collapse within the crude oil and natural gas markets. ConocoPhillips has managed a relatively meager 13% return on equity through the majority of 2012 and 2013, despite West Texas Intermediate Crude Oil prices largely trading within an $85 to $100 price band per barrel over the course of the past year.
Legendary investor Warren Buffett has already quipped, "It's only when the tide goes out that you learn who's been swimming naked." SEC Form 13F, of course, recently revealed that Warren Buffett and his Berkshire Hathaway (BRK.A / BRK.B) investment vehicle sold 10,594,641 shares of ConocoPhillips through the Summer 2013 quarter, while maintaining the 27,163,918-share Phillips 66 spinoff position. Berkshire had sold off its ConocoPhillips position down to 13.5 million shares and $940.4 million, by September 30, 2013. A repeat of the swift 2008 oil bust from $140 to $40 per barrel would expose legions of skinny dippers mistakenly frolicking within the ConocoPhillips waters.
Chevron is somewhat of a reprieve away from standard Big Oil conservatism. Chevron headquarters, of course, are still based out of California, instead of the Houston, TX energy capital. Rather than declaring war against environmentalists, Chevron has actually put billions of dollars to work within various alternative energy projects, in order to help position itself as the world's leading producer of geothermal power. Chevron Chairman and CEO John Watson cut his teeth in high finance, rather than chemical engineering and rugged oil platform work. Over the past decade, Chevron's counterculture has largely translated into alpha returns significantly above the Big Oil peer group. Exxon stock market returns have only surpassed those of Chevron over the most recent calendar quarter block of time.
Chevron has been running upon all cylinders, by simply maintaining its status quo as an integrated oil company. Contrary to ConocoPhillips, Chevron has refused to divest itself of downstream refining, chemical, transportation, and retail operations. Chevron has also largely sidestepped the natural gas fracking euphoria that now consumes the continental United States energy complex. In 2012, Chevron replaced 112 percent of its production and closed out the year having produced 1.8 million barrels of net liquids and 5 billion cubic feet of natural gas per day. These numbers held steady through Q3 2013, when Chevron reported that it was producing 1.7 (MB/D) in net liquids and 5.2 (MMCF/D) in natural gas.
Chevron sold one barrel of crude oil and natural gas liquids for an average price of $97 through this latest quarter. Energy analysts often highlight the fact that Chevron generated the most revenue per barrel of oil equivalent sold within its peer group over the past year. Sales and income performance has calculated out to 2013 return on equity of roughly 20%. Still, the Chevron asset mix has remained largely skewed towards crude oil prices. Over the long term, the inevitable restoration of price normalcy between oil and natural gas prices would put the brakes upon outsize shareholder returns at Chevron. As always, Big Daddy Exxon will remain the superior choice for conservative investors going forward.
1) Exxon Mobil
Q3 2013 ROE
In 2009, Exxon closed out a deal to purchase XTO Energy for $31 billion in stock, while also assuming $10 billion in debt. XTO, of course, brought millions of acres of tight rock formations and unconventional natural gas reserves into the Exxon fold. To date, Exxon bet big on natural gas and lost. Reuters calculated that average 2009 Henry Hub natural gas prices promptly collapsed to $3.99 per million British thermal units (mmBtu) from the record $8.93 average price established the prior year, in 2008. Henry Hub natural gas spot prices have remained near $4 heading into 2014. At these levels, the $41 billion XTO Energy acquisition would add next to nothing to the Exxon bottom line. If anything, XTO was acquired more so as a central piece of Exxon's 50-year plan. Exxon shareholders, who often think in decades, must recognize that XTO will reap significant long-term rewards, especially as natural gas replaces coal in power generation.
Exxon is the best capital allocator in the business, despite the mistimed $41 billion XTO acquisition. Whereas Chevron is notable for generating the most revenue per barrel of oil equivalent, Exxon traditionally pays the least to produce each barrel of oil equivalent. Bloomberg estimated that Exxon spent $19.27 to produce one barrel of oil equivalent through 2013. For the sake of comparison, Chevron paid $21.48 for BOE through the same time frame. Because of its high return on equity, Exxon can best reward shareholders by reinvesting capital back into the business, instead of paying cash back out as dividends. As somewhat of a compromise in dividend versus growth philosophies, Exxon has spent $113.9 billion in cash to purchase a net 1.1 billion shares outstanding from the beginning of 2008 to Q3 2013.
Be advised that the aforementioned SEC Form 13F also listed 40,089,371 shares of Exxon Mobil stock for a $3.4 billion value within the Berkshire Hathaway portfolio. For the quarter ended September 30, 2013, Mr. Buffett and his traders were purchasing 8,845,261 shares of Exxon, while also dumping the ConocoPhillips position. Perhaps Warren Buffett would agree that Exxon Mobil had further fortified its best of breed business moat heading into 2014. Exxon is a solid buy.