On October 6, 2013, I published an article on Seeking Alpha about what I perceived to be a decoupling of the price of oil with the share prices of major oil companies. My premise being that share prices of oil companies should be linked to the price of crude oil, and a decoupling of the two indicates an anomaly that should be investigated thoroughly when analyzing a company for investment. In presenting this theory, I fully realized that the price of oil is only one of many factors to consider (such as management, supply, demand, efficiency of operations, macro political and economic events, and speculators' opinions).
In my October article, I pointed out that since 2011 there appeared to be a decoupling of the price of oil and the share prices of oil companies. The price of oil was essentially flat during that period, while share prices of oil companies were moving in tandem in an upward projection. I used as examples Exxon Mobil Corporation (XOM), Chevron Corporation (CVX), and ConocoPhillips Company (COP). In summary my conclusion in the article was that there was a decoupling of oil prices and share prices that would most likely be corrected by a decline in share prices until the price of oil and share prices were again moving in tandem -- although obviously the correction could also occur by a rise in oil prices at a faster pace than the rise of share prices.
Last week, a number of oil companies saw a sharp decline in their share prices after weak earnings were reported by CVX, XOM and COP. I have therefore decided to review my previous theory, and also make a determination on whether this might be a good opportunity to buy major oil companies that are paying liberal dividends at this time.
Four Month Comparison
A lot has happened in the four months since my initial article. Two major events were the government shutdown and the tapering of quantitative easing by the Federal Reserve. There were also a number of ongoing macro economic and political events, any one of which could have an effect on the price of oil and share prices. I don't intend to go into detail about how each one of these events might effect my thesis, but instead I look to gain some insight on how my theory played out as an indicator in this recent four month time frame.
As shown in the ten year chart below, the price of oil since 2011 continued to trade in a range between $80.00 to $110.00 WTI Crude Oil NYMEX (WTI). On three occasions it failed to break $110.00. Brent Crude OIL (Brent) also traded in a range since 2011, although higher. The charts further show that the ranges of both WTI and Brent appear to be narrowing which suggests less volatility. As shown on the six month chart below, the price of WTI has gone down some since October, while the price of Brent has gone up some. In general however, the oil prices continue to be range bound.
I have also included below charts on natural gas prices, since natural gas is becoming a larger portion of the revenue of major oil companies. Natural gas now comprises 22% of the world's energy consumption. Unlike crude oil, the natural gas charts show a correlation to the upward movement of share price charts over the last few years, and might be one reason for the decoupling of share prices and oil prices. If so, this may become more pronounced in the future as revenue from natural gas continues to grow. Even though share prices of oil companies have tended to move somewhat in lockstep over the last ten years, this could change, company by company, as some grow their natural gas business faster than others.
Since publishing my article, the share prices of the example oil companies are a bit mixed but all of them rose to a peak in the four month period before entering into a decline which accelerated when CVX, XOM, and COP released their fourth-quarter earnings and annual financial statements last week.
- CVX went from a price of 117.87 on October 7th to a peak of 125.23 on December 27. It closed on January 31, 2014 at 111.63.
- XOM's price was $85.90 on October 7th, and hit a high of $101.51 on December 27th. XOM closed at $92.10 on January 31, 2014. XOM's sharp price rise may have been due in part to the announcement of Berkshire Hathaway Inc (BRK.A) that it took a $3.7 billion stake in the company.
- COP closed at $70.88 on October 7th, peaked at $74.34 on December 29th, and closed at $64.96 on January 31, 2014.
On January 30, 2014 XOM reported the following financial information:
- Earnings of $8,350 million decreased $1,600 million or 16% from the fourth quarter of 2012.
- Earnings per share (assuming dilution) were $1.91, a decrease of 13% from the fourth quarter of 2012.
- Capital and exploration expenditures were $9.9 billion, down 20% from the fourth quarter of 2012.
- Oil-equivalent production decreased 1.8% from the fourth quarter of 2012. Excluding the impacts of entitlement volumes, OPEC quota effects and divestment, production was essentially flat, with liquids volumes up 3.0%.
On January 30, 2014 COP reported the following financial information:
- Fourth-quarter 2013 earnings of $2.5 billion, or $2.00 per share, compared with fourth-quarter 2012 earnings of $1.4 billion, or $1.16 per share.
- Excluding special items, fourth-quarter 2013 adjusted earnings were $1.7 billion, or $1.40 per share, compared with fourth-quarter 2012 adjusted earnings of $1.8 billion, or $1.43 per share.
- Full-year 2013 earnings were $9.2 billion, or $7.38 per share, compared with full-year 2012 earnings of $8.4 billion, or $6.72 per share. Reported earnings for 2012 included $1.2 billion from downstream operations prior to the separation of Phillips 66 on April 30, 2012.
- Full-year 2013 adjusted earnings were $7.1 billion, or $5.70 per share, compared with full-year 2012 adjusted earnings of $6.7 billion, or $5.37 per share.
On January 31, 2014 CVX reported the following financial information:
- $4.9 billion ($2.57 per share - diluted) for the fourth quarter 2013, compared with $7.2 billion ($3.70 per share - diluted) in the 2012 fourth quarter.
- Full-year 2013 earnings were $21.4 billion ($11.09 per share - diluted), down 18 percent from $26.2 billion ($13.32 per share - diluted) in 2012.
- Sales and other operating revenues in the fourth quarter 2013 were $54 billion, compared to $56 billion in the year-ago period.
- In its news release, CVX blamed lower crude oil prices and refining margins for the decline in earnings as well as lower gains on asset sales and higher expenses. The company also stated that its net oil-equivalent production was down 4%, from a year earlier.
With the drop in prices, dividend yields of the oil majors have been rising.
- CVX currently pays a $4.00 annual dividend (3.6% yield at a $111.00 price). According to F.A.S.T Grafts, CVX has raised its dividends every year since 1995 with a annual dividend growth rate of 7.7%.
- XOM currently pays a $2.52 annual dividend (2.8% yield at a $90.00 price). According to F.A.S.T Grafts, XOM has raised its dividends every year since 1995 with a annual dividend growth rate of 6.2%.
- COP currently pays a $2.76 annual dividend (4.3% yield at a price of $64.00). According to F.A.S.T Grafts, XOM has raised its dividends every year since 1995 with a annual dividend growth rate of 9.3%.
In conclusion, my prediction in October of a correction in oil company stock prices has begun. The decline accelerated last week after the release of disappointing fourth-quarter earnings reports from all three companies. it is overly simplistic to assume that the correction in prices was solely due to the decoupling of the price of oil and share prices of the companies. However, there is evidence to support an argument that the shares of an oil company can only rise so far in price without a corresponding increase in oil and gas prices, and that observing the relationship between the two is a good tool to alert an investor to a possible correction.
One surprise in my research was the natural gas charts that, unlike the crude oil charts, did not show a decoupling of prices with company shares and instead showed a substantial rise in prices beginning in 2012. Since natural gas is becoming a larger percentage of revenue for a number of oil companies, this may be why the decoupling between oil prices and share prices lasted so long before a correction. In my October article I failed to take this into account and that was a mistake. In the future, if the growth of natural gas production continues, the importance of natural gas prices will become more relevant, and should be taken into account in any analysis.
The recent news releases on fourth-quarter earnings generally blamed the declines on lower oil prices, margins, and production, as well as higher expenses. I don't think anyone disagrees that the new techniques of deep water drilling and fracking will continue to drive the costs of production higher, thus squeezing margins. This should makes the fluctuations in the price of oil and gas much more important to company profits, and the decoupling of share prices and oil prices will be even more important in analysis.
As for the current share prices of the oil companies, it is too soon to tell if the correction is over. Oil is still selling in a range. Until it breaks out of that range I don't think we will see a substantial rise in share prices. Without getting into the details of my methodology, I think most companies are currently selling at about fair value, so I don't expect the correction to go much farther, although the market tends to overshoot on the upside and the downside. I anticipate that oil companies will now be range bound, similar to oil prices, until the oil prices have a substantial breakout from the range they have been trading since 2011. In other words the coupling of commodity prices and share prices will reestablish itself.
At this time I am of the opinion that the dividends of the major oil companies make them a buy for long term investors, especially if they can be purchased at the lower levels of their trading range, which should be established over the next several months.