The top 3 US oil companies (Exxon Mobil (XOM), Chevron (CVX), and Conoco Philips (COP) respectively) announced earnings this week and all three significantly beat the Street estimates. It’s no surprise earnings were much higher than a year ago considering that oil is now trading around $78/barrel versus the $50-$60 range in the relative period last year. Natural gas is now trading around $4.85/MMBtu versus $3.65 a year ago. Crack spreads were also much improved and all three companies had very profitable downstream refining results. It was an excellent quarter for all three companies.
The following table summarizes current valuations with data from Google Finance as of the market close on July 30, 2010.
1) B = Billions $
2) Not sure if Google Finance’s metrics include Q2 yet.
As the table above shows, valuations remain very cheap indeed. As a gross measurement, if all three companies were to duplicate earnings in Q3 and Q4 to match what they did in Q1 and Q2, XOM would earn close to $6/share, CVX close to $10/share, and COP over $8/share. Doing so and slapping on a PE of 10 would put CVX at $100/share and COP at $80. Further, one could argue that a PE of 10 on a big oil company is way too low when we live in an era when worldwide oil supply very soon won’t keep pace with worldwide oil demand.
It’s as if the Street believes:
- The US is making significant headway into “alternative fuels.”
- Middle class Americans will be able to afford the electric cars that aren’t yet available.
- US big oil isn’t worth investment dollars because they cannot grow production.
- Oil wars (both military and economically competitive wars) are over.
- That congress will finally realize that natural gas is the only fuel that can significantly replace foreign oil (that is, gasoline derived from foreign oil) in the transportation sector.
Nothing could be further from the truth. Arguably the US is as addicted to foreign oil today as ever. The only meaningful energy policy development has not been government led, but is Boone Pickens’ efforts in converting some of the nation’s large truck fleet over to natural gas.
However, when a country consumes 25% of the entire world’s oil production and imports 65% of that oil, converting a few thousand 18-wheelers is a drop in the bucket. Don’t get me wrong, I strongly support Pickens and his push to adopt natural gas transportation.
But the fact is, if the entire US long-haul trucking fleet were converted to run on natural gas tomorrow, the US would still have a huge foreign oil import problem. While we wait for congress to get it (don’t hold your breath), don’t look for the NGVs being made by Ford (F) and GM to be available in your USA hometown anytime soon – they prefer to sell them outside the US. Meanwhile, we continue to use gasoline refined from oil.
Electric vehicles? Well, where are they? With real unemployment rates arguably in the 15% range, how many Americans can afford $40,000 for a new electric vehicle that will give them range anxiety? Again, don’t get me wrong... I think electric cars make sense (in some areas) and support Project Better Place.
However, if we are going to burn coal to recharge them, where is the environmental payoff with that strategy? Each electric car to me just looks like a little coal plants spewing CO2 and heavy metal toxic particulates into the air we breathe and water we drink. Meanwhile, we continue to use gasoline refined from oil.
Biofuels? In general, biofuels are a failed strategy and one quietly supported by big oil in order to keep Americans addicted to liquid fuels (i.e. gasoline) instead of gaseous fuels (i.e. natural gas and hydrogen). Biofuels also suck up precious fresh water resources and cause huge dislocations in the food sector. With the exception of importing Brazilian ethanol made from sugar cane, biofuels are a failed long-term strategy. Meanwhile, we continue to use gasoline refined from oil.
With respect to the “production growth issue,” why is it that Wall Street doesn’t seem to understand that there are two components to oil revenue: oil production volume and price? This is so simple to understand... but I guess only derivatives are complicated enough to invest in.
The fact is, production growth at all three American big oil companies was flat or even negative during most of the 2007-2008 timeframe when all their stocks were on fire. Why? It was the price of oil, of course. Does anyone believe the long-term price of oil is on a downward trend? Of course not. These companies will be printing money for at least the next 15 years, assuming the oil crisis doesn’t cause the entire world economy to collapse into chaos. But if that happens, it won’t matter what you own, so you might as well own oil.
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Not investing in big oil because of production growth concerns is to ignore the long-term trend in oil prices, which is up. You don’t believe me? Today we have oil prices at near $80/barrel while oil demand in the US is down, we have unemployment at near 15%, and the economy is barely limping along after just emerging (“emerging” might be a stretch... ) from a near depression and total financial meltdown.
Hmmm... what would the price of oil be if the world economy was actually functioning nicely and growing? It would easily be over $100/barrel. If the big 3 oil companies were so profitable with oil around $80 in this Q2-2010, what would their profits be with oil at $125 in 2011 even if their natural production declines were in the range of 5%/year? Answer: enormously profitable... just as in 2007-2008. How were these companies priced in 2007-2008? Let’s have a look.
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It won't be long before these companies' earnings will push their stock prices back to 2008 levels.
Perhaps the Street believes US domination of Iraq and its oil will bring oil prices down drastically. I suppose this is possible – in the short-term. However, existing mature reservoir depletion rates as well as oil consumption growth in China, India, the rest of Asia and the Middle East means that even Iraqi oil hitting the market will have only a short-term and probably limited affect on the long-term trend of much much higher oil prices.
One thing we can be sure of, the biggest single entity oil consumer (the US military) will continue to use a lot of oil implementing the failed strategy of nation building and oil conquest. (Yet another reason to buy gold and silver.)
Wall Street simply doesn’t get all this. I like COP the best over the next 12 months because of their plans to sell assets, retire debt, and increase shareholders dividends. It's as if CEO Jim Mulva was shamed into action due to his company's severe underperformance against its peers during the recent "financial crisis."
CVX is a very close 2nd place and is simply way undervalued and a very competently run company.
XOM is getting no respect because of their paltry dividend and the recent dilution of shareholder value because of the XTO takeover using stock. XOM under $60 should be a alarming call to fire some of the overpaid executives running that company and for their past decisions to direct so much cash flow toward share buybacks instead of raising the lowest dividend in its peer group.
The management at XOM appears to be running the company for themselves instead of their shareholders. Hopefully, their yearly bonuses will be tied to share performance. If that is the case, they will need to give back 17% of their salaries because that is how much XOM has dropped YTD. That said, XOM too is way undervalued. Its credit rating is better than that of Uncle Sam. That is, I'd buy XOM before a 5 year T-bill and the yield is better (miserly as it is).
Meantime, I also like Petrobras (PBR) in spite of the supposed “political risk.” (I think there is much more political risk in the US than in Brazil!) I also like Murphy Oil (MUR) and Suncor Energy (SU) at current prices. Hell, I like almost all the oil companies! What the heck was the huge hedging loss at StatOil about (STO)? I like STO, but I need to look into this loss.
I also like gold and silver as perhaps the best way to store wealth for what is coming our way. President Obama, like Bush before him, has done absolutely nothing to solve the main economic problems in the US:
- Lack of an energy policy to address America's oil crisis
- A broken congress
- An un-constitutional Federal Reserve acting with no congressional oversight
- Government “regulatory” bodies that are completely corrupt and controlled by industry
- Lack of a fair and balanced income tax policy (i.e. flat tax)
Buy oil. Buy gold and silver.
Lastly, I recently viewed the GasLand documentary on one of the cable channels. This was a very disturbing show yet matches some of the information I have been hearing from acquaintances in Colorado, Louisiana, and Pennsylvania. The Natural Gas Lobby had better be proactive in addressing these issues and regulating themselves. It does no good to burn cleaner natural gas if we destroy our water resources to obtain the natural gas.
My gut tells me that the natural gas industry is cutting corners (i.e. saving money) and doing a poor job of protecting our air and water. I'm going to investigate this issue further. If there is fire behind this smoke, my energy policy will have to be modified. Off the top of my head, the big change will be to move away from both coal and shale gas toward nuclear and conventional natural gas via the trans-Alaskan pipeline (which the country cannot seem to build). China would have built it a decade ago.
Disclosure: Author long COP, PBR and STO