Oil vs. Energy Stock Prices: Something's Gotta Give

The charts below show the ratio between the price of the S&P 500 Energy stock sector and the price of crude oil per barrel. The ratio is clearly at its highest level in the past three years, meaning that oil stocks have not fallen as fast as the price of the actual commodity during the current decline. So either the stocks are due to play catch up, or the decline of oil is a bit overdone.

click charts to enlarge

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[CrossProfit]

“So either the stocks are due to play catch up, or the decline of oil is a bit overdone.”

Actually neither is correct.

It took analysts and the markets the better of two tears and over 6 quarterly results to realize that fixed overhead and production costs were not keeping pace with the price of oil. For instance; even though rig costs have increased over the past 3-4 years oil at $51 represents an even larger increase.

Add to the formula procurement costs; old leases remains more or less constant and when calculated on the newer U.S. leases (one in eight formulae), doesn’t really cost anything other than an eighth of the rig cost which is deductible anyway and you have a very lucrative situation.

At the risk of sounding like a broken record we will say it again; oil over $45 a barrel is high and we foresee oil remaining high for the foreseeable future. There is no impetus for bringing oil down below $45 as the U.S. economy can more than handle oil at $55 without being threatened by inflation. Over $60 (perhaps as high as $65) becomes a problem. Under $45 is also a problem as the drive to develop alternative energy sources diminishes.

There is no offshore deepwater production online today, costing $40+ per barrel to produce. As long as the bulk of supply comes from existing wells where costs are primarily below $10 per barrel, even with the new tariff and taxes from Venezuela, Canada and Russia etc. (call the pinch what you like), E&P oil companies have never had it better. With a production surplus, the Majors have some bargaining power and can not be squeezed excessively by any one country.

Better yet, U.S. wells with high production costs (over $16~) get a royalty cut from the supposedly universal 12.5% figure. In 2005 the average royalty paid (actually collected by the producer from themselves, whether it was paid or not in cash or goods, is not the issue here) was around 10%, not 12.5%, thus subsidizing ‘less profitable’ wells. Location in the U.S. is also a variable.

The old 1 to1 ratio is out and the new 1.18 to 1 ratio (1.18 to 1.41 range and expanding due to share buyback programs) is being applied today by most analysts. Unless there is a sudden tremendous upsurge in overhead and production costs the markets take of the situation is correct. Notice that for the major E&P the PE remains constantly below 13 (forget the French, there is so much hanky panky going on there that it is impossible to keep track who is sleeping with who, I mean who is being paid off by who, let me try that again – who replaced Saddam…you get the picture).

COP is the notable exception to the rule due to the acquisition of BR. COP is trading more in tandem with the price of natural gas as last quarter’s results show that their bottom line suffers severely when NG falls. On the bright side, COP has spread its sourcing of crude all over the place, now effectively impervious to any single political upheaval. Well done lads.

Refiners are more volatile as swings in crude price increase and decrease their spread more dramatically, hence; the likes of Valero aren’t doing as well (for the time being). Producers that are also refiners may lose at one end only to make it up at the other end.

BP may have placed too many of its eggs in one basket, relying on Russia for 18% of future production. We are about to find out how this plays out.

CrossProfit