By Mark Bern, CPA CFA
In the short term it may not matter how well management executes since perception is still driving the market. Perception, these days, expects global demand for oil to weaken at least through the first half of 2012. Therefore, oil prices are also expected to soften during that time period and, as long as perception holds true, the price of ExxonMobil (XOM) is expected to drift lower. I would expect a floor of around $70. By late spring we’ll need to take another closer look at driving trends and the overall economic picture to make a better determination of the trend during the summer vacation driving season.
I need a caveat here: all projections go out the window if the European Union implodes and contagion is not contained to Europe. No one knows with certainty how the EU situation is going to unfold, so investors should be aware of the problem without allowing it to significantly alter their investing decisions, in my opinion. Taking a longer view helps mitigate the shorter term potential volatility due to uncertainties that threaten the global economy.
Taking a little longer view, let us look out to 2013 and 2014. Current global oil demand is placed at 88 million barrels per day. Projections from the U.S. Energy Information Administration (EIA) for oil demand in 2013 are 91 and 92 million barrels per day, respectively.
Even as demand for oil is projected to decrease in developed countries due to more dependence upon renewable sources and conservation efforts, the demand for oil is expected to continue to increase in developing countries.
World demand is expected to approximate 112 million barrels per day by 2035, according to the EIA. This represents an increase of over 27 percent during a time when oil production is expected to peak. The obvious result is a continuing trend of higher oil prices.
But the demand picture for natural gas, again from the EIA, is even more dramatic, rising from 114.4 trillion cubic feet to 168.7 million trillion cubic feet over the same period, resulting in a projected increase of 47 percent in global demand. Overall global energy demand will continue to increase as hundreds of millions of people in developing countries join the ranks of the middle class and clamor for an improved standard of living.
I make these points about world energy demand, and specifically about demand for oil and natural gas, because that is the business in which XOM, the largest integrated oil company in the world, competes. The company has made strategic acquisitions, including XTO energy in 2010, to position itself for the future. Natural gas prices are low now and oil prices are softening in the short term, but the prospects for higher prices due to rising demand are good for both products.
In the intermediate term, 2013 to 2014, I expect that average oil prices are likely to rise to the $110 and $125, respectively. West Texas Intermediate (WTI) price for crude oil has been closer to $90 per barrel lately.
So, demand and product pricing expectations for oil look very good for XOM in the intermediate future and the picture gets even better further out (if you are an owner of XOM’s stock).
The story for natural gas is fairly similar except that current prices are more depressed than for oil due to excess supply coming on line from oil shale formations. I expect that the supply and demand imbalance that currently prevails will edge steadily toward greater equilibrium in the next few years as production increases level off and demand for natural gas for electric power production increases. That will provide a better pricing environment in the future.
At the current price of $79.79 (as of the close on Friday, December 2, 2011) the price/earnings ratio (P/E) is 9.6. This isn’t exactly bargain area but it is below the company’s historical average of about 12. It the price gets down to its support level around $70, the P/E would come down further to about 8.5 on a trailing twelve month (ttm) basis. Now let’s look at the forward P/E based upon expected earnings.
I expect earnings for 2012 of about $8.50 per share compared with ttm earnings of $8.28. That’s not a huge rise and is the result primarily of the slack demand expectations. If, as I expect, the price drops to $70, the resulting forward P/E would be about 8.2. Now we’re getting into the bargain range, especially when we consider the future prospects going out a couple of years. This would also produce a dividend yield of 2.7 percent. I expect dividend increases for the next few years to be in line with the 10-year average of seven percent.
Now add a stock price appreciation expectation of about ten percent (equal to the 5-year average) and we find we have an expected average total return average close to 15 percent. I also like the consistency of dividend increases as XOM has increased its dividend in every year over the last 28 years. I love those raises.
In closing I want to point out that my other favorites in the integrated oil patch are Chevron (CVX), Occidental Petroleum (OXY) and ConocoPhillips (COP). I have an article coming out on COP soon and have written previously on CVX and OXY.