Wow, it certainly is getting much harder to find new oil. While Exxon (XOM), Chevron (CVX), and BP p.l.c. (BP), have all reported fairly strong earnings, these companies have now failed to show consistent increases in their oil and natural gas production for several quarters now. Interestingly, now that the markets have recovered and oil is back at the hundred dollar level, the energy sector is now in focus again. With fears of a recession having abated and oil back near the hundred dollar level, energy stocks are popular once again. However, despite the recovery in oil prices and rally in most energy stocks, most of the large integrated oil companies have lagged other stronger performing sectors like the industrials.
Why is this? While there are a number of possible explanations as to why any given stock or group of stocks may lag a market move up or down, I think the reason most of these larger traditional integrated oil companies have underperformed the market is because of their consistently disappointing oil production numbers.
While oil prices are obviously usually the strongest traditional indicator of the overall health of the energy sector, many oil companies are having an increasingly difficult time simply maintaining their production numbers. With oil prices staying in the $80-$120 range but not making new highs, energy companies are having a tougher time growing their earnings without being able to increase production. With high but stable energy prices and rising commodity costs increasing the cost to find oil, the best performing energy stocks moving forward are likely to be companies that can consistently show production gains.
The only oil companies that have consistently shown strong gains in oil production over the last couple years have been the mid-majors. While companies like BP, Exxon, and Chevron, get all the attention, large but relatively small energy companies like Apache (APA) and EOG Resources (EOG) are showing some of their best production numbers in each company's respective history. These companies continue to raise their oil production numbers through increases in production from their existing oil fields, successful acquisitions, and efficient capital expenditures that have led to new oil finds.
While the largest North American oil companies have been hurt by their exposure to falling natural gas prices and the lower margin refining business, the mid-majors have been able to focus their efforts on the most profitable and largest part of their business. Apple (AAPL) did surpass Exxon as the biggest company in the world, but Exxon is still an over 400 billion dollar giant. Chevron is not far behind with a market cap of over $300 billion. With net assets and cash greater that the GDP of many countries, it shouldn't be surprising that these behemoths have trouble matching the efficiencies or successes achieved by their smaller peers. Today Apache's market cap is roughly $50 billion, while EOG resources market capitalization is $35 billion.
While Exxon and Chevron appear to be well run companies, it simply is not reasonable to expect them to be able to increase their production numbers at the rate they have been able to in the past. In addition, the competition to discover new oil fields has never been greater.
Companies like Chevron, Petrobras (PBR), BP, and Exxon, all have found significant new oil deposits fairly recently. These discoveries have largely been at extreme depths of 30,000 feet or greater, and these finds have also not been big enough to offset their lower production numbers from many existing fields. Discoveries like this are impressive, but they are also harder to come by and less profitable to bring to market.
The major oil companies have had some impressive discoveries in recent years, but the consistent discoveries and production growth achieved by the mid-majors over the last decade has been much more impressive. Apache reported a 25% increase in year-over-year oil production in second-quarter earnings, and 10.5% year-over-year production increases in third-quarter earnings. The company's well-timed acquisition in the Gulf from Devon and BP, as well as production increases from fields in Egypt, and Australia, were largely why Apache was been able to show these impressive production increases. Apache does get the majority of its production from Egypt, but the military's role in that country seems to preventing the political instability from having an effect on the company's long-term contracts.
EOG's latest quarter also showed similarly strong production increases year over year. Just last quarter EOG reported organic production growth of 11%, and this was on the back of 9.5% production growth year over year in the second quarter. EOG reported strong increases in its r North American gas and oil holding was largely why the company was able to show such strong production numbers.
To conclude, the largest companies in any sector often get the most attention, but to find value usually requires looking a little deeper. While strong energy prices and an improving economic outlook will benefit the energy sector as a whole, not all companies will benefit equally. With most of the larger integrated oil companies experiencing flat-lining to declining production numbers, the mid majors are likely to be the best performing companies amongst the oil producers. Finally, with the largest players in the oil industry with record amounts of cash on their balance sheets, capital cheap, and new oil fields increasingly hard to find, the mid majors could also be acquisition targets as well.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
