2 Integrated Oil Stocks To Consider Now

| About: Royal Dutch (RDS.A)

Anglo Dutch integrated oil giant Royal Dutch Shell (NYSE:RDS.A) is the world's largest oil company by revenue. Its existence is the result of the 2005 merger between Royal Dutch Petroleum and Shell Transport and Trading Company. The "A" series relates to that company with roots on the Royal Dutch side, and the "B" series relates to the traceability to the Shell side of the 2005 merger. I will be discussing the "A" series for the balance of this article, although the "B" series is virtually identical.

I developed an interest in Royal Dutch and its management in the first week of February, at a time when domestic benchmark West Texas Intermediate crude oil was selling for about $110 per barrel. At that time, management cited macroeconomic volatility as the primary reason for oil price volatility, and foresaw prices in 2012 swinging down to as low as $70 per barrel. Honestly, I thought management was crazy, but oil prices have been dropping in recent weeks, down to around $83 per barrel, the least expensive oil has been since early October, 2011.

The reasons for this decline in prices are well known. No one can be certain of what is going to happen within the European Union, and many of the countries in Europe are already in recession. The Chinese economy is slowing, at least by its own standards, and the American economy is not going full bore either. Add in that the world's leading user of oil as a transportation fuel, the United States, is producing vehicles with weight and engineering advances that could not have been imagined twenty years ago, further dampening demand for oil.

These same downward pressures are not isolated to oil. Natural gas is trading at about $2.30 per mmBTU in this country, barely above the historic low of earlier this year. Natural gas prices have declined again due to supply and demand factors, as shifts in drilling practices have brought about a glut in natural gas supply. Coal is also in a supply and demand squeeze. Thus far in 2012, we shrunk coal as a percentage of domestic energy production to about 40%, the lowest in the post World War II era. The result is a modern record stockpile of coal, well above the seasonally adjusted five year average.

That is the climate that Royal Dutch and its peers are operating in, and it is a far more perilous climate than we had seen six months ago. Yet, as a finite commodity, oil prices will go back up, ultimately to $200 per barrel, and much, much more. But that day is a little further away than it used to be.

While domestic gas drillers are doing what they can to reduce drilling or shift to oils, like Anadarko (NYSE:APC) has done, once outside of America, natural gas is a different reality. In Asia, dry natural gas costs about $16 mmBTU, and in Europe, it is going for about $10 mmBTU. Royal Dutch Shell has invested over $20 billion in natural gas assets, and will invest more, but not to sell in the United States. Royal Dutch Shell is investing heavily in Canadian territories for Liquefied Natural Gas in order to ship the product to China. It has spent $20 billion to develop gas assets in Qatar, largely for export throughout Asia. At current trends, in 2012 the company will generate more revenue from gas than from oil.

On the earnings front, 2011 represented Royal Dutch's highest revenue year in its history. This year, I expect it also, on the strength of its natural gas and downstream business set a company profit record. First quarter earnings of roughly $7.6 billion, or $2.80 per American Depository Share, were up about 6% from the same quarter of 2011. That puts the company on pace to approach $30 billion in earnings for this year. But what I like most about this company is that it is not as focused on near-term earnings as many companies are, and its capital spending of $4.6 billion in the first quarter shows no signs of slowing. The company also offers an attractive dividend yield of just over 5%, though under Dutch law there is a mandated 15% dividend withholding

For most anyone interested in a large, integrated, oil and gas company, I would put Royal Dutch Shell at the top of the list, even above other quality companies such as Exxon Mobil (NYSE:XOM) and Chevron (CHV).

For those with an appetite for a smaller integrated oil and gas company take a look at Suncor Energy (NYSE:SU), a large integrated Canadian company, but still with scarcely more than 10% of the market capitalization of the capitalization of Exxon, Chevron, or Royal Dutch.

Suncor is a leading driller and producer of controversial Canadian tar sands oil. The tar sands in 2011 accounted for 60% of the company's profit. Refining and marketing (downstream activities) accounted for nearly all the rest of Suncor's fine 2011 results, which came to $4.3 billion, or $2.67 per share, an all-time record for the company. It was a 60% jump from 2010, and the beat continued into the first quarter of 2012. There, earnings came to $1.46 billion, or $0.93 per share. This was a 43% advance from the first quarter of 2011.

Suncor would be a Wall Street darling, I believe, were it not for some of its excessive real estate spending that is eerily reminiscent of beleaguered Chesapeake Energy (NYSE:CHK). Mining and refining oil sands are far more costly than refining most crude oils. In general, the idea is that Suncor's expenses have gotten out of whack. There is political pressure from the United States regarding the proposed TransCanada's (NYSE:TRP) Keystone XL Pipeline project, which if built would be an economical means to ship the product to Gulf Coast refineries. Going forward, Suncor management will be focusing on the expense side of the income statement.

If you can stomach the environmental impact of Suncor's business, there is substantial earnings momentum, with a five year PEG of a miniscule 0.44, as its stock price has not really reflected recent earnings gains. As much as any integrated energy producer out there, Suncor appears to me to be undervalued.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.