If you have been to the gas pump lately, you probably felt the extra squeeze on your wallet. Around the U.S., the price of gas has gone up by about 30 to 40 cents a gallon since this time last year. While this is bad news for consumers, it is great news for Exxon Mobil (XOM). Exxon's earnings track the price of gas. When prices were at record highs in 2008, Exxon had its best year ever, making over $45 billion in profit. However, when prices collapsed in 2009, so did Exxon's business. Exxon's 2009 earnings were less than half of its 2008 earnings. Now that gas prices are slowly climbing up, so are Exxon's profits.
Exxon's history shows how important the economy is for an oil company's business. When the economy is strong, consumers and businesses are spending more so the price of gas shoots up. When the economy collapsed after the housing bubble burst, oil prices collapsed as well. With this logic in mind, I think it is a good time to invest in Exxon Mobil. After a severe and long recession, the U.S. economy is finally starting to recover. In October, the U.S. Bureau of Labor Statistics recorded unemployment below 8% for the first time since 2009. Housing prices also grew by 15% in September showing that consumers are buying again.
Now things are far from perfect in the world's economy. America is just barely showing signs of recovery and the European Union is struggling from serious debt problems. However, I don't think things need to be perfect for Exxon to grow. In 2008, the world population was about 6 and a half billion people. In 2012, the United States Census Bureau now estimates that the world population now exceeds 7 billion people. More people mean more demand for cars, heat and housing, all drivers behind the price of oil. Even though the American economy is far from running at full capacity, the extra population growth is pushing oil demand close to its peak in 2008.
As a result, Exxon is booming even while the rest of the economy has not fully recovered. Exxon came close to matching its record earnings in 2011. 2012 seems to be going even better. If Exxon keeps the same pace going forward that it reported in its second quarter earnings report, it is on track to break its profit records this year. A growing world population and economy are a formula for Exxon's success. While Exxon's revenues have grown significantly in the past few years, its expenses have not. Increased oil production has led to some increase in Exxon's total expenses, but most of Exxon's other costs stayed the same over the past few years. It looks like Exxon is keeping this trend for 2012 which is a very positive sign for Exxon's margins going forward.
This has also helped Exxon's cash flow position. When the economy tanked in 2009, Exxon was bleeding cash and had about $20 billion in negative cash flow. Since then, Exxon has been able to steadily increase its income and saw positive cash flow in 2011, the first time since 2008. This is another positive sign that the company is stabilizing.
The political environment is also good for Exxon going forward. In 2009, America came close to passing global warming legislation that would have heavily taxed sources of carbon, like gasoline. This would have been a huge problem for Exxon going forward. In the end this bill stalled and shows no signs of being reopened. Even if the Republicans do not retake the presidency, they will still have much greater representation in Congress than they did in 2009. It does not look like any global warming legislation will come into play anytime soon so Exxon does not need to worry about this risk.
Going forward, things look great for the major oil companies like Exxon, Royal Dutch Shell (RDS.A), Chevron (CVX) and BP (BP). When the U.S. economy finally returns to full employment, I think oil prices will hit new records. However, while this would be good for all oil companies, I think Exxon in particular is in position to benefit going forward. Exxon is by far the largest producer of oil. Exxon produces roughly 6 million barrels of oil a day making it a much larger refiner than its competitors. It is also the most profitable. Exxon's profits in 2011 were nearly double its nearest competitor, Shell. If the oil industry continues to grow, Exxon should see the lion's share of the gains. Exxon is also in a better financial position than its competitors. When the economy was bad a few years ago, Exxon's debt to equity ratio spiked to about 14%. Since then, it has improved quite a bit and is currently down at 9%. This is much better than the other major oil companies as Shell has a debt to equity ratio closer to 19% while BP is up around 42%. With less debt, Exxon has more financial capacity to invest in itself, and is better prepared for another economic downturn.
Another advantage is Exxon's huge reserves of oil. In order to take advantage of future high oil prices, an oil company needs to have oil. Assuming Exxon never finds a new source of oil, its oil reserves are large enough to meet existing demand for the next 15 years. Since Exxon continues to find and develop new sources of oil around the world, it should also continue adding to its stock going forward. A lack of supply won't derail Exxon's future profits.
Exxon's competitors are not as lucky. British Petroleum has still yet to fully recover from the disastrous oil spill in the Gulf Coast. Chevron and Shell also saw a drop in oil production this year. Exxon on the other hand was able to slightly grow its oil production. As it becomes more difficult to find oil, Exxon seems to be doing a better job.
If you assume that the world will eventually run out of oil like I do, oil companies will someday run out of reserves. When a company runs out of oil and falls out of the market, the remaining companies should become even more profitable. Since Exxon is so large, I think it has the best chance of being the last man standing in the oil industry. If it does, its potential future profit margins will be off the charts. It won't be any more expensive to refine the oil in the future, but it will sell for a whole lot more. As time goes by, I would expect Exxon's revenues to grow much faster than its expenses according to this logic.
In addition to oil, Exxon is also a major producer of natural gas. This is smart because even though oil is the clear source of energy today, this might not be true in the future. While Shell is also making large investments in natural gas, Exxon's other competitors are lagging behind so Exxon has a competitive advantage in this market. Currently, this strategy has not worked out very well. There is too much supply of natural gas on the market and not enough demand so natural gas prices are very low. However, this could change quickly as rising oil prices push consumers to find other sources of energy. When this happens, Exxon will be in position to take advantage of this shift.
Exxon is a massive company. It currently has the largest revenue of any company in the world and has the second largest market capitalization. It used to be number one but lost this title last year to Apple (AAPL). There's no surprise why Exxon is so big. It's in a lucrative industry and makes better decisions than its competitors. If the price of oil continues its current trend, Exxon should be taking back its crown from Apple as the world's largest company.