XOP: Exploration And Production To Outpace Refining

| About: SPDR S&P (XOP)


OPEC allows for inflated prices without requiring US production cuts.

The lifting of the 40 year US crude oil export ban allows for international trade in a fruitful environment.

Trumps environmental beliefs will likely reduce regulations on oil companies.

Refineries will be hurt by the lifting of the export ban, thus Exploration and Production is the subsector to focus on.

After a horrible start of the year that put significant pressure on the energy sector as a whole, we have witnessed a massive, sustained rally by the whole sector. After watching companies like Chesapeake (NYSE:CHK) and other S&P Oil companies work their hardest to stay afloat, we have been lucky enough to witness good times once again. For those who made a bullish call early in the year and held on, there has been real money to be made.

As you can see from the graph below, while the energy sector has rallied, the subsector of exploration and production of oil and gas (NYSEARCA:XOP) has recently seen some increased gains. I believe this disparity between the drilling and exploration and the overall energy sector has not been effectively priced in and there are huge gains to be made from the exploration and production industry.

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The reason for this disparity has been the undervaluing of certain catalysts by the market. The first catalyst that any article on oil must discuss is the OPEC Deal. This deal could not be better for the United States. As all the other countries we compete with in the oil industry cut back their output and raise prices, we have no such agreement. This means that we have the gift of increasing output while watching price remain inflated. Increased output and increased price means more profit for American companies. However, despite the obvious value of this deal for American oil, I believe this has already been factored into oil's present rally.

The second catalyst , in non-chronological order, is the removal of the 40 year crude oil export ban on the US. This ban, lifted by the government last December, disallowed for WTI crude oil, the American standard, to be shipped worldwide without refining. The lifting of the ban allows the US to start exporting oil. This means that the WTI oil price, which for years has been artificially depressed in relation to the Brent price, will no longer be hurt by its artificially limited market. Now that it has been lifted, if economically sound, it no longer hurts to overproduce oil because demand is no longer deflated.

What this means is that instead of US oil producers having to worry only about US demand, they can now focus on world demand. As we can see from the graphs below, while the world oil supply is increasing at the same speed as demand, OPEC will prevent it from following suit. This increased demand without the supply to fulfill it will leave space open for economically sound US exports. Now that they are legal, this will become a more practically explored money making opportunity for US oil companies. This catalyst, on the other hand, has not been properly priced into the current rally because at the time of the ban lifting, there was little economic gain to be had. Oil was in oversupply and exports were rarely practical. Not that this fact has changed, the market has failed to take the international ramifications into account.

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The third Catalyst I would like to discuss, while the least important, is the election of Donald Trump to POTUS. He has all but said he wants to remove the EPA. While his election had been factored into prices in many ways, the fact that exploration and production companies, some of the most EPA regulated companies on earth, will have a likely significant decrease in oversight and regulation will allow for increased efficiency and reduced production prices.

These three catalysts create a very favorable for Oil companies as a whole. Yet, one sector of the Oil business most likely will not find favor in such an environment in comparison to the others. This is the refining business. This will likely be hurt because in order to export any oil, in the past, it had to be refined beforehand. The lack of necessary supply of refineries allowed these companies to inflate prices and their demand was only increasing. Now that straight crude oil can be exported without refining, the oversupply of crude oil, and the necessity to refine it, will soon disappear. This is likely to hurt the bottom line of many of these companies. As can be seen below, the E&P subsector has remained negative despite the overall bullish environment of the industry and the current environment should allow it to catch up.Screen Shot 2016-12-07 at 5.44.05 PM.png

Due to this, I wanted to focus my investing on just the exploration and production subsector of the industry. Of all the ETFs I looked at to get a well diversified exposure to the industry, SPDR S&P Oil & Gas Explore & Production ETF had the lowest exposure to the refining and marketing business at 17.6% compared to a standard of around 35%.

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Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in XOP over the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.