Exxon Mobil: Quo Vadis - After OPEC+ Supply Cut?

Oct. 06, 2022 6:16 AM ETExxon Mobil Corporation (XOM)21 Comments
Cavenagh Research profile picture
Cavenagh Research
3.17K Followers

Summary

  • On October 5th, OPEC+ decided to reduce oil supply by 2 million barrels a day, which is equivalent to approximately 2% of the global demand.
  • Exxon Mobil stock surged more than 4% the trading day following the OPEC+ announcement, speculating that higher oil prices would support profitability.
  • But long-term, this profitability is vulnerable to political, economic, and structural risk. And the oil & gas industry is already flashing warning signals.
  • One day after the OPEC+ meeting, Shell warned that Q3 earnings are likely going to be lower than expected.
  • Thus, it could likely be that Exxon's profitability has peaked in Q2 2022 when the oil major delivered EPS of $4.14/share.

A Exxon gas station is seen with dark blue sky in the background at dusk.

JHVEPhoto

Exxon Mobil (NYSE:XOM) stock surged more than 4% the trading day following the announcement that OPEC will cut oil output by 2 million barrels a day. But is the OPEC decision bullish for XOM? Perhaps in the very short term, yes -- as there will be a few more quarters of strong earnings.

But these earnings are very vulnerable in the long-run, as political risk, economic risk, and structural risk (energy transition) are pending over the market like a Damocles sword -- waiting to cut oil prices lower.

The OPEC Meeting

On October 5th, the OPEC+ group decided to reduce oil supply to the world by 2 million barrels a day, which is equivalent to approximately 2% of the global demand. The output cut comes at a time when the major western economies are already struggling with high inflation, which is to a major degree provoked by high energy prices.

However, according to Bloomberg analysts, the actual cut in output is closer to 800 thousand barrels a day given that some OPEC+ members have failed to reach their production targets.

The US government has criticized the output cut sharply, saying the decision would be a strong headwind to the health of the global economy and would be most painful to 'the weak' emerging markets economies. And as a consequence, OPEC+ would achieve little more than pushing customers into a recession. Reportedly, white-house speaker Karine Jean-Pierre even said that it would be 'clear' that the OPEC+ is 'aligning with Russia'.

Saudi Arabia, however, dismissed allegation to inflict pain on western economies. Energy minister Prince Abdulaziz bin Salman justified the decision saying output cuts would stimulate prices such that investors are encouraged in long-term supply investments.

State Of The Oil & Gas Industry

The OPEC decision to cut oil prices in context of such a stressed economic environment, could very well be regarded as a political move. But investors should also consider that cutting oil output may also be a sign of weakness for the market.

Given a slowing global economy, within less than 6 months oil prices (WTI benchmark) slipped from a high of $121/barrel to $79/barrel. Such a rapid decline is obviously not in the best interest of the OPEC+ member states, who consider a price of around $100 as 'fair' -- and they are fighting to get it.

Notably, about a week ago, Saudi Aramco warned that the oil & gas industry is struggling to meet demand. But isn't it a conflicting message then, that the OPEC now reduces supply? (Note that Moderna warned that the company would be struggling to supply enough booster Covid-19 vaccines, as the 'true' demand push faded). In my opinion, talking up confidence is a strong signal of a slowing market.

The WTI benchmark only increased by about 5% following the day of the OPEC+ decision. This is, in my opinion, a 'weak' move as compared to what the 2 million barrel headline number might imply. It looks like markets are fighting the story that the oil market is in a deep supply shortfall.

Implications for Exxon Mobil

As OPEC+ is manipulating supply and industry confidence to push up oil prices, Exxon will likely enjoy a short-term margin boost. But this margin boost is needed.

One day after the OPEC+ meeting, Shell (SHEL) warned that Q3 earnings are likely going to be lower than expected, citing lower refining margins and energy trading volume/profits. And the drop is significant: According to the company's estimates, refining margins for the September quarter are expected to drop by almost 50%, from around $28/barrel in the June quarter to $28/barrel in the most recent quarter.

Thus, it could likely be that Exxon's profitability has peaked in Q2 2022, when the oil major delivered EPS of $4.14/share.

Economic Risk

In my opinion, if the world is indeed slipping into a recession, energy prices will eventually drop, as they have always done in a slowdown. Notably, following the dot-com burst, oil prices slipped by about 50%. And before the financial crisis oil stood as high as $140 per barrel (July 2008), only to crash to as low as $40 per barrel by the end of the year.

Oil price performance

Financial Times

Exxon Mobil's profitability and stock should react accordingly, as for the past recessions XOM always depreciated in value and underperformed the S&P 500 (SPX).

Dot-Com Crash induced recession (March 2000 - mid/late 2002)

-12% for XOM vs. -33% for SPX.

SPX vs XOM Dot-com crash

Seeking Alpha

Financial Crisis (December 2007 - May 2010)

-31% for XOM vs. -21% for the SPX.

SPX vs XOM financial crisis

Seeking Alpha

Structural Risk

Investors should also consider that the world is working hard to phase out oil and gas. And the OPEC+ supply cut should do nothing less than provoke an even stronger commitment from western economies to cut the dependence on fossil fuels.

It is true that higher oil prices will stimulate long-term investments, as Prince Abdulaziz bin Salman argued. But investments are likely being made in alternative energy sources, not in fossil fuel producing assets.

Accordingly, XOM shareholders should enjoy the higher oil price environment while it lasts. And push Exxon management to distribute as much as possible of the accumulated value to shareholders. Because the current cyclical peak will likely be the industry's last dance (personal opinion).

Conclusion

In my opinion, the OPEC+ decision is less a political move, than a sincere attempt to fight a slowdown in demand for oil -- which could be due to economic and/or structural risk. Accordingly, it could likely be that Exxon's profitability has peaked already in Q2 2022, and that the oil major's Q3 results disappoint.

I do not recommend, however, to sell XOM stock. For that, the political environment is simply too unpredictable -- reflecting on the Russia-Ukraine conflict, as well as the recent OPEC+ decision. Moreover, given high inflation, many investors still consider the oil/energy complex as a good 'place to hide'. And it may very well be for now. 'HOLD'.

This article was written by

Cavenagh Research profile picture
3.17K Followers
5y experience as an investment analyst for a major BB-Bank. Currently working towards the CFA charter. Passion for risk-assets (Growth, Contrarian, Emerging Market) ex-colleague and close friend of Investor Express

Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within 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.

Additional disclosure: Not financial advise.

Recommended For You

Comments (21)

To ensure this doesn’t happen in the future, please enable Javascript and cookies in your browser.
Is this happening to you frequently? Please report it on our feedback forum.
If you have an ad-blocker enabled you may be blocked from proceeding. Please disable your ad-blocker and refresh.