DJ Oil Stocks Look Like a Better Bet Than Oil Itself -- Barrons.com
Monday, September 12, 2022 07:33:12 PM (GMT)
By Avi Salzman
Oil prices have fallen nearly 30% since peaking in March, and some analysts have been downgrading their expectations for prices this year and next. But oil stocks have held up for the most part, a sign that investors are more confident in management teams to navigate volatile commodity markets and come out profitable on the other end.
Brent crude futures, the global benchmark, were trading at $94.80 on Monday, up 2.1% on the day. But Brent is down 26% from its March peak of $127.98. And that's only after gains of more than 7% in the past three days. Brent had hit an eight-month low of $88 last Wednesday. West Texas Intermediate crude, the U.S. benchmark, was also up on Monday to $88.18, but has fallen 29% since March.
That weakness hasn't spread into the equity market. Oil stocks are holding up much better than oil prices, with the Energy Select Sector SPDR Fund (XLE) trading 5% higher in the past month. It's down just 12% from its highs. Exxon Mobil (XOM) is off just 8% from its peak, and Chevron (CVX) is down 11%.
Oil companies have relatively low debt loads now, and have reduced their operating costs, meaning they can make money even as oil prices fall. While analysts have been cutting earnings estimates for many companies in other industries in recent weeks on recession fears, that's not the case in oil and gas. Analysts' 2022 earnings expectations for Exxon have jumped 16% since the end of June.
Financial discipline is particularly important today given the many factors causing prices to swing. Russia's invasion of Ukraine sent oil prices skyrocketing, but the momentum has reversed and few analysts see prices reaching their spring peaks this year. Markets had been expecting a steep drop in Russia's oil exports after the war, but only a small percentage of Russian oil has come off the market. Most of it has been diverted away from the U.S. and Europe to other markets like China and India, keeping overall global oil supply relatively steady.
In addition, economies around the world are slowing down, and possibly contracting. China's Covid lockdowns have depressed economic growth there, and Europe has struggled to handle slowing growth and high inflation. That has sapped demand for oil.
OPEC is forecasting an oil supply surplus this year, leading it last week to cut production by 100,000 barrels per day after previously raising production. Several factors could quickly change the calculus, however, and cause markets to move quickly in either direction. Bank of America analysts wrote last week that oil could move $20 in either direction in the fourth quarter.
"On the negative front for prices, a global recession could drive oil demand growth much lower while an Iran nuclear deal could push supply higher," BofA analyst Francisco Blanch wrote. "On the positive front, the European energy crisis could lead to substantial demand switching into oil while potential supply disruptions from Iraq, Libya, Russia, or others could reduce available oil volumes."
Those looming geopolitical factors have frightened investors away from betting on oil prices, causing liquidity to drop in the futures market. "The fear remains greater than the greed," wrote RBC Capital Markets analyst Michael Tran in a note published on Sunday. Macro fund managers "rented" the oil trade earlier this year, but have been spooked by the strong dollar, which tends to cause oil prices to fall, and all the policy uncertainty. Tran thinks that oil is likely to rise from here as that uncertainty diminishes but many traders may stay on the sidelines. "Recent price discovery has been poor, but we believe that policy confusion has peaked and the de-risking of such policies presents asymmetric upside price risk," he wrote.
While a 30% drop in oil prices would have sunk oil stocks in the past, this year is different. "Equity investors appear more optimistic through the balance of the year," Tran wrote.
And most oil companies are perfectly happy with $80 oil. Major oil companies can all stay solidly profitable even if oil prices fall below $60, so they're still in very good shape at current price levels. Exxon said earlier that its break-even prices had fallen to $41, and it's working on reducing them even more.
For the first time in a decade, investors believe in management teams to stick to their production plans instead of pumping too much oil and causing prices to fall. The old boom-and-bust cycles may be over, or have at least paused. Energy stocks have also become a consistent source of dividends, which tend to put a floor under stock prices as long as investors believe that companies won't cut the dividend. Several companies have been offering variable dividends on top of their normal dividends. At its current pace, oil producer Pioneer Natural Resources (PXD) has a 10% dividend yield.
"In fact, more than 90% of our planned capital investments that bring on new volumes over the next 6 years generate returns at a greater than 10% at or below Brent prices of $35 per barrel for the life of the investment," said Neil Chapman, who runs Exxon's oil and gas production division, at the company's investor day earlier this year.
Investors may be iffy about oil prices right now, but they're willing to take those kinds of numbers to the bank.
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