Are Big Oil Companies In Trouble?

Recently the Big Oil companies have been under fire from all sides. The media, falling commodity prices, environmentalists, Barack Obama’s impending new policy changes, and many other factors have been weighing down on the stock prices of Exxon Mobil (XOM), ConocoPhillips (COP), BP plc (BP), Chevron Corp. (CVX) and the other oil giants.  A lot of investors are wondering if these are opportunities for value plays or if they are just dreaded value traps.  The answer, as with most questions dealing with energy, is more complicated than it may seem on the surface.

Everyone knows about the run up and the respective run down of commodities that occurred this year but that doesn’t explain the whole story.  I, along with many people that follow the energy sector, believe that the ride on the way up was slightly overdone and that the ride on the way down was way overdone.  As I have stated before, these companies and their analysts didn’t factor in $147 crude oil and $13.60 natural gas into their projections for earnings.  Crude oil around $90-$100 and natural gas around $7.50 as the average yearly price was where I saw almost every single companies’ estimates.  I can promise you that crude oil and natural gas will beat these numbers for yearly averages without much difficulty.  Don’t be fooled by the argument that the recent run down in commodity prices means these firms are doomed.

The media hasn’t helped the cause of the Big Oils either.  Almost every time I have seen any of these companies mentioned on television, it is generally with a negative connotation.  People blame them for any sort of problem they can think of and while I do not believe it has a huge affect on the markets, I do believe some people are discounting the fact that if Barack Obama is elected he will more than likely aim legislation against them.  Whether or not this legislation is going to be effective and reach an administration’s goals is for a completely different post (or 10 posts), but there are definitely pressing issues that could affect the majors starting in 2009.

Firstly, and sort of windfall profit taxes levied on the majors would result in a short term nuisance that would have an impact on the stock prices.   Over the long term this would not hurt the majors because any corporate level income tax is going to be passed on directly to the consumers through higher energy commodity prices.   This is not an opinion, this is economic fact that will occur if windfall profit taxes are levied.  To see how this worked the first time through you can examine the correlation between the time the Big Oil tax cuts were enacted and commodity spot prices.

The much larger problem for the majors is the environmental issue.  This will have a much longer affect on the equity prices than any tax will.  It is also harder to see the future when it comes to this environmental aspect.  Governments both domestically and internationally may take action against the majors for their carbon emissions, and this is especially likely in Europe.  I wouldn’t be surprised if new carbon emission laws came into effect in Europe before the end of 2009.  The extent to which this will damage the equity prices is unknown but I would suspect that the majors will be partially at the mercy of the carbon trading market as they will be forced to buy more credits.

All is not lost for the majors.  Many of the majors do have long term upside, as highlighted by BP’s recent acquisition of natural gas shale in the United States or ConocoPhillips’s stake in LUKOIL (one of the three major energy producers in Russia) which has produced huge returns as of late.  There are intellegent individuals that work for these companies and many of these bumps in the road will be sorted out over time.  Exxon Mobil just reported the largest quarter of any company ever in the history of the world, and I wouldn’t expect any sort of slow down regardless of energy commodity prices.  I wouldn’t advise jumping into the majors, but I also wouldn’t recommened steering clear of the majors as they will pay a solid dividend in a tough economic environment.

Disclaimer: The mutual fund the author manages is long COP, the authors family is long XOM and COP.

Posted in Categories: Commodities, Contributor, Energy, Eurozone, External Research, Stocks, USA.

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Comment by Jason

2009-01-10 14:12:34

What about peak oil? That is also affecting the oil giants if a big way.

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