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Oil Selloff: Integrated Majors as Flight to Safety

Nilanjan Choudhury

Oil prices crashed further yesterday, in reaction to the cut in global crude demand growth by two major energy consultative bodies.

While the OPEC international oil cartel cut its 2015 forecasted consumption by 280,000 barrels per day from its previous expectation, the U.S. Energy Information Administration (EIA) trimmed its demand outlook for next year by 240,000 barrels per day.

The U.S. Energy Department's weekly inventory release, which showed a surprise jump in crude stockpiles, added to the commodity’s woes. As a result, the West Texas crude futures in New York were down 1.6% on Thursday to close at $59.95 per barrel, the lowest since Jul 2009.

Most Producers Under Pressure, More So the Shale Operators

Though the current oil prices are hard on most companies, it is a particularly battling time for the North American shale producers. This is because hydraulic fracturing (or fracking) – a method used by these firms to extract the commodity by blasting underground rock formations with a mixture of water, sand and chemicals – is far more expensive than conventional oil recovery.    

Considering that majority of the U.S. shale output needs oil to be at around $75 per barrel to break even, most of the projects will lose money at the prevailing prices. Especially, the smaller companies will find it difficult to service their debt burdens as they will have less cash on hand.

Look at Integrated Oil Majors Instead

Considering the crude dynamics – ample supplies in the face of weak demand – investors do not see an immediate rebound in the sentiment and expect more punishing times ahead.

In this current turbulent market environment, we advocate the relatively low-risk energy conglomerate business structures of the large-cap integrateds, with their fortress-like balance sheets, ample free cash flows even in a low oil price environment and growing dividends.

Advantages of the Business Model

Thanks to their integrated structures, companies like Exxon Mobil Corp. (XOM), Chevron Corp. (CVX), BP plc (BP), Royal Dutch Shell plc (RDS.A), TOTAL S.A. (TOT) are able to withstand plunging oil prices and still protect their top and bottom lines on downstream strength. With the refining unit of these conglomerates being buyers of crude – whose price is in a freefall – their profitability improves due to a fall in the input cost.

The companies’ financial flexibility and strong balance sheet are real assets in this highly-uncertain period for the economy. Most of them remain in excellent financial health, with ample cash on hand and investment-grade credit ratings with a manageable debt-to-capitalization ratio. On top of this, managements have established quite a track record of conservative capital management and cash returns to shareholders. They also pay a growing and safe dividend, yielding attractive returns.

In terms of assets, the integrated players own a strong and diversified portfolio of global energy businesses that offer attractive long-term growth opportunities. Their strong inventory of development projects and increased capital expenditures should help volume growth in the long run.

Exxon Mobil, Chevron the Standouts

Exxon Mobil and Chevron must be glad they did not let go their refineries. Both the companies – carrying a Zacks Rank #3 (Hold) – reported strong third quarter earnings on improved downstream results that saw refining margins climb on lower input costs.

Importantly, Exxon Mobil and Chevron’s dividend payouts are lower than their European counterparts, ensuring enough cash to cover investments and shareholder policies even in the most challenging of times.   

Finally, while access to domestic low cost oil adds to Exxon Mobil and Chevron’s competitive advantage, a strengthening dollar helps international project returns.

Read the Full Research Report on BP
Read the Full Research Report on CVX
Read the Full Research Report on TOT
Read the Full Research Report on RDS.A
Read the Full Research Report on XOM


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