The United States is in the midst of another oil boom, the biggest in 40 years. These levels of production were last seen towards the end of the 1960s during the biggest US oil boom in history. The United States is on track to overtaking both Saudi Arabia and then Russia as the largest oil producer worldwide. Through this article, I will be exploring the general picture of the oil industry in 2014 as well as providing how and why to play the move through ExxonMobil.
As the second largest company by Market Capitalization in the world, ExxonMobil doesn’t need much introduction, so lets keep it short. ExxonMobil is an American multinational oil & gas corporation. It is a descendant of Rockefeller’s Standard Oil, which broke up at the turn of the 20th century due to its overarching monopoly. In 1999, Exxon and Mobil, both independent at the time, merged and founded what was then the largest company in the world. Since then, it has been fighting with Apple $AAPL over the title.
As can be inferred, due to the industry it operates in, ExxonMobil is a risky stock. This is the precise reason I chose Exxon over any other Oil company. Having such a large market capitalization, Exxon provides a lot of safety in a truly risky business. Later in the article, I will be revealing other companies in the industry that are much smaller but provide a higher risk coupled with reward.
Below is Exxon’s YTD chart. On the 27th of December 2013, Exxon hit an All-Time high of 101.625 closing at 101.51. Overall Exxon had a rather mediocre year with most of the action occurring towards the end when buying increased with momentum picking up and following through toward the end of the year. Price appreciation can be attributed to several factors such as increasing crude prices and a strong operational and financial position.
In its annual report, the EIA (Environmental Information Administration) predicted US crude oil output to rise by 800,000 barrels per day until 2016, when it hits 9.6 million barrels a day. The drastic increase in oil production is due to advanced technologies being deployed in the extraction of shale oil fields. This will bring a renaissance in domestic oil production.
In addition to this prediction, the United Sates is set to overtake the largest Oil and Gas producer in the world, Russia. The ascendance comes as Russia struggles to maintain its energy output and isn’t developing new technologies as the ones produced in the United States. The EIA stated that the US produced 22 million barrels per day in July, which is slightly more than the 21.8 million produced in the Russian Federation. With this surge in production, the US has reduced its reliance on foreign oil and imports have thus fallen 15%.
In terms of Oil in the US, the question of supply isn’t an issue anymore, its all about the demand and the cost of production.
ExxonMobil has a current P/E ratio of 11.88, which is undervalued when compared to its historic 15-year average of 14.9. It also offers an earnings yield of 7.88% with a current EPS of $7.66. $XOM pays an indifferent dividend of 2.5%, which isn’t enough given its size and capital reserves. Instead of dividend distribution, Exxon is big on share repurchasing. In Q1 of 2013, ExxonMobil bought $5 billion worth of shares, this fell in Q2 with $4 billion and Q1 at $3 billion. This has led them to put money back into dividends and balance both dividends and buybacks as they are competing with companies to the likes of Chevron, which provides a 3.24% yield, or ConocoPhillips with 3.92%.
Exxon trades at a FCF of 18.3x on a 5-year average. When putting it into perspective, $XOM might seem like an expensive company relative to others in its industry. This fact is ignored when taking its operating history into consideration.
Looking at long-term metrics, Exxon’s shares look inexpensive relative to both its own history as well as when comparing it to the S&P 500.
Going forward, Exxon is taking a more active stance on its earnings per barrel as well as its production mix. Over the next few quarters and years, the spending will ultimately flatten off which will result in greater earnings per barrel, free cash flow and increased returns from what we have seen in the past two years. Relative to its peers, Exxon provides larger natural gas holdings, greater share buybacks and provide better value.
Exporting the Oil
The United States is going through some crucial times in the energy sector. This surge in oil production has brought legislation passed long ago into question. The law is on the ban passed 40 years ago on oil exports by the US government. It was passed during a time of severe oil disruptions. This law bars producers from exporting crude without a special license from the Commerce Department. The US is currently exporting about 100,000 barrels a day, which is far less what it would be able to if the law were lifted. Large Oil Companies like Exxon are on the forefront of this ongoing battle to lift the law. If the government cedes to the pressure, profits will skyrocket, as the US producer will be able to supply oil worldwide. Chances of this occurring are high. Not only would the lifting of the law benefit oil producers, they would also help the US balance of trade as well as allowing energy markets to operate more efficiently.
The US Federal Reserve has recently given the green light for the long-awaited commencement of the Taper program. A program that intends to scale back on the monthly bond purchases of $85 billion by the FED. In other words a stimulus injected to boost the US economy. The Fed (central bank) asserted that the economy was strong enough and reduced the bond purchases by $10 billion, lowering the total amount to $75 billion. The scaling back has fueled hopes for a better economy and has consequently increased the energy demand, thus propelling Crude Oil prices higher to around $100. This has vastly benefitted the oil industry, and mainly ExxonMobil. As the US macro-economic picture improves, and gas prices move higher, Exxon will be able to sell its Crude for higher prices, increasing its profit margins considerably.
In addition to its domestic expansion of production, it is reaching out internationally to further increase its production. Exxon Mobil has recently signed a joint venture with the Russian Oil giant Rosneft to explore a tight formation of oil in Western Siberia. This deal between the world’s largest listed oil firm and the worlds top oil-producing nation could cost upwards of $500 billion. This truly is an ambitious project. Russian Deputy Prime Minister Igor Sechin said, “This project, in terms of ambitions, exceeds sending man into outer space or flying to the moon”. Exxon plans to invest $300 million in an area that could yield more than 15-20 billion barrels of Crude Oil.
In order to attract more oil companies, the Russian Government is providing tax incentives. It has recently abolished export duty and slashed mineral extraction tax.
The whole endeavor has already begun and is expected to continue well into 2016-2017. The tax breaks will provide ExxonMobil with favorable operating margins in developing the shale gas in the region.
A popular belief is that we are running out of oil, and it is only a matter of years before all the oil from the planet runs out… This statement could not be further away from the truth. The planet does posses oil, and plenty of it. The only difference between now, and a few years ago when the ideology was popular is that we now have the technology to extract oil from remote areas underground.
Nevertheless, it is important to look at what ExxonMobil is doing in terms of alternative energy. Although the company isn’t too keen on biofuels, it is bullish on the hybrid market. Since the late 1970s, Exxon has been working on improving lithium batteries. It develops ways to make the battery withstand higher temperatures. Something interesting to know is that a large number of cellphones possess those lithium batteries. The current focus of ExxonMobil has recently been shifted to replacing the less efficient nickel-based hybrid car batteries with lithium batteries and is currently selling its technology to companies like Toyota and Ford. Although ExxonMobil heavily relies on the oil industry as its main source of revenue, it does nevertheless have an expanded reach over the energy sector.
This whole oil boom is driven mostly by increasing Shale Oil production. Even though ExxonMobil has significant exposure to that market through a series of acquisitions, a company directly involved in the production of Shale oil in the key areas such as the Bakken Oil field in North Dakota or the Eagle Ford formation in South Texas, could prove to be more interesting. My favorite pick in that area would be $CLR Continental. Continental is right in the middle of the action. It is the leading producer in North Dakota’s Williston Basin. Its goal is to triple production by 2017, this offers an unparalleled 5-year growth outlook amongst any company of its kind.
Another way of playing the oil boom is through the purchasing of the US oil ETF $IEO. This is a safer investment compared to $CLR but risker than $XOM. But it does provide everything to gain exposure to the boom.
It is no doubt that the US will be top dog in the Oil industry for a considerable amount of time. The surge in oil production will not only benefit oil companies such as ExxonMobil and Continental, but will also help with the broader US economic recovery. The three picks from this article are $XOM, $IEO and $CLR (in order of riskiness).