Oil Majors Not the Place for Rising Oil

The rally in oil stocks since the OPEC agreement to cut 1.8mbd of oil production for the next six months has been tremendous. As usual, investors only seem to be getting the stock picks less than half right.

The stocks that investors should be buying are the low cost shale producers. Companies focusing on the Permian Basin, Eagle Ford, the STACK and SCOOP in Oklahoma, and the center of the Bakken have huge advantages to other producers, especially the oil majors who OPEC will continue to keep a thumb on.

In Jeff Reeves’ MarketWatch article he adds onto an idea I suggested to great criticism last year, that the oil age is ending. Jeff points out that the oil majors will be on the chopping block sooner than later. Many don’t believe this as they chant about the financial strength of the likes of Exxon (XOM) and Chevron (CVX). That strength is an illusion though, which will become clear within the next few years.

The weakness of the oil majors is both internal and external. They are subject to short-term challenges and long-term secular trends.

Internally, both Exxon and Chevron have loaded up on debt, not unlike most of the other oil majors. Their idea is that future production and asset sales will be able to pay down that debt. While no projection is foolproof, it is at least questionable that either company will be able to pay down their debt and continue to pay their dividends long-term.

There is a major change in the oil industry. No longer can companies presume to live forever on oil demand. With that reality starting to set in, companies will actually have to pay down their debt, rather than just stretching it out.

Once companies start to run into debt maturities and no banks or investors to finance more debt, they will have very hard decisions to make. That time is coming a lot sooner than anybody expected. While OPEC still projects growing oil demand to the 2030s, Royal Dutch Shell (RDS.) suggested that oil demand could start to fall within 5 to 10 years.

Once Exxon and Chevron start to struggle more noticeably, the first thing to go will be more of the non-core assets. The problem is that in an industry that will be in runoff in a decade or two, who will pay much for those assets. The answer is nobody. The last big asset sales are going on right now and those assets are low cost shale, not deep water, heavy oil or other fringe assets. Exxon and Chevron are not rich in oil shale assets compared to their total assets.

From my perch, investors in both companies are vastly overestimating the value of those companies’ assets. The massive physical quantity of assets that most oil majors have has become a detriment. Many of those assets will become stranded in the 2020s as electric vehicles become affordable to the mass market and 2030s when EVs dominate new car sales.

In addition, between now and the mass adoption of electric vehicles, OPEC is making an implicit threat to the oil majors. Drill more and so will we. That effectively blocks most deep water megaprojects which require too much upfront capital and time to pay back the investment. Who is going to invest in higher cost deep water oil if OPEC is committed to underselling it?

The majors are in a tough spot with deep water as one of their major assets. There will be a few more megaprojects here and there, in the most advantageous spots and often from the most desperate companies. But, judging from the nearly trillion dollars in CAPEX cuts from 2016-2020, the megaproject is all but dead.

Wood Mackenzie has also noted that about 60% of U.S. shale is viable at about $60 per barrel. That is compared to deep water’s 20% viability at $60 per barrel. The oil majors need a lot to turn their ships and there doesn’t seem to be enough ocean anymore. The oil majors needed their deep water assets to produce or at least generate good sale prices. For the most part, neither is going to happen.

While both companies could salvage themselves with strategic transactions and transform into natural gas first companies, investors should be looking for opportunities to sell both Exxon and Chevron. Selling Chevron on this rally is a good idea as it has massive legal issues that could create negative financial events. Exxon has a questionable ability to manage its dividend and debt as well, but won’t likely enter terminal decline for a few years.

As an added note, the same things affecting the oil majors are affecting the deep water drillers. The death of deep water oil megaprojects is not only bad for the oil majors, but also for the companies providing deep water drilling services.

Companies such as Transocean (RIG) and SeaDrill (SDRL) have both rallied, but it is a sucker’s rally. Take SeaDrill for instance, major shareholder John Fredrikson created a vehicle, called Sandbox, to cherry pick the remaining good assets from it and other dying deep water drillers last year. Investors shouldn’t just sell SeaDrill stock, they should start a bonfire with it because that’s the only value it will hold in a few years. TransOcean’s rally is a gift to those trying to escape that stock and escape it they should as day rates will never see the light of day again. Save your money, sell both.


Comments are closed.