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Big Time

By Roger S. Conrad on Sep. 25, 2015

At the height of the shale oil and gas revolution, investors dismissed the Super Majors for their lack of production growth despite massive capital expenditures. Critics also maligned the group for missing out on the shale gale that powered significant upside for shares of North American independent producers.

Today, bears warn that the severe downdraft in oil and gas prices will pressure returns on mega-projects approved in a much more benign environment, threatening the major integrated oil companies’ credit ratings and dividends.

The Bloomberg Global Integrated Oil Index has given up almost 38 percent of its value since June 30, 2014, roughly on par with the Alerian MLP Index and significantly better than the 69.7 percent loss posted by the Bloomberg North American Independent E&Ps Index.

(Click graph to enlarge.)AMZ BRNGINTO BRNG50 Roger Conrad

Although the major integrated oil companies won’t be immune to further downside and deserve their fair share of criticism, their bulletproof balance sheets, diversified operations and focus on longer-lived resource bases put them in prime position to weather the storm and emerge stronger on the other side.

Moreover, our favorites have the financial wherewithal to address their perceived deficiencies. Further downside in crude-oil prices will give investors with a longer time horizon an excellent opportunity to buy these high-quality names.

History Lesson

From late November 1985 to early April 1986, crude-oil prices fell by almost 70 percent. And with the exception of a spike during the Gulf War, about 18 years passed before oil rallied to more than $30 per barrel—a level that WTI had held before Saudi Arabia opted to ramp up production in 1985 as part of an effort to regain market share.

This surge in production from Saudi Arabia, which, up until then, had cut its own output to accommodate competitors’ volumes and keep oil prices elevated, inflicted significant pain on non-OPEC producers, especially those with excessive leverage.

Over this period, shares of Chevron Corp (NYSE: CVX) and Exxon Mobil Corp (NYSE: XOM) outperformed by a huge margin.

(Click graph to enlarge.)XOM CVX WTI Roger Conrad

Big Oil prospered in the 1980s and 1990s for several reasons:

  • Revenue from their refining, marketing and distribution operations benefited from growing demand for gasoline, diesel and jet fuel—a product of an extended period of low oil prices.
  • Strong balance sheets and a long history of paying reliable dividends meant that these companies maintained their access to low-cost debt and equity capital. Whereas cash-strapped rivals were forced to cut back operations and sell assets, Big Oil grew even bigger through inexpensive acquisitions.
  • The major integrated oil companies’ operating costs declined because reduced drilling activity prompted oil-field services companies to cut costs in an effort to win business.
  • By surviving the downturn, Chevron and Exxon Mobil were able to hire skilled workers and experienced executives let go from weaker companies.

 

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