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Why Appearances Can Be Deceiving In European Oil Markets

When markets in general or particular sectors come under pressure, those of us of a contrarian bent start looking around for bargains. Oil company stocks and European stocks have both been under enormous pressure recently, so many are looking at European oil stocks as particularly cheap. That is only natural and is generally a good investing strategy, but some degree of care is called for. Sometimes a cigar is just a cigar and sometimes stocks that have dropped have done so for good reason.

To demonstrate that point, let’s take a look at two large European diversified oil companies, Total S.A. (TOT: ADR) and Royal Dutch Shell (RDSA: ADR). Both have lost significant ground over the last few months. TOT is down over 21 percent from its June 24th high while RDSA has lost 13 percent since it peaked on July 2nd. It is tempting, then to conclude that Total, having been harder hit, has more upside should a bounce back occur. I actually heard an analyst on CNBC the other day saying just that. His logic was that large multinational oil companies, regardless of where they are headquartered, are historically undervalued, and the cheaper the better.

Total SA


That is, as I say, tempting; unfortunately it is also wrong. Total is likely to stay mired for some time, while Shell has a good chance of recovering quite quickly. To understand why, we must understand the two main factors that have caused them to tumble.

First, the price of oil has fallen around 17 percent since it peaked at the end of June. It is obviously no coincidence that that turnaround has coincided with the decline in both TOT and RDSA. Lower oil prices affect not only the profitability of oil companies, but also the value of their largest asset, the oil in the ground. That said, though, U.S. giants have fallen less during the same time period. Exxon Mobil (XOM), for example, didn’t peak until the end of July and is since down around 10 percent.

The difference is that European stocks in general have been hammered. The specter of deflation is rearing its ugly head in the region, and the ECB, in the manner to which we have become accustomed, have tried to talk their way out of the situation and delayed decisive action for as long as possible. This is almost inevitable when one central bank attempts to reconcile the diverse monetary needs of multiple, very diverse economies, but the likely outcome is a prolonged period of, at best, sluggish growth in the Euro Zone.

This wouldn’t matter if both companies had an equal mix of global exposure, but that isn’t the case. In 2013 Royal Dutch Shell derived 38.9 percent of their revenue from Europe, while Total depended on the continent for nearly double that, 74 percent. That is why, while stock in both companies trades at single digit P/Es and a significant discount to the broader market, Shell is likely to turn quickly when oil prices stabilize, but Total faces a long uphill struggle. In this case, as in many others, the most obvious value is not necessarily the best.

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