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Dan Dicker

Dan Dicker

Dan Dicker is a 25 year veteran of the New York Mercantile Exchange where he traded crude oil, natural gas, unleaded gasoline and heating oil…

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Look At Oil Majors As The Disconnect Continues

XOM

As a trader, you can sometimes get so frustrated with the market that you’ll do something impulsive – and stupid.

I call this the “Screw it!!” impulse.

It can come on suddenly, and make you move to double or triple down on stocks that are truly horrible and not likely to reward you, no matter how much commitment you have. With oil stocks not reacting very positively to oil prices, that instinct can be strong, as the disconnect between the two is truly unprecedented. With oil prices well above $64 a barrel here in the U.S. (above $70 for the more global Brent benchmark), most oil stocks should be roaring. But they’re not.

In fact, some of the biggest oil companies – like Exxon – are at price levels concurrent to when oil was trading nearer to $40 a barrel, not $70.

Exxon is an excellent starting point for assessing where our portfolios are, where they should be, and whether this instinct to say “Screw it!!” and push the rest of our chips forward is a reasonable one or a road to disaster.

In the ‘dark days’ of 2016 when Exxon-Mobil was also trading in the low $70’s and oil was at $40 a barrel, all of the major oil companies were dealing with maintaining dividends while slashing capex and debt at the same time. It would seem, even forgetting about the added profits of $70 oil versus $40 oil, that cash flow was a far tougher problem then. With nearly 3 years of hardship behind them, there has been a real revolution among all the oil companies to increase efficiencies, reduce debt monumentally, trim capex to cover only core asset development and generally do a heckuva lot more with a heckuva lot less.

But so far, that excellent work by the majors has gone generally under appreciated by the markets, in some cases – as with Exxon – valuing the shares at the same price as in 2016.

Don’t just believe me: Goldman-Sachs also sees the tremendous disconnect that’s occurring between the price of the oil barrel and the price of many of the oil majors – which they think is creating a new ‘golden age’ of cash flow for them.

At a moment like this, a trader’s instinct is to use Exxon as a canary in the coal mine, bypass all of the majors and look to make an even better potential score in the even more under appreciated independent E+P’s, like Anadarko, Occidental and Hess. But perhaps there’s a better strategy in staying with the big guys, with their diversity and rock solid dividends.

So, let’s start with Exxon: With shares trading in the low $70’s, Exxon delivers more than a 4% dividend, unheard of for the mother of all oil companies. But recent reports were uniquely uninspired on almost all counts: Capex is up without a concurrent increase in production, the share buyback program continues to be on hold, projects in Russia have been a complete bust – and the overpayment of XTO in 2010 still plagues them with expensive natural gas resources. Add to that their plan to add $5b of capex to develop the hardly guaranteed acquired Bass Permian assets and you can see from the chart below why Exxon is the ‘least-favored nation’ of energy majors since the start of the year:

What will strike you as well is the one shining orange line at the top of the chart, my long-term favorite major Total (T). Why are they leading the pack? Well, for all the reasons that Exxon is not – Capex is mirroring production, dividends and FCF continue to rise, debt continues to fall. They buy assets at discount in Angola, Argentina and Guyana instead of a premium in the Permian.

While it is true that Exxon-Mobil has historically been a tremendous value as their dividend reached above 4%, Total’s steady 5% dividend remains higher.

In fact, if you were looking for another major besides Total, I’d send you more readily to the other Euro-majors – BP and Shell – before their US counterparts, Chevron and Conoco-Philips.

In pushing more chips forward in this moment of unreasonable disconnect between crude oil and oil stocks, we’ll surely avoid the worst possible outcomes of the “Screw it!!” impulse, while still investing in tremendous value oil companies.

Next week I’ll delve into some higher risk, higher reward ideas I continue to see, for those who like to plunge harder.




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