I titled my latest book "Shale Boom, Shale Bust" because I knew the long down cycle in oil prices was going to impact U.S. independent oil frackers the most severely. But no one in the energy world has been immune from the now-14-month downturn in oil prices. Even the super-majors, which will be reporting their quarterly results next week, are facing deep spending cuts, dividend problems down the road and likely serious overvaluation in their share prices. Let's look at the two on the furthest ends of the super-major risk spectrum, as I see it: Chevron (CVX) and Exxon Mobil (XOM).
Don't believe any of the optimistic talk on break-even prices from the previously reporting oil companies like Hess (HES) -- any sustained oil price under $60 a barrel will ultimately bankrupt all of the independents out there. For the super-majors, we know the prognosis is far better -- their wide portfolios of production and their "steady" cash flow from downstream and chemical divisions make their ability to survive the downturn far better than dedicated producers'.
But even super-majors have their breaking point -- a point where they won't necessarily need a mega-merger as happened in the late '90s with Texaco and Amoco -- but a point at which their considerable dividends, and therefore share prices, are at risk. To me, Chevron leads the list of the most vulnerable.
The stock market has always valued super-majors' shares for the most part upon growth potential in production -- but circumstances have changed this year with the likely end to the Federal Reserve's zero interest rate policy. That inevitable rate hike has injected dividends as a more important valuation metric, particularly with oil companies that have been used by investors as bond proxies, like Chevron and Conoco-Phillips (COP).
Chevron has particularly overvalued its growth potential, expecting a huge bounce in oil prices and a 40% growth in revenue. This won't likely happen. Combine that with a $7 billion drop in free cash flow in the first half of this year, and the 5% current Chevron dividend becomes a noose around its neck as Chevron attempts to ride out the oil price bust, instead of a good reason to own shares now. Conoco-Phillips mirrors many of Chevron's characteristics, but its free cash flow loss isn't nearly as bad and it can likely retain the dividend far longer without a cut.
But Exxon Mobil continues to look like the most sturdy and dependable of the super-majors. It's not that capex has been cut in roughly the same percentage as the other super-majors, including Chevron. But Exxon continues to have the most conservative portfolio of long-term oil projects, the most diverse downstream divisions and, most important -- considering how Fed policy is about to matter so much -- its spending has been committed to share buybacks for the benefit of shareholders, as opposed to dividends. This critical difference allows Exxon shares to be less dependent upon interest rates to value the stock and also allows for a fast reduction in share buybacks without the concurrent decline in share price as opposed to a dividend cut. This is precisely what Exxon has already begun to do, and can continue to do, dependent upon how long the bust cycle in oil lasts. For this reason, it remains my No. 1 U.S. super-major -- the safest of the energy behemoths.
No one in the energy sector has been immune from the crushing drop in oil prices and the prospect they will stay "lower for longer" -- not even the super-majors. Don't take any of your energy investments for granted, assuming that just because their name is Chevron or Exxon Mobil that "everything will just be fine." You still need to be vigilant, even with investments in these American energy icons.
