Is oil doomed after Doha?
Leaders from many of the world’s largest oil producing countries met in Doha during the weekend of Apr. 15, to discuss what can be done to restore higher oil prices. The rout in global commodity prices has weighed heavily on energy companies, but also energy-producing nations such as those that comprise OPEC. Consequently, the Doha meeting was one of the most highly anticipated events of the year for the energy sector. Investors and analysts held high hopes that the countries could come to an agreement to freeze, or better yet, cut production.
Unfortunately, those hopes were dashed when the summit ended without a deal. That cast oil’s fragile recovery since the Feb. lows into doubt. The lack of a deal at the Doha meeting throws cold water on the thesis that major energy producers could effectively coordinate to cut production in an effort to stimulate oil prices. Many global producers, even within OPEC, are not agreeable to a cut in production, because they badly need to keep bringing oil to market for cash flow.
With a global production freeze or cut looking increasingly unlikely, investors should prepare for a lower-for-longer oil price environment.
Fallout in the energy sector
Oil prices sunk immediately after news broke that no deal had been reached. West Texas Intermediate oil fell 6 percent the following day. There was good reason why investors and analysts held out so much hope for a deal. Global oil production has soared, driven by shale drillers in the U.S. and new oil coming to market from Iran, now that sanctions on that country have been lifted.
There is also a tangible effect on the major global oil and gas stocks such as Exxon Mobil (NYSE: XOM). Exxon Mobil is arguably the best-of-breed integrated major, as its fundamentals have held up relatively well compared to most other companies in the energy sector. For example, despite the huge collapse in commodity prices, the company still earned $16.2 billion in profit. It generated a 7.9 percent return on average capital employed, which was far higher than its peer group. Exxon Mobil accomplished all this by focusing on efficiency and cutting costs everywhere it could. It slashed its stock buyback program by $9 billion last year. Capital and exploratory spending came in at $31.1 billion last year, down 19 percent from 2014.
Exxon Mobil's refining business also helped the company remain profitable last year, in one of the worst years for the oil and gas industry in recent memory. Downstream earnings more than doubled last year, to $6.5 billion, thanks to improving profitability in refining. Refining actually improves when oil prices decline, because falling oil prices lower feedstock costs and boost margins.
A potential deal to freeze global oil production caused renewed optimism from investors and analysts alike. Exxon Mobil stock has recovered 33 percent from its Feb. lows, as investors had become more bullish. In the last month, 10 analysts increased their earnings per share estimates for Exxon Mobil in the current fiscal year, compared to just one analyst earnings reduction. But even Exxon Mobil is not immune from the collapse in global commodity prices.
Exxon Mobil needs higher oil prices because it has a number of large upstream projects coming online. The company completed six major upstream projects last year with total production capacity of almost 300,000 barrels per day, including two major deep-water projects in offshore Africa, and an expansion of the huge Kearl Canadian Oil Sands project. Moving forward, there are several more projects that Exxon Mobil will soon be ramping up. Construction activities continue to progress on 10 major projects that will come online over the next two years. They expect to start up six of those in 2016, which will add more than 250,000 barrels per day of working interest production capacity.
But without a global agreement to curb production, the value these projects realize for Exxon Mobil will be limited. Soon after the Doha meeting concluded, Exxon Mobil’s credit rating was downgraded one notch by Standard & Poor’s. This was a huge event, because Exxon Mobil had previously held the coveted ‘AAA’ credit rating—the highest level possible. In fact, Exxon Mobil was one of only three U.S. publicly traded companies to hold Standard & Poor’s highest credit rating. This speaks volumes for how much damage has been done by the fallout in the energy markets, and how badly Big Oil needs higher commodity prices.
Doha failure is a setback for the climate change movement
The lack of an agreement at the Doha meetings signifies a further setback for climate change. The reason is because the rise in global oil production, which has sent commodity prices tumbling, has incentivized consumers to continue purchasing traditional vehicles. Higher gas prices were helping to incentivize the purchases of hybrid and electric vehicles.
Moreover, climate scientists generally agree that nations around the world, particularly those in under-developed nations, need to curb the production and consumption of fossil fuels such as oil, natural gas, and coal, if the world is to stay within ‘2 degrees Celsius’. This refers to the maximum increase in global temperature that climate scientists widely agree will keep rising sea levels and other harmful environmental consequences in check.
Overall, the world continuing to burn through more oil and gas will only exacerbate the release of harmful carbon dioxide emissions, which contributes to the greenhouse effect and global warming. Therefore, the failure of OPEC nations to agree to cut production is a setback for those concerned about global warming.
Mark your calendars
With no deal, the recent rally in oil prices looks to be in jeopardy. The world continues to be over-supplied. A global production cut is the only way to bring global oil economics into harmony, as worldwide demand has not nearly kept pace with supply. The next critical date for oil is in June, when OPEC members are scheduled to meet once again.
However, an agreement at that meeting seems doubtful. Iran has indicated no willingness to cut production. It was only recently allowed to bring oil to market after having Western sanctions lifted, and other global producers like Russia which depend heavily on oil revenue are reluctant as well. As a result, investors should prepare for the likelihood of a “lower-for-longer” oil price environment, as the one sure fix for rising oil prices seems off the table.
Companies to watch
Chevron (NYSE: CVX): Like Exxon, Chevron badly needs higher commodity prices. It has two huge liquefied natural gas projects in Australia that will begin production this year.
Analysts are very bearish on Chevron because of persistently low commodity prices. Chevron stock was downgraded by Raymond James analysts in Mar., to market perform from underperform. Analysts currently expect Chevron to earn $1.12 in profit per share this year, which would represent a 66 percent year-over-year decline in earnings.
BP (NYSE: BP): BP is one of the hardest-hit integrated majors by the decline in oil prices. BP’s first-quarter core profit fell 80 percent year over year. On a pre-tax basis, the company lost a massive $865 million in just the first quarter alone. The company cannot continue to lose money, and therefore needs higher oil prices. The Doha deal puts that in doubt. Analysts expect BP’s full-year earnings to decline 59 percent from 2015 levels.
Bob Ciura is an independent equity analyst. Since 2012, his work has focused on fundamental investment analysis of publicly-traded companies in the energy, technology, and consumer goods industries. Bob has a Bachelor's degree in Finance and an MBA in Finance.