Watching oil prices fall as impressively as they have over the past six months, it wouldn’t be unreasonable to predict a challenging road ahead for the U.S. oil and gas industry. Some American producers are facing particularly difficult straits, as falling crudes prices threaten the financial viability of shale production, given the capital-intensive nature of hydraulic fracturing. And there seems to be little hope for a quick rebound in oil prices: after OPEC’s decision late last month to maintain current output targets, Credit Suisse cut its first-quarter forecast for Brent to $68 per barrel from $87 in October. The Dow Jones U.S. Oil & Gas Index fell 7 percent the day after the OPEC announcement, for an overall 23 percent decline since June.
So oil stocks may not be flashing too many “buy” signals at the moment. But there are diamonds in the rough. Consider those companies with balanced asset portfolios that include refineries, which benefit from lower feedstock costs and therefore help to offset declining revenue on the production side. The stocks of European majors are also trading more cheaply than their U.S. counterparts of late, says Credit Suisse analyst Edward Westlake, making them worth a closer look.
There’s also the matter of timing. Falling oil prices notwithstanding, U.S. majors ExxonMobil and ConocoPhillips are both about to see improvement, rather than deterioration, in their financial results. That’s because both are winding down the major capital expenditure phase in a handful of very large projects. ExxonMobil’s 2014 capital expenditures, for instance, are on target to come in at $37 billion, down from $42.5 billion in 2013, as the company reaches the end of its planned investment in a $19 billion LNG project in Papua New Guinea. ConocoPhillips’ capital expenditures are also due to taper off next year as it decreases investment in its Surmont oil sands project in Canada and an LNG project in Queensland, Australia. “The majors are entering a period of improved cash generation because of the timing of these mega projects,” says Westlake.
Big Oil also has experience on its side. After all, it’s not the first time that major oil companies are grappling with volatile prices. Barely over a decade ago, a combination of increased OPEC supply and reduced demand sparked by the Asian financial crisis sent oil plummeting to below $20 per barrel in the late 1990s. Companies couldn’t do anything about crude prices, so they controlled what they could: their own expenses. In response, U.S. majors invested in productivity-enhancing technology and also reduced their staff. Westlake expects a similar focus on rooting out inefficiencies this time around. Majors also know how to keep their eye on the future. While oil markets are currently imbalanced in part due to the strong growth in U.S. shale, the world will need the oil and gas from shale to meet rising longer-term demand.
In other words, the smart money isn’t fleeing oil stocks en masse at the moment but rather positioning itself properly within the industry. Could there be further downside? Of course. But as Lord Rothschild famously said, it’s better to buy when there’s blood in the streets. Much of the oil and gas industry is struggling right now. But those that survive the current downturn could emerge stronger than ever.