Things Get Ugly for Big Oil

07/31/2009 9:43 am EST


Jim Jubak

Founder and Editor,

By: Jim Jubak

Pick:  NYSE: XOM

I think this quarter marks an important transition for oil stocks. Everybody now accepts that oil prices will be low enough so that oil company earnings will look terrible in comparison to 2008. Declines in revenue and earnings next quarter aren’t going to move oil company shares much in October as long as they’re a result of today’s relatively low prices in the range of $60 to $70 a barrel.

Instead, the story is going to be falling production. There’s a growing consensus that the major oil companies are going to have a tough time increasing production in the coming quarters. If that turns out to be right, it will push oil stocks down some more. If it’s wrong, well, share prices of oil companies could be off to the races.

Well, relatively. This is still a sector depressed by the drop in global demand.)

But in the next quarter or two, the emerging consensus stands a good chance being wrong when it comes to ExxonMobil (NYSE: XOM). And that’s why I’m going to keep the stock in Jubak’s Picks, albeit with a slightly lower target price.

After the really miserable earnings and revenue numbers that oil companies are posting this quarter, everybody knows the oil business is terrible. Well, actually not just terrible; it’s getting more terrible every minute.

On July 30th, ExxonMobil reported really stinky (a technical Wall Street term that means “even worse than anyone expected”) earnings and revenue numbers. Earnings per share dropped 63% from the second quarter of 2008, while revenue dropped 46% (to a mere $74.5 billion).

But that wasn’t the focus of what analysts said to the financial media and in their research notes after the company’s earnings conference call. Instead, the story was production. The company had said that in the quarter, production was flat (once you exclude declines due to OPEC production quotas and the divestiture of assets) as declines in production from existing fields offset increased production in the United States and West Africa.

Despite that, chief executive officer Rex Tillerson stuck to his projections for a 2% increase in production in 2009. So, how, several analysts asked, was the company going to get a 2% increase in production for all of 2009 after showing no growth in the second quarter?

No way, said Macquarie Securities in an analyst note. One percent, tops. “I have some suspicion about whether they can do this,” Barclay’s Capital told Bloomberg.

Bring on the skeptics, I say. The more doubt, the more profit for investors—if the company can hit its target.

And there are some good reasons to believe ExxonMobil can.

First, the perverse way that the production-sharing contacts that ExxonMobil signs with national oil companies and the countries that own the oil help increase production as oil prices fall. When they were climbing, that decreased the amount of oil ExxonMobil got from these contracts. With oil prices down, the company will get more oil.

Second, unlike competitors such as Royal Dutch Shell (NYSE: RDS.B), ExxonMobil isn’t cutting spending on exploration and development. Spending on capital projects and exploration came in at $12.2 billion for the first half of 2009. That's essentially unchanged from the $12.5 billion spent in the first half of 2008 and, as CEO Tillerson said, is "in line with our longer-term plans." 

And third, the company had scheduled nine major projects to come on line in 2009 and four of those have already started production. They’ll be able to contribute more to production growth in the second half of the year as they ramp up.

Of course, even if ExxonMobil is right about production growth for 2009, the stock is still going to struggle with what everyone knows about low oil prices. As of July 30th, I’m setting a new, slightly lower, target price of $87 a share, down from $91, by June 2010. It closed below $71 Thursday. (Full disclosure: I own shares of ExxonMobil in my personal portfolio.)

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