If Oil Prices Fall in 2014, These 2 Energy Giants Will Endure

Heading into the new year, a primary concern for energy investors is the next direction oil prices will take. While there's no denying the fact that global demand for oil, particularly in the emerging markets, continues to rise, there are also a set of potential concerns for oil bulls. These include the strengthening U.S. dollar and the potential for tightened monetary policy by the Federal Reserve, which could weigh on domestic oil prices.

As a result, the next significant move in oil prices is little more than a guessing game. However, for those investors predicting a drop in global oil prices, energy behemoths ExxonMobil (NYSE: XOM  ) and Chevron (NYSE: CVX  ) will likely endure such an event better than less-integrated majors.

Diversified business models provide a cushion
ExxonMobil and Chevron, which are two of the largest energy companies in the world, are widely considered to be defensive options within the energy sector. That's not just because of their massive sizes, but also because of their diversified business models which include activities spanning both the upstream and downstream spectrum.

This is the basic sentiment behind a recent Goldman Sachs analyst upgrade of ExxonMobil, which caused its shares to rally to an all-time high. Furthermore, the diversified nature of integrated majors is often a key consideration for value investors, who prefer wider economic 'moats' to any given business. For evidence of this, look no further than the sizable investment made by Warren Buffett into ExxonMobil earlier this year. Buffett, who is perhaps the most famous value investor of all time, purchased 40 million shares of ExxonMobil.

Furthermore, falling domestic oil might actually serve as a tailwind for integrated majors heavily dependent on refining operations. This is particularly true if the spread between domestic oil and the international benchmark widens. Should West Texas Intermediate decline substantially, in conjunction with resilient Brent crude prices, refining margins will widen—meaning refining will no longer crush ExxonMobil's and Chevron's profits.

One domestic major vulnerable to falling oil
Should oil prices decline meaningfully next year, ConocoPhillips (NYSE: COP  ) has the most to lose of these three domestic oil majors. That's because ConocoPhillips isn't nearly as integrated as its two peers, having spun off its massive refining unit. ConocoPhillips now considers itself an exclusive, independent exploration and production company, which did have its share of advantages in 2013.

For starters, the deteriorating conditions for downstream activities, including refining, were a major sore spot for the integrated majors such as ExxonMobil and Chevron. This was no more obvious than in the earnings reports out of ExxonMobil and Chevron for most of the year. Consider that ExxonMobil has posted a 31% drop in net earnings in the first nine months of the year. Chevron, meanwhile, saw its own earnings fall by 13% through the first three quarters of 2013.

All this time, ConocoPhillips was immune to falling profits brought on by worsening refining operations. Consider that ConocoPhillips' diluted earnings per share are actually up a strong 18% through the first nine months of the year. However, refining might soon be a bright spot for the oil majors, but no such benefit will be realized by ConocoPhillips.

In fact, falling oil prices would be a severe headwind for ConocoPhillips, which warns investors of the following oil price sensitivities: For every $1 per barrel change in West Texas Intermediate, the company's earnings stand to fluctuate between $30 million and $40 million. As a result, it's plain to see what pronounced effects falling domestic oil would have on ConocoPhillips' earnings.

The bottom line
Rising or falling oil prices are a key consideration for energy investors, but this is particularly true when it comes to ConocoPhillips. It may take some by surprise, but not all U.S. based energy giants will react the same way when it comes to the next direction in oil prices. ExxonMobil, Chevron, and ConocoPhillips may seem identical on the surface, but investors would be wise to pay attention to the significant differences in each company's operations.

Should oil prices fall next year, ExxonMobil and Chevron will withstand much better than ConocoPhillips. For better or worse, ConocoPhillips is much less integrated than its two competitors, meaning it has the most to lose of these three from a significant fall in domestic oil prices.

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  • Report this Comment On December 19, 2013, at 8:02 PM, PEStudent wrote:

    Personally, with China and India sucking up more of the world's oil output and with studies suggesting the USA will always need to import 1/3 or more of its crude oil - at least until many are using electric cars that have a not-yet-invented battery technology- I'm not worried about crude oil prices falling significantly. OPEC will cut back production if it does.

    I've decided a blend of Exxon Mobil and Conoco Phillips is a good way to go. Neither one is going to crash, both have stable long-term histories with growing reserves, holdings and recent discoveries (add in Exxon's 10% efficiency advantage in refining) that give them some durable competitive advantage and they both have appeal to value investors. Besides assets and durable competitive advantage, growth is the third pillar of value analysis and with China and India sucking up more and more of the world's oil output, I don't see petroleum use declining until a new battery technology is developed to allow most people to drive electric vehicles.

    The USA, unless there's a technological explosion in oil shale technology, will continue to import 40% or more of it's oil. In any case, OPEC has reacted to Alaskan oil, Russian oil, etc. by restricting output enough to keep prices up. With continuing standard of living advances in China and India, etc, I doubt we have to worry about significant oil price drops.

    For the short term, the article repeats itself to mention that falling oil prices will hurt COP's earnings, but it doesn't mention what rising oil prices will do to them, nor COP's recent four significant deepwater finds (18%-35% ownership) in the Gulf of Mexico and what that will mean when it comes online.

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