Big Oil Earnings Show Why Diversification Is King

With oil prices still foundering, many analysts predicted doom and gloom for the earnings reports from big oil. Five of the majors have reported, and while things are bad, they're perhaps not as tragic as some predicted -- although some companies dropped more than others.

ExxonMobil (XOM 0.39%) and Royal Dutch Shell (RDS.A) (RDS.B) saw earnings plummet by 44% and 56%, respectively, while BP (BP 0.98%) and Total (TTE 0.52%) fell by 20% and 22%. What made the difference? Should investors throw in the towel on big oil? Tune in to learn what happened and why, and what comes next for big oil.

A full transcript follows.

Sean O'Reilly: How are big oil earnings holding up after a 50% drop in oil prices? On this energy edition of Industry Focus.

[INTRO]

Greetings, Fools, I am Sean O'Reilly joining you here from Fool headquarters in Alexandria, Virginia. Joining me here in the studio is the one and only Taylor Muckerman and Tyler Crowe. How are you today, gentlemen?

Taylor Muckerman: I'm good.

Tyler Crowe: How can we be "the one and only" when there's two of us?

Muckerman: I might be the one and only Taylor Muckerman. I haven't looked at that on Google.

O'Reilly: Do a Facebook search.

Crowe: I am not the one and only Tyler Crowe.

Muckerman: I'm scared to Google myself.

Crowe: Yes, that's a bad idea.

O'Reilly: A bunch of Motley Fool stuff would pop up, I assume.

Muckerman: I would imagine, yes. Unfortunately... fortunately.

O'Reilly: One can only hope. You're still young, it's fine!

Today we are talking about big oil earnings. A lot of the majors have obviously reported earnings. Six months ago oil prices crashed, which of course begs the question of how they held up. What are we looking at here, guys?

Crowe: As you would expect, everybody's earnings went...

Muckerman: Down.

Crowe: Down, down, down, down, down, down.

Muckerman: Downtown.

Crowe: Some of them a lot worse than others. A couple of them held up pretty well. All things considered, I think Wall Street -- based on analysts' estimates and things like that -- people were expecting things to be a heck of a lot worse than they really were.

O'Reilly: Were they really well hedged? What was the deal there?

Crowe: In all honesty, I think it was just one of those things where people were looking at it thinking, "Oh my god, this is going to be horrible, this is going to be horrible, this is going to be horrible."

When it wasn't as bad as everybody thought, they were like, "Oh, OK. It was bad, but not as bad as was expected."

There were a couple things going in place. So far, we've had four of the five of what we'd call "big oil," of the majors, that have reported. We're still waiting on Chevron, which reports tomorrow [May 1].

But everybody has so far reported. If we just do a quick rundown of how much things have declined, ExxonMobil down 44% from last year...

Muckerman: This is earnings, not stock price, right?

Crowe: This is earnings.

O'Reilly: Bottom-line earnings.

Crowe: This is earnings. We're not talking about stock prices, because that would be something I don't think any of us...

Muckerman: I would be buying!

Crowe: Yes, if you drop 44% on ExxonMobil in a day, that is the most incredible...

O'Reilly: Oil prices fell 50-55%. Throw in a little cost-cutting there, and that's how you get the 44% drop?

Crowe: More or less. But at the same time, you've got ExxonMobil down 44%, Royal Dutch Shell down 56%. Then some of the smaller ones, BP down 20%, Total down 22%.

A couple of these guys were able to make big gains, obviously, because there is a drop in oil prices, but at the same time when you see that drop, they get a gain in refining. Most of these guys, even though they saw very, very large declines in their upstream earnings, we saw a pretty big increase in refining earnings.

One of the ones that probably had the best results in my opinion, looking at it, would have to be Total. Their upstream earnings were actually reduced by the least, if you just look at the oil and gas.

O'Reilly: How did they pull that off?

Crowe: They were able to do that because prices took a big drop, but they actually increased their production by 10%. Everybody else pretty much held steady. ExxonMobil saw a little bit of increase.

Muckerman: Like 2% for ExxonMobil. But I think also with BP and Total, they're not as exposed to U.S. oil prices.

Crowe: That's a very large...

Muckerman: Because the spread widened. It was really narrow until oil prices started falling and people started freaking out about U.S. shale. Then all the surplus of supply -- so then the spread widened a little bit.

Crowe: Yes, the ones that are exposed a little bit more to the United States got hit a little bit harder, like ExxonMobil and, surprisingly, Royal Dutch Shell. Even though they've been trying to get rid of everything American as of late because of that price differential, their American operations alone actually posted a $1.1 billion loss on the production side.

They're seeing a whole world of hurt right now. Of all the ones on this list, Royal Dutch Shell actually showed the biggest signs of weakness overall. What it really showed is that their oil and gas production is probably some of the costliest...

O'Reilly: Well, they're big into the North Sea, correct?

Crowe: They're big into the North Sea. They're big into other really expensive projects, like you've got the Kashagan project in Kazakhstan, that hasn't produced yet.

O'Reilly: Also, the safest country in the world, I hear! Sarcasm...

Crowe: But if you look at everything that has happened with them and their costs, their upstream profits declined more than 87% on a year-over-year basis, with oil prices for them, their realization, declining a half.

O'Reilly: How should Royal Dutch Shell investors be viewing this? Should they be praying that oil prices rebound fast, or do you think that Royal Dutch should be able to recalibrate their operations to lower-priced oil?

Muckerman: Right now, with oil prices down for everyone, I think investors should be more concentrated on how they roll BG into the fold, because the company's spending what, $75 billion on that?

Crowe: Yes, the $70 billion BG Group acquisition. They're making a really, really big push into LNG and offshore drilling, especially in Brazil.

I think more than anything else, they need to make sure that that happens right, and they're able to get some sort of cost savings in there because it looks like some of their production costs are pretty high right now.

Muckerman: Yes. I think, of the group, maybe Royal Dutch Shell holders should be the longest-term investors. They're just placing a $70 billion bet on industries that are probably not going to really take off for another five-10 years.

O'Reilly: Trucking companies are just starting to switch to LNG, but we're still a long way away.

Muckerman: Yes, and global distribution is still ramping up. Then deepwater oil -- if oil prices stay like this, no one's going to be drilling offshore for a while. Even though that is where the majority of future reserves likely are held, you're still not going to see meaningful production out there at a meaningful profit, for at least a couple years, in my mind.

Crowe: Yes.

O'Reilly: Got it. All this really seems to speak to the beauty of being a big oil company, the integrated model.

Crowe: Yes. Actually, I want to have an open apology here.

Muckerman: Cue violins!

Crowe: Cue some violins, some sad, sappy music. Austin, you got anything in there for that? No?

Basically, a couple years ago ConocoPhillips (COP 0.39%) spun off its refining assets into Phillips 66. At the time, it looked like an amazing move.

O'Reilly: Everybody was talking that up.

Crowe: Yes. The capital allocation looked a heck of a lot better, share price appreciation was looking fantastic for that. What it did, is show that ConocoPhillips' assets on its books, those refining assets, were extremely undervalued in the market.

I remember a couple years ago, I actually was advocating for big oil companies to do something similar because if you looked at their books their refining assets -- all the downstream, midstream assets -- were extremely undervalued on their books.

O'Reilly: Doing a sum of parts valuation, obviously?

Crowe: Right, sum of parts.

I apologize. You were right, I was wrong. Sticking with those, hanging on to them -- because this quarter and this downturn in oil prices is a great example of why big oil has been so successful for so long.

Through these commodity price swings, having that integrated model where your refining, your marketing, and your retail sales can cover during times of low oil prices or when oil prices are high -- you're going to get hit one way or the other -- but it keeps the ship a heck of a lot steadier.

I think if we just saw what happened with ConocoPhillips...

Muckerman: Yes, it proves it right here in this quarter.

Crowe: Yes. ConocoPhillips' earnings for this past quarter dropped 90% from this time last year.

O'Reilly: Because they're essentially an E&P now. 

Muckerman: That's it, yes.

Crowe: They are. They're a pure Exploration & Production company.

O'Reilly: Oof.

Crowe: When you look at that, you have to say, "Maybe hanging on to that integrated model was the way to go."

Muckerman: But then... It just depends on if you want to play this cycle game, or if you want to be a long-term shareholder. The integrated model definitely suits that mind-set a little bit better.

O'Reilly: OK, everything is 20/20 in hindsight. It would have been nice to have not spun off Phillips 66, but where do shareholders in Conoco go from here? Is this a throw-in-the-towel thing, and go to a stronger player like a Total?

Crowe: With ConocoPhillips, it was a really rough quarter. But at the same time we're talking about a company that over the very long haul has done a respectable job of generating cash flow in excess of their capital expenditures, over the long term.

They've had a couple bad quarters like this. It's going to happen. More than anything else with a company like this, you just have to stay the track. They still pay a dividend in excess of 3%, so it's a strong dividend play.

I don't see why, just because they have a bad quarter, that we need to immediately start heading for the exits on something like this. I think it's certainly worth sitting and riding it out for a little while longer, to see what happens with oil prices over the next couple of years.

O'Reilly: It's probably a little "too little, too late" there.

Muckerman: It depends if you're a teacup investor or a roller-coaster investor. If you're a roller-coaster investor, hey, you hop into a ConocoPhillips because there are going to be some ups and downs.

O'Reilly: Right.

Muckerman: If you're a teacup rider, it's still fun, but it's a lot safer in your mind, so you invest in an ExxonMobil.

O'Reilly: Got it. Buffett had a pretty big stake in Conoco. Did he start trimming that last year?

Crowe: Yes.

Muckerman: He's been trimming most of his energy holdings.

Crowe: A very large portion.

Muckerman: Except for Suncor, right? He bought more Suncor.

Crowe: He bought more Suncor. He sold all of his ExxonMobil. He sold a very large stake of ConocoPhillips, and has been kind of plucking assets off of Phillips 66. What he did was a small exchange where he bought part of their lubricating assets in exchange for some of Phillips 66's shares.

O'Reilly: Merging it with Lubrizol or something.

Crowe: Yes, it was a tax-free way of taking a business.

O'Reilly: Do you think he's doing this because he's like, "They really need to have that refining part of their business"... have you guys seen anything along those lines?

Muckerman: I think Warren Buffett just does what Warren Buffett does.

O'Reilly: Touché.

Muckerman: I don't think it has anything to do with the cyclicality of the business. Like Tyler said, the whole Phillips 66 thing was just a tax avoidance, and he wanted to acquire a business that had exposure to energy through their lubrication business.

But then he's adding more to Suncor, which is an integrated; it's just not as big as the ones we're talking about today, because it's predominantly only in Canada.

Crowe: Yes. More than anything else... I thought I knew Warren Buffett. When there was that rumor that he'd sold ExxonMobil, I was like, "Wait, wait, wait. Let's hang on. He may be just adding to his position."

I was wrong, so I'm not going to try to take any stab into what Warren Buffett is doing anymore, because I've been proven wrong many times by trying to predict what he's thinking.

Muckerman: It doesn't seem like he's a straight value investor anymore. He's a tax avoidance...

O'Reilly: Shuffle things around.

Muckerman: Yes. It's a much different picture than it was several years ago. He's got too much money. He's got to do more creative things.

O'Reilly: Right, for sure. Very good. Thank you both for your thoughts. Have a good one.

Muckerman: Thank you.

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