The Energy Market: Moving From One Hyperbole To Another

Hyperbole is the word of the hour when discussing oil and its fluctuations in pricing and stability throughout the energy market. With "The Big 5" dominating the scene, one citation offers the insight that we should be expecting more from our distinguished diggers, as their process for exploration might be quite costly in the long run.

Companies like BP (BP -1.17%) and Exxon (XOM -0.09%) have been around for 100 years. Sophisticated shareholders are familiar with the volatility of the market, and have their back-ends covered. If you're looking to invest in oil, don't expect this game of chance to puff up your profits.

A full transcript follows the video.

Sean O'Reilly: Trading on the stock market got halted, so we went and got ice cream, on this energy edition of Industry Focus.

Greetings, Fools! I am Sean O'Reilly joining you here from Fool headquarters in Alexandria, Virginia. I am joined today by the one and only Tyler Crowe. How are you today, sir?

Tyler Crowe: Doing pretty good. Good morning.

O'Reilly: What do you think was the cause of the New York Stock Exchange halt yesterday? My money was on hackers.

Crowe: Company retreat.

O'Reilly: Company retreat?

Crowe: Yeah. They went on a corporate company retreat and they were, like, "We can't be there."

O'Reilly: All the tech guys for the New York Stock Exchange went camping in New Jersey?

Crowe: Yep.

O'Reilly: Is that what you're saying?

Crowe: That's my thought.

O'Reilly: Cool. Did you get what I did there? Somebody tweeted, or was on CNBC, and they actually recommended going to get ice cream while trading was halted.

Crowe: Yeah. Why not?

O'Reilly: You should.

Crowe: What else are you going to do? It'll be there when you get back.

O'Reilly: It will be, unfortunately. Today we're talking about oil, but more specifically, we'll be talking about energy market hyperbole and the way of the dynamic between the media and what's actually going on.

Crowe: Yeah. Whenever you watch financial media, it's already "dusted up" with some nice English to make things sound...

O'Reilly: It's all the problems of the 24-hour news cycle. They report on cats in rivers and stuff.

Crowe: Right.

O'Reilly: But with a financial spin.

Crowe: With a nice financial spin. Especially in energy as of late, it's been quite funny to the level of hyperbolic change that can happen in a day -- in less than 24 hours.

O'Reilly: Overnight.

Crowe: I remember reading an article from one of the major news outlets a couple days ago that said, "With Iran's oil coming online sometime soon, and this glut of oil we already have today, oil is just going to keep going down." They were talking about how futurist contracts are two years out, and at the lowest they've ever seen, and "How is anyone going to make any money when this happens?" This morning, that exact same news outlet says, "Maybe this is a bit overblown."

O'Reilly: "Demand is picking up!"

Crowe: Demand is picking up. By the time Iran brings their stuff on, we're going to be in short supply because people are under spending now. It boggles the mind. I couldn't imagine -- if someone who was the day trader person -- how you could keep up with that, and keep a certain level of sanity.

O'Reilly: There's no way. My favorite example of that was this past winter when they were talking about oil going to $20.

Crowe: Yeah... $20.

O'Reilly: The world would have to be ending. It got to $38 during the recession. It was there briefly. For a day.

Crowe: Yeah. Then everyone went, "We can't do this."

O'Reilly: "Wait, wait, no."

Crowe: Let's also talk about how that was a few years before when we were all talking when the CEO of Gazprom -- one of the most prominent Russian national gas companies, yet has an "in" in the industry -- said oil during 2006 and 2007 could easily go to $250 a barrel. There is so much hyperbole in the energy market. It's quite ridiculous.

Anyone that's an individual investor can't keep up with it in anyway. You could try to reshape, rebuild your thesis every day around what you're seeing in the media, but it's impossible. Build a thesis that can withstand a long-term time horizon, and stick with it. There's no other way for you to do it.

O'Reilly: I was actually thinking that yesterday. If you're buying oil shares right now -- being courageous and all -- there's that Warren Buffett quote that says, "Don't buy anything unless you're OK with the stock market closing for 10 years." He cited how during World War I, it actually closed for three months. I was, like, "I'd be OK with that."

Crowe: The market shut for three hours yesterday, and everybody freaked out.

O'Reilly: I got ice cream out of it. I don't know what else to tell you.

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Now we're moving onto what I really want to talk about today, which is an article -- are we allowed to say Bloomberg?

Crowe: You just did, so I guess we can.

O'Reilly: Bloomberg, the organization, put this out as citing some analyst. A gentleman came on and gave this thesis of why you should be shorting oil companies -- the big ones. International ones, Exxon, BP... and it wasn't because oil is down 50% from last year. It was for another reason. What can you tell me about this?

Crowe: The underlying thesis he was looking at here was the fact that finding new sources of oil for these very, very large major, integrated companies is becoming very expensive.

O'Reilly: These are hundreds of billions of dollars CapX organizations.

Crowe: We're talking ExxonMobil, who's somewhere in the $35-billion-a-year range in capital expenditures. They're going out and exploring in places where finding and developing that oil is much more expensive than other places.

O'Reilly: Wasn't it just Shell that just got the O" to go to the Arctic?

Crowe: Shell does.

O'Reilly: They have to go to the Arctic to find oil.

Crowe: They're spending $1 billion this year alone in exploring the Arctic.

O'Reilly: What amount of money would you be willing to go to the Arctic for to find oil?

Crowe: One billion.

O'Reilly: That's about right? Okay.

Crowe: Sounds good for me. His theory is because there are less expensive forms of oil out there like sources from OPEC and shale -- which is becoming less expensive...

O'Reilly: Because of efficiencies, obviously.

Crowe: Because of efficiencies and things like that. Basically what he was saying was, because these things are taking hold, the underlying thesis was the marginal cost barrels these guys are paying somewhere in the $70 to $95 a barrel range, and that's unsustainable over the long term, and these companies are going to bleed money.

O'Reilly: I immediately thought of a hole in that. T. Boone Pickens in the '80s in his first book talked about how it was cheaper to drill for a barrel of oil on the floor of the New York Stock Exchange than it was to actually go out and find the oil. He's referring to the company he was doing LBOs and getting green mail to not take over.

Crowe: Fancy man using acronyms. LBO is leveraged buyout, for people out there.

O'Reilly: I'm sorry. To the laymen: leveraged buyout.

Crowe: For a second, I even had to think about one.

O'Reilly: His point was, if you're an oil company, you don't have to find oil in the ground. You can just go buy another oil company. If that scenario actually played out, what's to stop ExxonMobile from spending $35 million a year on capex to find oil, to just buy EOG (EOG -0.48%) and all these other guys?

Crowe: There isn't. If you look at the financial distress that younger companies without the protection of a very strong credit rating, having refineries in mid-stream operations that can cover times when oil prices are lower, to keep the cash flow going and things like that -- there's nothing stopping them from doing that.

O'Reilly: They'll just go on an acquisition spree to replace their reserves.

Crowe: You came up with one point, and I had a few when I read it. A couple of them seemed they were very nitpicky. A couple of examples on the demand side were only looking at very mature markets like the United States and Europe, and how they're the drivers of demand over the future. That's not necessarily the case.

The thing that stuck out to me more than anything else was the fact that so much of the focus was on the production of oil, and how these high, marginal cost barrels that places like ExxonMobil and Shell are going to drill in the Arctic and Russia, how that's going to kill them. However, if you look at these companies in general, oil production specifically is not as big a component of their earnings as some people may expect.

We call them big oil companies, but the most oil-centric, big oil company today is Chevron (CVX 0.75%). It's a little more than 60%...

O'Reilly: Which is not high.

Crowe: A little more than 60% of their production comes from oil. Whereas the other four -- we talk about the big five of the usual suspects when we talked about big oil -- ExxonMobil, Chevron, BP, Shell, and Total (TTE -1.28%). Aside from Chevron, the other four's production mix of oil and natural gas is right in that 50% range. Somewhere between 45% and 55%. To merely look at oil and say, "This is the problem they're going to have forever" seems a bit disingenuous, because you've got...

O'Reilly: You've got natural gas, you've got refineries.

Crowe: They have all these other options to generate cash flow, and perhaps it's not as robust as it was back in 2005 when the price of a barrel of oil was $120, and costs for services were a bit lower than they are today. To completely shut out the idea that these companies, who have been around for 100 years and have gone through price spikes like this -- and even worse -- that we're seeing the end of them, and they should be shorted, and they are going to be unprofitable long term. I just don't see it. These guys are pretty smart.

O'Reilly: It just seems like they have a lot of levers they can pull.

Crowe: There's a lot of different things that they can do to make it work. Perhaps they're not the strongest performer when you compare them to the S&P 500, but they've never been that way. Nor has stock appreciation been a major component for them. If you look at someone like an ExxonMobil, their biggest shareholder value is the fact that they have a stable, growing dividend that's been going on for more than 25 years, and they buy back copious amounts of stock to boost shareholder returns. That's the value proposition that you get with somebody like ExxonMobil. It's not ride the wave of the growing production.

O'Reilly: Get rich tomorrow and all that.

Crowe: No. This is a 20-year time horizon stock. You're not going to get rich buying ExxonMobil today and selling it a year from now.

O'Reilly: Awesome. Very good. Well thank you for your thoughts, Tyler. We'll see you next week.

Crowe: We'll see you next week.

O'Reilly: Want to go get some ice cream again?

Crowe: Sounds like a good idea.

O'Reilly: Awesome. If you are a loyal listener of Industry Focus, we would love to hear from you with any questions or comments you might have. Just hit us up at [email protected]. Again, the email is [email protected]. As always, people on this program may have interests in the stocks that they talk about, and the Motley Fool may have formal recommendations for or against those stocks. So don't buy or sell anything based solely on what you hear on this program. For Vincent Shen, I'm Sean O'Reilly. Thanks for listening, and Fool on!