Somebody apparently forgot to tell the market that oil prices have pretty consistently stayed above $60 per barrel all year. Shares of oil and gas companies have been knocked down about 10%, as measured by the SPDR Oil and Gas Exploration & Production ETF. And this month, those shares are trending lower, not higher.
But that could be good news for potential energy investors, because it means that shares of independent oil and gas drillers like ConocoPhillips (NYSE:COP) and integrated oil majors like Royal Dutch Shell (NYSE:RDS.A) (NYSE:RDS.B) are trading at a discount to their January highs.
Let's look at how these two oil and gas giants are doing to see if one looks like a better buy than the other right now.
Both Conoco and Shell pay a dividend, although in terms of yield, there's not much comparison between them. Shell's current 6% yield is approximately three times that of Conoco's. However, there's more to a dividend than just current yield. Smart investors should also consider the company's dividend history and whether its finances might force a dividend cut.
Conoco and Shell have strong dividend histories -- with one big exception that I'll get into momentarily. ConocoPhillips has been paying a dividend since it was formed by the merger of Conoco and Phillips Petroleum in 2002. Shell has paid one for decades. For the most part, the companies have regularly increased their dividends.
The big exception was in 2015, in the depths of the oil price slump. Shell, which makes a lot of its money from its downstream (refining and marketing) operations, was able to cruise along without cutting its dividend, although to conserve cash, it did start to offer a scrip dividend program, which gave investors the option to receive dividends in shares, not cash.
Conoco, on the other hand, which was solely an explorer and producer, was forced to cut its quarterly dividend by nearly two-thirds, from $0.74 to just $0.25 a share. While that was probably the best move for the business, it wasn't great for investors. With oil prices back up, both companies are generating plenty of cash to cover their dividends -- Shell recently ended its scrip program -- so Shell prevails in this category hands down.
Winner: Royal Dutch Shell
Both companies' managements have made some smart moves recently. Shell CEO Ben Van Beurden, recognizing the problems for his business if the world continues to move away from fossil fuels, has made big investments in liquefied natural gas. Many analysts believe that the LNG market is likely to grow faster than the oil market in the coming years. Van Beurden thought so, too, and bought gas giant BG Group during the energy price slump at an attractive price and seems to have successfully integrated it into Shell.
Not to be outdone, ConocoPhillips CEO Ryan Lance put together a detailed turnaround plan that involved selling off underperforming assets, particularly in Canada, and using the money to pay down the debt that the company was forced to take on during the downturn as well as to reward shareholders. That plan is proceeding well ahead of schedule.
One way to pit these two management success stories against one another is to look at return metrics, particularly return on capital employed. ROCE is a measure of how well management is deploying its resources. In this case, both companies' returns have been gradually improving over the past year, but Shell -- thanks in part to its larger size and more diversified income stream -- has been posting positive returns on capital while Conoco's have been negative on a trailing-12-month basis.
Props to Conoco for playing a poor hand well, but Shell still wins this category.
Winner: Royal Dutch Shell
By now, it should be obvious that Shell is clobbering Conoco, two metrics to none. So I went looking for a metric by which Conoco could win, just to see if one existed. And, in fact, I couldn't find one. But the closest I came was in looking at the companies' debts.
The larger company by far, Shell has a lot more long-term debt than Conoco, $70.1 billion to Conoco's $19.7 billion. But from a relative standpoint, Shell's balance sheet is in better shape, with a debt-to-equity ratio of 0.24 compared to Conoco's 0.30 (lower is better). In addition, much of Shell's debt financed the aforementioned purchase of BG Group, which clearly added value to the company, while Conoco's debt was incurred just keeping the lights on.
However, Conoco has paid down a substantial portion of its long-term debt, which was creeping up toward $30 billion in early 2016. Over the past year, Conoco has slashed that by 25.5%. Shell has been paying down its long-term debt, too, cutting it by 23.5% over the same period.
Honestly, though, the difference between 23.5% and 25.5% is negligible, particularly since Shell has a $20.3 billion cash hoard that it could tap into to pay down some of its debt. So, under normal circumstances, I'd still give this category to Shell. But -- especially in this NCAA tournament season -- nobody likes to see a blowout, so I'm going to give the win to the underdog.
Why the top seed won
When you compare an independent oil and gas exploration and production company like Conoco to an integrated oil major like Shell, the oil major is going to have a lot of advantages that the independent doesn't. Size and economy of scale are both important, so it stands to reason that behemoth Shell is going to absolutely flatten ConocoPhillips when they go up against each other head to head.
Now, of course, nothing is certain, and sometimes the University of Maryland-Baltimore County resoundingly defeats the University of Virginia. That's why it's important to do these kinds of comparisons when looking for the best investment. But in this matchup, it was an easy win for Royal Dutch Shell.