This year has brought a fantastic ride for Big Oil. Thanks to the various geopolitical disturbances in oil -producing countries around the globe, crude oil prices have been on the higher end of the spectrum for a major part of the year.
The curtains are down on yet another round of earnings for these behemoths, and it should be no surprise that they rang up fantastic profits. The market, in turn, is duly ratcheting up their share prices. The net result: Mostly everyone seems satisfied, from top management to the retail investor.
Well, almost everyone. The bottom lines definitely look better, but the underlying fundamentals aren't as good as you might think.
When any single fact is given undue emphasis, people generally tend to take it for granted that the particular fact in question explains everything. Let me put that in perspective. Suppose we hear about an "upstream earnings increase of $X billion on higher prices for crude oil." Sounds impressive, right? The last three editions of quarterly earnings have seen CEOs and CFOs crowing over "growth in earnings" when compared to last year's corresponding quarters.
But how long does management expect to survive solely on that fact? For several months, maybe, but what then? What about next year? Will these companies be able to project a similar growth pattern? Not unless they can increase production -- at the same time hoping that current crude oil prices remain stable.
Numbers don't lie
Here's how the major oil producing stocks fared against the S&P 500 in the past 12 months and how they stack up in terms of production.
Returns in the Past 12 Months
Nine-Month Production for 2011 (in MBoe/d)
Nine-Month Production for 2010 (in MBoe/d)
Production Change (%)
Royal Dutch Shell
Sources: Google Finance, company filings, and author's calculations.
MBoe/d = Thousand barrels of oil equivalent per day.
*Total's production data are for the first six months of the corresponding years.
Other than Exxon, not a single oil major reported cumulative growth in production for the first three quarters of this year. And the best part? All these stocks, except for Total, beat the overall market in the past 12 months -- and some of them quite handsomely.
The immediate future looks bleak
All these companies have major projects in the pipeline. But an overwhelming majority of the projects will add to production only post-2014. Chevron's major LNG projects in Australia won't even start until after 2014. Shell's floating LNG facility won't be operational until 2017. BP, meanwhile, has lost out on the Rosneft deal to drill in the Arctic. Only Statoil looks good to add to production in the near term, following the acquisition of Brigham Exploration. Conoco's proposed spin-off of its refining and marketing segment should make it leaner and more profitable, too. But only time will tell. In other words, there won't be significant production growth in the foreseeable future for most of these companies to counter the natural decline and depletion of their existing reserves. Now, that worries me.
A looming crisis
Demand for energy from emerging economies won't exactly be skyrocketing in the next three years so as to warrant a huge increase in crude prices. According to the Energy Information Administration, world energy demand is forecasted to grow 13% from 2008 to 2015. How much less would be the growth in the next three years? Add to that the weak global economic outlook for this period, and we have a perfect recipe for a fall in crude prices.
With the monster projects at these companies not becoming operational overnight, the next three years look pretty dicey. With weak fundamentals, things look downright scary.
History suggests that crude oil prices can take a plunge -- at times unexpectedly -- if global markets tank substantially. The major oil stocks will naturally be the ones to bear the brunt. The uncertainty surrounding global economic conditions over the next couple of years is only heightening my fears. Simply put, a plunge can be painfully bad if the company's underlying fundamentals are shaky. It's foolhardy to merely bank on market conditions to drive up stock prices.
I'm not suggesting that these companies are like a house of cards about to collapse. But I genuinely believe that the smaller upstream companies out there are better prepared to grow fundamentally and organically and are better equipped to take a possible hit. Of course, any form of disruption in oil-supplying countries is capable of pushing up prices. But it wouldn't be wise to simply bank on that. Big Oil may not be as rosy as it's portrayed.