This has been a tough year for the oil industry, but the major players are weathering the storm.
The price of oil has declined dramatically and smaller energy companies are hanging by a thread. In contrast, big oil remains in a good position, and companies like ExxonMobil (NYSE:XOM) and Chevron (NYSE:CVX) have enough cash on hand to sustain them for the duration of this crisis.
In fact, this could be a prime opportunity to acquire smaller companies that cannot stay in business by themselves. Big oil, however, is not budging and not buying yet.
It's fair to say that the major industry players are being patient when it comes to making a purchase in today's market. In this video segment, the Motley Fool energy team discusses why big oil is taking such a measured approach to opening its wallets.
Listen to the full podcast by clicking here. A full transcript follows the video.
Sean O'Reilly: Oil majors have -- you're talking about the balance sheet of Exxon is like the least cash -- but they have $40 billion or something.
Tyler Crowe: That and then all the stock that they have of their own.
O'Reilly: Yeah, the Treasury stock.
Crowe: Yeah, the Treasury stock, yeah.
O'Reilly: So oil majors have cash to spend but they haven't been making a ton of acquisitions, and then the devastation in the oil industry has been going on for over a year now. Do you guys think they'll actually start shopping at some point?
Taylor Muckerman: Well, I think we talked about it a little while ago as well when we were talking about Exxon's cash balance, that they kind of need that cash in order to sustain dividends. Because if not, the cash from operations isn't going to sustain that if oil is in the $40 range. And Exxon is addicted to the share buybacks, so they'll have to cut that even more if so. So the cash has kind of been held as a necessity.
Obviously, if these companies start going bankrupt like we've talked about in the previous segment, there's going to be some opportunities. And these companies that are failing aren't necessarily failing because they have terrible assets. They're failing because they were run terribly. So they're going to be out there for the cheap and, yeah, there will come a point where Exxon and the like decide, "I think we have enough to sustain our dividend for the next year or so. Let's go ahead and spend."
Not at like $10 [billion]-$20 billion, but let's go out and spend $500 million, a billion here and there, to go ahead and pick up some lucrative assets in Texas or where the Utica base center, something along those lines. They're not going to reach with this cash. They're going to be safer bets that are very cheaply valued in my mind.
Crowe: Yeah, and I mean I think this is on everybody's minds again now because we just heard the recent talks of... there was a story came out on Bloomberg that Apache (NYSE:APA) had been courted by somebody.
Muckerman: No small company, mind you.
Crowe: Yeah, they're pretty formidable-size company. So, when we heard... when you hear somebody the size of Apache getting acquired, everybody's fingers immediately play, "Oh, it's going to be Chevron. Oh, it's going to be Exxon. It has to be one of these guys because they're the ones that have capital."
Surprisingly, it came out that it was actually Anadarko Petroleum that did it, so now that that has happened, it just goes back to everyone talking about Big Oil. "Oh they've got the cash, they've got the treasury stock, it must be those guys. When are they going to make their move?" And we've been wondering that for a long time. We looked at it and said, "Oh these companies are so cheap and some of them are really looking distressed. They can get them on the cheap."
But at the same time, the situation hasn't exactly improved from back in February-March to today. And a lot of, if you listen to the conference calls of the companies that we're talking about -- ExxonMobil, BP -- all them are still kind of preaching that idea that, "Hey, guys, we could be in this for a lot longer than some of these wildcatters. Oh, we'll be back in six to 12 months." Big Oil is like, "Hey, guys, this could... 2016-2017 might be, maybe when we start to receive recovery, but it could take that long." And so if you are one of the buyers or potential merger people in these companies, why bother? Why bother with making a ...
O'Reilly: You could buy some in bankruptcy court.
Crowe: Yeah, you could buy something later when it's even cheaper or even when it's more distressed. Or maybe wait a little bit longer because you have some efficiency programs you want to get through and you're now all of a sudden starting to generate some cash from these low oil prices, which we are starting to see from some players surprisingly. And once that comes around, that could be a certainly, a more attractive opportunity. I mean when the name Apache came out, what made that so attractive to a lot of people, if you look at Apache's assets they have a very strong presence in Permian Basin.
And the Permian has historically been a huge oil and gas producer for us in the United States and with shale starting to take hold, everyone started to say well, with all that acreage there, somebody that has a decent position in the Permian like Chevron, that could really compound that and become one of the key drivers for them pull in this, in their next wave of development. You know, 2017 a lot of the things that they've been working are starting to wrap up and everyone's starting to wonder what are they going to do next. And somebody like Apache could be a big lever for them to pull later on.
O'Reilly: Now you guys may or may not be able to answer this so it's totally fine, but maybe you just take a stab. At what point, and to Taylor's point, he's talking about Exxon's committed the dividend, they want to hold [...], they also need to balance that I assume with just reserve declines. At what point do they need to be like, "Yeah we should probably buy one of the smaller guys just to up our reserves or something?"
Muckerman: Most of these guys are generally breaking even or just barely growing reserves year over year. The recapitalization, is that ...?
Crowe: Yeah, the replacement rate.
Muckerman: Replacement ratio they generally want to keep that like 100 so that they're right there. You see it fluctuate between 95 to 105. So some years they'll be a little less, some years will be a little more, but generally these companies are big enough to where they're just trying to stay steady, right?
And if the price of oil, which is what they kind of base their reserves on, on their balance sheets, going to stay this low, then it will continue to decline. And, yeah, the only way to really boost that is through acquisitions because they would have to drill a heck of a lot to move the needle in terms of how much they're producing and selling.
Crowe: And at least in terms of, again, Big Oil, they're not in a huge rush. I mean somebody could say there's a panic because ExxonMobil doesn't completely replace its reserves in a single year. They have if not just proof but if you look at their kind of pipeline that they talk about, of potential reserve, they have 90 billion barrels of potential reserve.
O'Reilly: Just hanging out.
Crowe: Just they're working through that they haven't, you know, it's like it's not in our prove reserve because we haven't dropped them into our balance sheet. But it's like, we're working on 90 billion barrels of potential oil. So they're not in a huge rush in any way to go do this. And I think one of the important things that they're going to look for is not just cheap, not just you know grow reserves, but fit.
What is going to be a company when they bring them on that is going to be a good strategic fit? Royal Dutch Shell has been looking to make their purchase of BG Group, because they're like, "We're going to make a big splash into LNG." And so with the BG Group, they're kind of pushing more toward LNG.
So if you have somebody like ExxonMobil or Chevron who may be making some big move in the future, they're going to want to find something that really fits within their development portfolio that they can not only develop, but kind of combined with what they have and get a lot of cost savings and things like that.
I certainly, after ExxonMobil made that XTO purchase in 2011, it took them a few years to figure it out. And I think they learned a lesson from that.
Taylor Muckerman has no position in any stocks mentioned. Tyler Crowe owns shares of ExxonMobil. The Motley Fool owns shares of ExxonMobil. The Motley Fool recommends Chevron. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.