It takes courage to be an energy investor these days. It seems that every oil rally fails when report after report screams "oversupply". Investors buy, thinking that prices can't go any lower, and the market promptly proves them wrong by heading south. Given the recent history of failed sustained recoveries, many investors must wonder if the current rally that has sent oil prices from the mid-$20s to $40 per barrel is sustainable.
Although no one knows what will happen to crude prices in the near term, there are three potential upside catalysts that can sustain the rally, and shares of three companies, ExxonMobil (NYSE:XOM) , Chevron (NYSE:CVX) , Schlumberger (NYSE:SLB) will each benefit if any of the events occur.
Summer is coming
Summer driving season is a positive catalyst for crude, as consumers drive more in summer. For example, crude inventories fell to 460.8 million barrels in September 2015 from 479.4 million barrels in May 2015, despite the oil glut. With gasoline prices so low, many consumers could drive more in 2016 than they did in 2015, and inventories could draw down faster than expected. With the market so focused on the inventory number, faster than expected inventory drawdowns would send crude prices higher. Falling inventories will also reduce the probability of the worst-case inventory-overflow scenario.
Russia's "uncle" point
Russia, the second largest crude exporter in the world, may be in worse shape than Saudi Arabia. In part because crude prices are so low, Russia's economy is in shambles, and its leaders are nervous. Russia needs higher crude prices to sustain its budget and to finance its energy investments for the future. Because of its situation, Russian Energy Minister Alexander Novak said on January 28 that his country is ready to discuss a potential crude output cut with OPEC after many months of refusing to come the table.
Although the odds are still against a coordinated OPEC-Russia cut, the fact that Russia is willing to talk about potential cuts increases the probability of a solution. Russia and some major OPEC nations are next scheduled to meet on March 20 to discuss a potential production cap to stabilize crude prices.
Syria is a flash point
With crude prices below $38 per barrel, the geopolitical premium for crude is pretty much nonexistent. Geopolitical premium could make a comeback, however, if the tentative ceasefire in Syria falters and things get out of hand. Currently Iran and Russia are indirectly fighting for the Assad regime, and Saudi Arabia is indirectly supporting the Assad rebels. If there is a confrontation between Saudi Arabia and Russia, the number one and number two largest crude exporters in the world, the resulting newspaper headlines could cause crude to spike.
Three stocks that would benefit
As I mentioned in another article, ExxonMobil, Chevron, and Schlumberger each have excellent balance sheets, attractive dividends, and will survive a prolonged downturn. All three stocks will also benefit if any of the above scenarios occur and crude prices rebound.
Although ExxonMobil and Chevron have substantial downstream businesses that won't benefit as much if crude prices rise, their upstream businesses will benefit enormously if crude prices recover. ExxonMobil's upstream business made $857 million in profits when Brent averaged $43.42 in the fourth quarter of 2015, versus the $5.4 billion it earned in the fourth quarter of 2014 when Brent averaged $76 per barrel. Chevron's upstream unit lost $1.36 billion in Q4 of 2015, versus the $2.67 billion in profit the unit made in Q4 of 2014 when crude prices were $32 higher.
Similarly, Schlumberger's profits should be higher if crude prices rise. Because oil producers will spend more on capital expenditures and oil field services if crude prices rebound, Schlumberger's fortunes should improve if crude prices head to $60 per barrel or higher. Schlumberger reported pre-tax operating income of $1.29 billion in Q4 2015, down from the $2.78 billion it earned in Q4 2014 at much higher oil prices.
Given that summer driving season is rapidly approaching and Russia is actively looking to stabilize the crude market, the recent rally might have some legs. If OPEC holds steady production, non-OPEC production falls faster than expectations, or if tensions in Syria get worse, crude prices could rally substantially. ExxonMobil, Chevron, and Schlumberger will each survive even if oil prices stay down longer, but will make substantially more profits when crude prices rise again.