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The Case for Big Oil Shares

Oil has not responded proportionately to euro and S&P 500 strength and shown relative weakness when the euro and S&P 500 sag, as they did last week. I would not be surprised if oil prices fall below $70 as the euro/dollar cross violates its uptrend line and falls below 1.46 as risk appetites mute and expectations of a tightening in Chinese monetary policy/shift in the Yuan FX regime continues to haunt the FX markets.

While the industrial production surge in the West and Asia, Opec compliance with supply cuts and the dollar's collapse all anchor crude oil prices, it is entirely possible that Saudi Arabia will boost oil production to checkmate Iran over its nuclear ambition even as the Great Powers impose tighter sanctions at a time when fuel, distillate and heating oil demand is rising. In any case, the Saudis are losing market share to the Russians, who have exploited Opec supply cuts to boost their own exports in the global spot market.

I do not envisage an oil price collapse like the Shaikh Yemeni engineered netback slide in the 1980's or the post Silicon Valley techs bust collapse in 2000. The Western central bank have slashed interest rates to near zero and removed any immediate probability of a double dip economic recession. As long as the high growth-lower dollar mix is intact, I doubt if oil prices collapse. A 60-75 range is probably the most likely scenario but all bets are off if Saudi Arabia shifts its production policy and breaks with Opec compliance constraints this winter. Velero's shutdown of its Delaware refinery, Pemex's lower drilling estimates for the Gulf of Mexico, ECB Trichet's hint of removing credit support lines, high inventories (tankers loaded with crude oil off the coast of Dorset, Western Scotland and Singapore!), low petroleum product demand and higher risk metrics all mean that a breakout above $80 will not happen. So while I am interested in Big Oil shares, my buy zone is lower than current levels. So I would only buy Exxon at 68-70, Schlumberger at 54-58, Occidental Petroleum below 70 and Norway's Statoil in Oslo at 135 Norwegian kroner. Crude oil has lost its momentum and so will the shares of Big Oil (the supermajors once known as the Seven Sisters!)

Exxon , the most valuable company in the world, the flagship of the Rockefeller empire, the oil colossus with 3.7 million barrels in daily production and 23 billion barrels in proven global reserves, has hardly been a winner share even as the large cap indices surged 50 per cent since March and crude oil doubled to $75. Exxon has been largely ignored but its share price is not a high beta play on black gold, unlike oil exploration and production companies like Marathon, Apache, Murphy Oil or Anadarko. In addition, Exxon Mobil has been punished for its refining and chemical business, which actually provides a natural hedge to a fall in oil prices and whose $60-80 billion value is not reflected in current multiples. However, Exxon 's production volumes will get a boost due to its Qatari LNG offtake, estimated to be worth $75 billion alone.

Unlike BP and Shell , Exxon did not lock horns with the Kremlin and retains its priceless access to Sakhalin. In addition, Azerbaijan, the Gulf of Mexico, Angola and Australian LNG projects could well turbo-charge the shares even as lower drilling costs increases the potential of the $26 billion capex budget. With long life reserves in Qatar, Canada and the US, the integrated, global, scalable upstream/downstream model of Exxon Mobil make it a superlative Big Oil holding for the long term, albeit without the wham-bang acrobatics of the high beta exploration or drilling outfits. Exxon can well earn $6 a share in 2010 so it trades at a modest valuation multiple of 12X. I would use any market dip to accumulate XOM at 68-72 for a 90-94 target.

Schlumberger (SLB) is the world's leading oil services firm, the natural partner of both Big Oil and state owned companies such as Pemex, Saudi Aramco, ARAMCO, Qatargas, Gazprom, Pertamina etc. Schlumberger shares got sandbagged from their 2008 high of $105 as crude oil prices collapsed and oil drilling budgets were slashed in the worst global recession since the Great Depression. SLB is still plagued by mediocre revenue growth, the fall in global E and P budgets and lower seismic demand. However, SLB can well earn $3 a share in 2010, with upside if deepwater and North American natural gas spending ramps higher. This means it is doubtful if SLB will fall below 52-54. Upside? Probably somewhere between 75-80 next year.

Occidental Petroleum, or OXY , has long been my Big Oil darling and Oxy has helpfully doubled in 2009. No other American supermajor can remotely match the scale and sustainability of Oxy 's reserve growth in the next five years. This is due to Oxy 's strategic acreage in California, its role in the Qatar/UAE's Dolphin project, its exceptional 25-40 per cent returns on capital, its role in the ENI consortium for the Iraqi Zubair oilfield, a potential gusher. Oxy , created by legendary oilman Dr Armand Hammer, whose first business deals were with Lenin in Soviet Russia, deserves a valuation rerating even though it trades cheaper than Exxon , Chevron and BP . Stat (STL in Oslo) is a pure play on offshore Norwegian production, the European as market and deepwater Brazil. I believe Statoil is undervalued in Oslo. In essence, Statoil, Shell ENI and Repsol reserves are priced at $60 Brent. Statoil is on a roll due to its Norwegian offshore volume growth and profits in its Russian LNG and natural gas trading business. I would buy Statoil New York ADR at 21 for a 26 target.

© Khaleej Times 2009