Amid energy shares' lull, is it time to buy Standard Oil twins?

Dubai - Shale oil revolution has resulted in new paradigm in economics of oil drilling, production and supply

Energy has been the worst-performing sector of the S&P 500 index in 2017 as oil prices plunged from $56 to $46 even after the Opec extended its November output cut and natural gas prices lost 22 per cent, down to $3 per million British thermal units. Not even public evidence of a Saudi-Russian rapprochement and 90 per cent GCC compliance on the output cut deal was enough to stabilise oil prices.
The shale oil revolution has resulted in a new paradigm in the economics of oil drilling, production and supply. For instance, US producers raised output by an incredible 900,000 since Saudi Arabia brokered its original Vienna deal last November. Technology creates obsolescence at breakneck speed (Black-and-white TV? Typewriters? Telex machine?) and the electrification of the world's auto fleet/Uber economy will lead, long term, to an epic plunge in oil prices, possibly down to real 1999 levels near $20 Brent. This is all the more possible since Moore's Law operates with a vengeance in the technology of hydraulic fracturing, making Texas's vast Permian Basin the new swing producer of black gold since it will generate new output on a scale unseen since the epic Saudi Arabian, Iraqi and Kuwaiti oil strikes in the late 1940s. "Howdy" is the new tagline of the world oil market in the Age of Shale.
Keynes pointed out that we are all dead in the long run - but must trade and invest in our human lifespans. I see some data points that convince me that there could be a tactical bullish trade in Wall Street's oil and gas supermajors and oil service companies. Why? One, Nymex oil futures on the West Texas Intermediate crude contract have moved from contango to backwardation. This is a telltale sign of a balance between oil supply and oil demand. Two, the season increase in refinery utilisation rates and field maintenance will lead to drawdowns from admittedly bloated crude oil inventories. Three, oil exploration and production shares have grossly underperformed their high-yield debt or credit default swap value range. This implies, though does not confirm, a tactical bottom in valuations. Four, the Qatar embargo and terrorists attacks in Tehran inject a geopolitical risk premium on oil prices. Five, global PMIs show clear evidence of the first synchronised global economic recovery since 2010. Global demand could thus rise to 100 million barrels a day by end-2018.
However, these data points are only bullish on oil prices in the short/medium term. Long dates futures contracts on the New York Merc suggest the West Texas crude will trade below $50 in 2020. Like Shakira's hips, oil futures do not lie - though they can well mislead. Still, it is rational to be bearish on petro-currencies and shares/property in Planet Crude from Abu Dhabi to Aberdeen. Yet this does not preclude tactical trades in oil and gas supermajors. So I channel the ghosts of John D. Rockefeller to help me choose the best ideas among his corporate progeny.
Exxon Mobil, the fabled Esso ("put a tiger in your tank" of my boyhood!), is a value buy for me but only if it falls to 75-76. Exxon has slashed its cost structure and drilling/capex budget. It has added to long-life reserves at rock bottom prices. It has boosted its free cash flow yield, reduced its debt/Ebitda ratio to 0.9 and vastly boosted its net interest coverage ratio. It can well deliver four per cent output growth in the next three years. Its 3.8 per cent dividend yield at 76 puts it in deep value zone. I would not be surprised to see Exxon bottom at 75-76 for a 85 target if West Texas regains the $50 handle this autumn. The risk/reward in Jersey Standard (Exxon) at 76 is compelling.
Chevron used to be once known as Standard Oil of California, has the highest output growth profile in Big Oil, thanks to its megaprojects in Angola, the Australian LNG plants and the Caspian Sea. Its 4.2 per cent dividend yield if the shares trade at 104 is even juicer than Exxon, even as its valuation relative to earnings and its own oil and gas reserves is at a discount. Now that the Gorgon and Wheatstone LNG plants are almost complete, Chevron's capex will tank and free cash flow will surge. Its Permian Basin acreage alone virtually guarantees 2018 output growth estimates. This is beyond yummy, especially if speculative bear raids send the shares down to the late-1990s.
The writer is a global equities strategist and fund manager. He can be contacted at mateinkhalid09@gmail.com.