In American oil and gas, it's better to bet on big players

Ticker: XOM

Author: Stock Analyst  Date: 2021/04/26

American oil and gas companies have not yet moved to an increase in production after it fell by 2 million barrels per day. against the backdrop of the pandemic, despite the comfortable level of oil prices. Probably, the current price level does not look stable enough to take risks and switch to active drilling. In such a situation, we consider it appropriate to bet on large players who pay high dividends and are able to feel comfortable even with a price correction of 15-25%.

The American oil and gas industry has several differences from most of the world's peers. The cost of production in the United States is in the range of $ 25-35 per barrel (compared to about $ 10-12 per barrel in Russia), and drilling new wells in many regions can be effective with oil prices at the level of $ 45-50 per barrel. Moreover, shale oil, which in the United States a year ago was about 63% of production, is highly dependent on continuous drilling, since old wells are depleted rather quickly. An additional problem is the high level of debt burden on many small producers. These factors led to the fact that oil production in the United States fell from a peak of 13 million barrels per day. at the beginning of 2020 up to 11 million barrels per day. at this moment.

Drilling activity in the US has been steadily increasing over the past six months, but is still too low to trigger an increase in production. So far, the US Department of Energy predicts that in 2021, oil production in the United States will average 11.04 million barrels per day, and in 2022 it will grow to 11.86 million barrels per day.

Despite all the problems and risks, the US oil and gas index has practically recovered from the crisis, although its dynamics is significantly weaker than that of the S&P 500 broad market index, which includes many technology companies that turned out to be the beneficiaries of the pandemic. This dynamic leaves a limited upside for further recovery. the return of oil prices to pre-crisis levels has actually been won back by the market.

Of course, history shows that you should never underestimate US shale oil production. After the 2015-2016 oil crisis, drilling activity also slowly recovered, and it all ended with the fact that, thanks to the support of oil prices by the OPEC agreement, the United States was able to reach record production levels and become the world's largest oil producer. However, now the situation is somewhat different. Small oil producers, on average, have not been able to move to the stable generation of positive free cash flow, which lenders have been waiting for them for the past 10 years. The growth in production at any cost has led to a high level of debt burden on a number of small and medium-sized players. In such a situation, banks are already less willing to lend to oil shale producers, especially given the spread of ESG-related issues and the rate on the long-term growth of renewable energy sources. This makes betting on small and medium-sized manufacturers rather risky, since the next correction in oil prices, for one reason or another, may once again deprive them of the opportunity to reach a positive FCF, and also limit opportunities for development.

Against this background, we consider it most appropriate to invest in shares of large companies with a stable financial position, potential for cost reduction and a stable high dividend yield, which will support quotes in the event of market turbulence.

Exxon Mobil, the largest oil and gas company in the United States, is just such a company. Exxon has a diversified portfolio of assets in more than 40 countries around the world, which makes its business relatively shielded from specific country risks. Dividends are central to Exxon Mobil's investment story. The company has been raising them for 37 years and has continued to do so even in the difficult year of 2020. The dividend yield is expected to reach 6.2% over the next 12 months, one of the highest in the US oil and gas sector.

At the moment, the sustainability of dividend payments is beyond question - Exxon Mobil has enough oil prices of about $ 45-50 per barrel to earn enough free cash flow to pay dividends without raising debt. Moreover, Exxon Mobil's current strategy is aimed at optimizing its asset portfolio and, as a result, increasing operating cash flow by $ 8-11 billion by 2025 compared to the forecast for 2020. We recommend buying Exxon Mobil shares with a target price of $ 63.8, which corresponds to an upside of 15%.

Chinese oil and gas looks weak

Among the three largest Chinese oil and gas companies, only Sinopec was able to return to pre-crisis levels. Sinopec has helped a significant share of petrochemicals in the business as the petrochemical industry was able to recover faster and more confidently from the pandemic.

It should be noted that the weak performance of CNOOC shares is not primarily due to fundamental factors. In January, CNOOC was blacklisted by the United States, which imposes restrictions on the import of American products. And since March 9, the company's shares have been excluded from the New York Stock Exchange. This inevitably led to the sale of shares by American and international investors. Against this background, Petrochina shares came under pressure, although they continue to trade in New York. However, Petrochina also has chronic problems that have led to a continuous drop in stocks since the fall in oil prices in 2015. Among them, one can single out the prime cost of about $ 55 per barrel, the near-zero margin of oil refining and the loss of profitability of import and resale of natural gas and LNG.