I’ve been talking about the fast moving geopolitics of oil to my subscribers, with the upcoming US election, Russia/Ukraine, European energy issues and the new Israel/Hamas war – but let’s also not forget the incredible changes that are happening right in front of our eyes in the oil patch, specifically the last two deals between Exxon (XOM) and Pioneer (PXD) and the latest between Chevron (CVX) and Hess (HES).
Perhaps one blockbuster deal wasn’t enough for me to get a firm grip on what is happening here and make more generalized opinions on how it would affect our investments. But TWO of these, with many of the same attributes, has me believing we’ve definitely got a trend going with all of the conclusions for the future we can draw from it. So let’s talk about them both.
The long-term plan of many of the independent shale companies since they started (way back) in the early 90’s, was to be bought – but few thought it would take 30 years to catch a bid from a major and at, in some cases, near to 100 times the initial public offering price.
But, why now? And why this price? And what does that mean for us as energy investors?
To be sure, oil majors have had frankly horrible timing on consolidation efforts in the past. Remember Anadarko? Before Occidental overpaid for it at the height of the pre-pandemic collapse in 2019, it was initially the target of Mike Wirth at Chevron, who ultimately found a lot more value in the acquisition of Noble energy in October of 2020. Exxon’s buyout of XTO Energy in 2010 might rank as the most overpriced acquisition of assets by anyone in the oil patch ever, although it managed a better deal in shale when it bought the privately owned Bass family assets in the permian in 2017.
What’s been clear through all these consolidations is that mega-majors, hungry for production growth have often preferred buying already developed assets than developing them themselves, but their timing has often been suspect.
That’s the first takeaway — buying future production often beats the economics of developing it, but in no way are oil executives good predictors of energy markets.
Fast forward to the latest two deals. What’s immediately different between these, as opposed to the others I’ve already mentioned has been the relative lack of premium that either major was forced to pay over current stock valuations of both Pioneer and Hess. That tells me that no matter what Scott Sheffield or John Hess might publicly say, they both believe that there’s limited probability of another round of massive growth like they experienced leading up to 2014 and again post-pandemic, compared to the risks of stagnant oil prices or a faster shift to natural gas, or even a surge in renewable conversion in the future. They both figured that now was a pretty good time to cash out – and didn’t require much of a cash premium to do so.
And for Exxon and Chevron? They also understand these risks – but as integrated energy companies, they have the optionality that shale oil specialists just do not have. In rising oil markets, they can access shale assets that they are acquiring now, while also afford to leave those assets less utilized when oil prices fall. In declining markets, they have choices: ramp up their natural gas production, or rely upon downstream refining, or their commercial chemical business or yes – even add capital and growth to their low carbon businesses, including carbon capture and hydrogen.
The bottom line for me? All four parties recognize that oil might not have the most robust long-term prospects, especially with oil prices currently nearer to the top of their historic range at near $90. This is not to say that I think oil stocks are ‘finished’ as an investment – quite the contrary. We have seen energy sub-sectors left for dead, like Canadian E&P’s and even coal, that rose again from the ashes….when the price was right. Oil will be the majority part of the global energy portfolio, through 2030 and beyond. That I can say without a doubt, even if the IEA is mostly right about ‘peak oil demand’.
But especially given the geopolitical environment that has been emerging in the last two years with Russia and Ukraine, the coming US elections and current Middle East realities, all of which I spoke about at length in my last letters, I don’t see dedicated crude oil exploration and production as the best place to put our energy investment dollars in the near term. That can change – and what would change it most quickly would be a drop in oil prices back towards $60 a barrel, or better yet, $40. Right now, the crude oil tail is wagging the dog and oil’s price is outstripping it’s products: gasoline demand is dropping, and refining stocks seem to me to be just at the beginning of price moderation after a very big run. Natural gas supplies are ample, particularly in Europe where the weather outlook is for more wind and rain from another El Nino event, rather than bitter cold. But that could also change. My point is that oil prices are currently being buoyed more by geopolitical risks in the MidEast that should moderate and a covering of shorts by traders that were caught in a squeeze – BOTH of which aren’t the fundamental drivers for sustained constructive growth or incentives for aggressive investment.
I’ve gotten some pushback from my paid subscriber family for this ‘suddenly bearish turnaround’ on oil stocks, although it’s really more of an adjustment, and has hardly been sudden — we’ve been raising cash for several months now, and finding limited reasons to add to positions particularly in dedicated oil stocks, like the two that just got bought. One subscriber was pretty blunt: “Dan, You seem to be all over the map lately. Give up on oil for green stocks? Are you kidding? Cancel my subscription”. He cited the excitement from pundits like the WSJ and Barrons, who are convinced that this ‘doubling down’ by the majors is a harbinger of only great things to come for oil.
Here’s what I told him and am telling you: As far as the financial press goes, they are historically an awful investing resource. The worst. Like the public at large, they hype stocks at the highs and talk most negatively about them at their lows when they’re just about to turn around. I’m hardly perfect either, but here’s what I do know: The only big oil patch deal that wasn’t a tell for a negative turn in oil (if only a temporary one) in the last 15 years was the Chevron buy of Noble during the pandemic, and the ONLY reason that came off at a low buy price was because Vicki Hollub at Occidental was dumb enough to get in a bidding war for an incredibly overpriced Anadarko and won(?!), leaving Wirth with lots of cash he expected to spend burning a hole in his pocket. Meanwhile, Hollub needed a bailout for that horrible timing from Warren Buffett at 9% interest, plus stock options. Despite OXY’s resurgence, she still should have been fired.
If I ignore these trends and slavishly tell subscribers to just keep buying oil stocks, I am just not doing my job. I didn’t make a living investing in oil and oil stocks by listening to the advice of the WSJ or Barrons. In fact, no one ever did. I still believe in oil, just that the cycle is nearing a mid-term peak and other sub-sectors will provide better upside opportunities through 2024.
However, all is not lost. There are still several values I can find left in the energy space (that the financial press are of course ignoring) that have recently been the victims of a very hawkish Federal reserve. We should be looking to moderate some of the “traditional” investments we have ridden so successfully in the last nearly two years, and find some diversification in other places we have mostly left alone up until now.
You must always revisit your investment thesis, and when indications are to modify or even abandon them, you do yourself no good by hanging on and ‘hoping’ for a resurgence — luckily, oil prices and oil stocks are at the high end of their ranges and represent nothing but profits to us here. The two mega buys of Pioneer and Hess by Exxon and Chevron are screaming at me to take some of those profits off while I still can.
dan@dandicker.com
