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Oil Industry: Farewell, Good Old Days

by: Andrew Snyder October 12, 2008 | about stocks: CHK / OIH / OIL / UNG / USO / XLE / XOM    

Andrew Snyder

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I sure hope those mega-profits the oil industry reaped over the past few years were well saved, because the glory days are over. Not only is a major economic slowdown destroying demand for oil and natural gas, but the absolute lack of available credit is putting the crimps on any remaining plans to explore and develop new territory.

In my home state of Pennsylvania, natural gas companies as recently as this summer were going door to door trying to buy mineral rights from landowners. With energy prices in record territory, they were writing some huge checks. It is a similar situation across the country. Now that prices are down almost 50% from their highs, energy companies are starting to believe they made a huge mistake.

In case you have not noticed, crude prices have been plunging right along with the equities market this week. Earlier today the price of a barrel of oil dropped below $80 for the first time since September of 2007.

If the International Agency on Energy (IAE) is right with its demand estimates, more price cuts are on the way. The group announced today that it believes world oil demand will increase by just 0.5% over the next year. That would be its lowest growth rate since 1993.

Nearly every month for the past year, the IAE has cut its energy outlook. It is likely more cuts are on the way as this impending recession grips the world’s throat. Companies across the oil industry will be hurt.

Of course, the first company many investors think of when they hear about the oil industry is Exxon Mobil (NYSE:XOM). Sure, its days of $12 billion annual profits are gone for a while. But it will remain in business.

Hundreds of other not-so-well-capitalized businesses will be wiped clean. Not only is demand for their product tapering off, but they cannot get the credit they need to expand and find cheaper energy reserves.

Energy-sector companies like Chesapeake Energy (NYSE:CHK) that have fallen by more than 80% since July may look like fantastic bargains at this level, but do your homework before you leap into this mess of an industry.

Chesapeake is deadly low on cash and its bills are stacking up. Its reserves which it was counting on for big payoffs are now worth more than 40% less. Cash flow is going to be hard to come by.

It is the same tune all across the sector. In a recessionary environment, you have to be very careful about investing in the energy industry. There are some fantastic values out there thanks to high levels of panic, but you have to do your homework and pay attention.

Disclosure: none

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This article has 17 comments:

  •  
    Oct 12 09:01 AM
    Well, Andrew, time for me to put on my *Leading academic energy economist in the world' beret again. Take the first line of your contribution for example, about the lack of credit putting the "crimps" on plans to explore and develop. Although this is not certain, I would call it very bad news if it is true, because the demand for oil and gas is NOT going to go into a nosedive, and when this macroeconomic/financia... trouble blows over, that demand is definitely going to begin climbling again.

    You mentioned the IEA (as I call it). Its executive director mailed me a month or so ago and suggested that I was off my nut because of my ridiculing the forecasts of his organization. Specifically, he said that I said that the IEA had predicted a production of 121 mb/d in 2030, when actually the IEA only predicted consumption. This was what is generously called 'a departure from the truth', because I spent a few very pleasant hours discussing this crazy production forecast with my class at the engineering university in Bangkok, and as for Monsieur Mandil (of the IEA), I explained to him that an intertemporal consumption forecast without some indication of production over the same time horizon hardly deserved to be called nonsense.

    Of course, what that gentleman is doing is backing up his drowsy employees, because as his fellow countryman M. de Margerie must have explained to him at one of those wonderful Parisian lunches, it is not at all certain that world oil production will ever exceed 100 mb/d.

    On the other hand, you are almost certainly correct when you say that there are some beautiful values "out there" thanks to excessive pressure on the panic button.
    Reply
  •  
    Oct 12 09:20 AM
    Tough times ahead!

    industry.bnet.com/ener.../

    Reply
  •  
    Oct 12 09:51 AM
    Andrew,

    No offense, fella, but the last time I checked (this morning) oil prices were still at RECORD historic highs. And worldwide production was still DECLINING, and still controlled by a CARTEL.

    As regards NG, the U.S. is now awash in the stuff thanks to modern exploration and production techniques. But don't confuse the two! Oil can be transported and sold the world over, but NG production is STRANDED by its very nature. And don't worry, we'll find uses for ALL of it as a utility and transportation fuel.

    As for energy companies going broke, that's always been true. (Not just for them, actually, but for all types of private enterprises.) Again, not to worry, the one's that don't survive will be replaced by others.
    As Boone Pickens himself would tell you, he's become a billionaire several different times!
    Reply
  •  
    Oct 12 10:48 AM
    Once again, in this chicken/egg issue, we are failing to recognize that
    it is a rising dollar that has caused falling oil prices. The world's need for oil will not diminish until a satisfactory replacement is functional.

    In fact, prices will reverse eventually as drilling/production is temporarily
    curtailed due to lack of credit financing for those enterprises. It may also follow that exploration/drilling activity will move over to cash- rich large cap integrated companies for the time being.
    Reply
  •  
    Oct 12 12:54 PM
    I concur completely with Sponger. We are totally dependent on hydrocarbon fuels in the years ahead. Alternatives, such as electricity, hydrogen, or bio-fuels, have infrastructure and technical problems to be overcome. You can include political problems as well.
    Reply
  •  
    Oct 12 01:42 PM
    Ignore the idiocy of the blowhards above and pay attention ot Mr. Snyder's comments.
    Reply
  •  
    Oct 12 02:49 PM
    Don't ignore the comments above: They're not idiotic as atavista says. It's a boom and bust commodity industry, always has been and always will be. Natural gas is different. The author talks about Pennsylvania, which is likely natural gas leases that people are paying a lot of money for and then he goes on to talk about the price of oil. Need to keep the two separate. We'll bounce around for a while on prices and then slowly start creeping back up, then go into a hard run up, then of course, another fall. Make sure the companies you buy at this time have good balance sheets and low debt. I know for a fact that they see this as a buying opportunity.
    Reply
  •  
    Oct 12 03:14 PM
    Companies like XOM have the cash to purchase assets on a cheaper basis than what the pricing was in the last year. XOM has been stubborn in its belief that oil and gas pricing was too high for price sustainability nand therefore refused to pay the asking prices of 100 dollar barrel oil for proved and probable assets.

    How long the respite in pricing I simply don't know. But the CHK's of the world are increasingly vulnerable to takeover at a less than desireable price than just 6 months ago.
    OPEC's historical power has not to be able to maintain high pricing but to rather the ability to drag low pricing off the floor.But only after 18 to 24 months of wrangling amongst its members.

    the early predictions of the Exxon's, the Chevron's and the Total's of the world going the way of the Dodo hyave been pre-mature at best and wholly inaccurate at its worst.

    In an age of lower pricing and tight credit who but the well heeled can sit and wait and self fund purchases of assets.
    Reply
  •  
    Oct 12 07:13 PM
    Try $43 billion in annual profit Mr Snyder -after all expenses and depreciation. That is more than enough PROFIT in one year to buy Goldman Sachs or Boeing or Eli Lilly or Occidental Petroleum just to name a few. XOM is by far the biggest, most profitable and financially strongest company in the world. And they sell a product that is a necessity and they sell it for cold hard cash. I would certainly rather own XOM shares for the next 20 years rather than depreciating "ultrsafe" US Treasuries.
    Reply
  •  
    Oct 12 09:01 PM
    Maybe it's a good time for XOM to snap up CHK? After all, it's hard for XOM to get more oil from those national oil companies.
    Reply
  •  
    Oct 12 10:24 PM
    XOM is an integrated oil company and historically a very well managed one. People seem to think that the only reason it makes its gigantic profits is because of high crude prices when in fact reasonably high profitability numbers were being posted when crude was still in the 60's.

    As crude prices fall, refining margins tend to move higher. In the most recent era of rapidly escalating price at the pump, refining costs were not able to be passed through. Ask Tesoro, Valero and other pure refiners about that. With falling crude prices increased refining profitability must return or there will be a refining throughput contraction as those least able to compete will otherwise begin to falter.

    XOM will also be able to realize better margins in its chemical production which can be a huge profit center for them in times of lower feedstock costs. Vertical integration and conservative management has worked very well for them and I wouldn't count them out just yet.

    I suspect there will be a recognition this coming week that with very low debt, huge cash reserves, and an extremely strong balance sheet that XOM stock was only sold off because of the need to raise money for the redemptions of funds in the panic and it is a screaming buy at these levels.
    Reply
  •  
    Oct 12 11:42 PM
    Andrew, you forgot the most important counterbalance which is that many productive fields are quickly playing out as in Mexico, Alaska even Saudi Ariabia from what many experts are stating and are not easily being replaced; the new finds are mostly very expensive to get at.

    NG is interesting , one bitter winter and the price goes back up. Canada is using most of its NG for tar sands and gulf is starting to play out.
    Reply
  •  
    Oct 13 08:06 AM
    CHK is not out of cash and the vast majority of their debt is long term. You should really learn how to read a press release, balance sheet, and footnotes to an 10Q and 10K before you go about amking assertions.
    Reply
  •  
    Oct 13 09:30 AM
    valueinvestor123: you are correct. The original author was partially correct in his article that CHK and others are having cashflow problems but they are most certainly not out of cash. What they are is outspending their cash. That is a huge difference from being out of cash.

    What can CHK do to avoid catastrophe? It is really very simple and its like what a huge number of U.S. consumers should do...STOP SPENDING MORE THAN YOU MAKE!!!! CHK was spending well north of 150% of its cashflow on drilling and leasing. Now all they have to do is cut back spending to where it is less than their cashflow and debt repayment. If they stopped drilling completely, which I don't think they should do, but if they stopped completely, they have more than enough cashflow to cover their debt payments, their ongoing overhead and operationse expenses and still have cash left over to put in the bank. Now what they should do is just continue to slow down their spending over the next 2 quarters. Possibly sell some assets, although this is a horrible time to sell. Maybe they can work a deal with some of the deep pocket cash hoarding major O&G's like Exxon or Chevron. They could get some cash either infused or they could get someone to pay for their drilling.

    Remember, they have 2 deals with PXP and BP where those companies will be covering virtually all of their drilling expenses over the next year in the Fayetteville and Haynesville shale plays...2 of CHK's better plays. They may not be able to get that much leverage now a days, but they have really nice assets...undrilled acreage in key plays...and majors are looking for growth.

    My prediction: as a shareholder in CHK I think these shares will at least double over the next 12 months OR CHK is bought out by one of the big guys! either way, if you've got a few years, this will be a good play.
    Reply
  •  
    Oct 13 11:16 AM
    Exxon learned from past mistakes. In the eighties, they invested heavily in alternative energies. The exact same ones that are being persued now. Exxon brought up global warming, then in the eighties, as a reason to continue research in alternative energies. This was denounced as one of Exxon's lies to gouge the tax payers out of their hard earned money. The US government broke theur promise to support alternative energy, because the price of oil fell to $10 and gasoline was cheap. This is about to happen again soon. People will forget $4 gas. They will forget that 1700 less people died on the highways this year. They will again buy vehicles to feed their egos. The US government will forget about alternative energy until the next crisis.
    Reply
  •  
    Oct 13 01:46 PM
    Isn't it strange that as we get closer to the Presidential election, the prices of gasoline and heating oil are dropping? Why do you suppose that is? Also, these prices rise and fall with the stock market, it seems.
    Reply
  •  
    Oct 13 10:23 PM
    Tony D. says: Isn't it strange that as we get closer to the Presidential election, the prices of gasoline and heating oil are dropping? Why do you suppose that is?

    I suppose that it is because the feed stock to refineries, crude, has decreased from ~$120/bbl or $2.85/gal, to ~$80/bbl or $1.90/gal. I suppose it is related to the end of driving season when gasoline always drops significantly each year. I also suppose it is related to a general slowing of demand as the economy contracts. You apparently haven't been paying much attention to how it works.
    Reply
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