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How to Make the Oil
Industry Pay for Your Fill-Ups |
Published:
May 12, 2008
Back
in early 1999, venerated magazine The Economist famously ran
a cover story entitled "Awash in Oil" predicting crude oil would
trade around $5 per barrel for a prolonged period. With oil at
more than $120 per barrel today, that now seemed a ridiculous prediction.
And in fact, the cover came close to marking the all-time low in
oil prices, but it's important to take into account the
historical context of the headline.
At that time, many pundits believed the world was in the
midst of a global glut of supplies. OPEC seemed powerless to
control supply and new oil discoveries in the deepwater prompted
some to predict a resurgence in supplies from non-OPEC nations.
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As my chart
to the right shows, oil prices languished throughout most of
the 1980s and 1990s. With the exception of a few short-lived
spikes, crude spent most of this era trading under $20 per
barrel. From those levels, $5 didn't seem so outlandish. |
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At first glance, you might assume that this era of depressed
oil prices spelled trouble for companies involved in the
production and sale of oil and oil-related products.
Certainly that was true in
many cases, but there
was one group that bucked the trend and managed to produce solid returns
for investors: "Big
Oil" companies.
Consider that ExxonMobil (NYSE: XOM), then called simply Exxon,
produced a gain of more than +1,200% between 1985 and 2000.
That's a nearly +19% annualized gain, slightly higher than the
return for the S&P 500 over the same time period. And Exxon
managed this impressive performance despite the prolonged
weakness in oil prices.
So what was the secret to Big Oil's success? First and foremost,
these firms have historically tended to have access to the
world's most attractive oil and natural gas reserves. These
fields were prolific and could be produced at a low per-barrel
cost. That meant that even when oil prices were hovering around
$10 per barrel, many of the Big Oil firms could still turn a
profit.
In addition, in the energy industry these large firms are often
called "integrated" oil companies. The reason for that term is
that most integrated oil companies are involved in three
business lines: production of oil and gas, refining, and
chemicals.
Clearly, the production side of the business directly benefits
from higher oil and gas prices, but that's not necessarily true
for refining and chemicals.
Refining is the process of turning raw crude oil into the
products we consume every day, such as gasoline and jet fuel.
Refiners make money on the spread between the price of oil and
the prices for refined products -- refiners do not benefit
directly from high-priced oil.
As long as gasoline prices are high relative to oil, refiners
can make money even with oil at $10. Refining operations offer
the integrated oil companies a measure of diversification --
when profits from oil production are poor due to weak oil
prices, refining profits might be able to pick up some of the
slack.
Chemicals manufacturing involves producing products like
plastics that are manufactured from oil and/or natural gas.
Profits from chemicals manufacturing are cyclical and depend on
factors like the health of the overall economy. However, the
profit cycle for the business isn't in lockstep with crude oil
prices -- the chemicals business also helps diversify revenues
streams for the integrated oil firms.
With their diverse operations, the integrated oil companies managed a respectable performance
during the lean years for oil; you can imagine what has happened
more recently as oil rallied to more than $120 per barrel. Profits for
companies like Chevron, ExxonMobil, ConocoPhillips, and BP have
soared to all-time records. And the stocks have risen to reflect
that surge in profitability -- the S&P 500 Integrated Oil Index
is up +210% since 2000. That bests the S&P 500's roughly +8%
gain over the same period by a factor of about 25-to-1.
But the party isn't over yet, and here are a couple of ideas to
profit from high crude prices -- essentially using the oil
industry pay for your fill-ups. . .
Important Note:
In the remainder of this article,
Market Advisor editor Paul Tracy
provides in-depth profiles two of the most promising oil
companies available. One is a national oil company with a new
discovery that, by some estimates, could contain 30 billion
barrels of oil -- which would make it the most important
producer in its oil-rich region. And with refining demand only
getting stronger, Paul also uncovered an integrated oil company
posting some of the fattest refinery margins in the industry. However,
in order to view the remainder of this article, you'll need to
subscribe to our premium investing newsletter --
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Advisor. After you subscribe, you'll
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-- Paul Tracy
Editor
StreetAuthority
Market Advisor
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