The Downside of High Oil Prices for Exxon, Oil Majors

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Energy major Exxon Mobil’s (NYSE:XOM) stock has only risen by about 3% in 2012 despite oil prices posting an increase of 18% in the same period, largely related to the political standoff with Iran. [1] Analysts are blaming the relative year-to-date underperformance of energy stocks primarily on low natural gas prices in the U.S. Investors are also apprehensive about whether the current oil prices are sustainable going forward.

A MasterCard (NYSE:MA) report stated that U.S. retail gasoline consumption had declined by 7.2% last week over the same period last year because of high prices. [2] Low-end consumer demand can hurt downstream margins and pull down crude prices in the medium term. Rival ConocoPhillips (NYSE:COP) will be spinning off its downstream business in Q2 this year to focus on its upstream business.

Click here for our full analysis of Exxon Mobil.

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Natural gas glut

Natural gas prices in the U.S. have touched their lowest levels over the past decade because of an oversupply in the market and weak demand resulting from a mild winter. Close to 50% of Exxon’s global natural gas output is in the U.S. and Canada. [3] The company is the largest producer of natural gas in the U.S. and has disclosed that it will not consider reducing output because of the weak pricing environment. Weak prices can weigh on Exxon’s upstream revenues, which contribute a major portion of the company’s overall valuation. Should this low price environment persist it could have an impact on the company’s stock price and our valuation.

Oil price impact

High oil prices have a strong favorable effect on Exxon’s upstream operations as shown in the chart below. The company earns a large share of its profits from selling crude oil to its own downstream operations as well as third-party refineries. However, high crude prices impact the company’s downstream margins and push down end consumer demand.

The EIA estimates that crude may sell at an average of $106 / barrel for the rest of the year. Exxon’s stock price may have also been impacted by its high capital expenditures, which have not helped the company stem declines in overall output. [1]

We are in the process of revising our $94 price estimate for Exxon Mobil, which is at a 10% premium to its current market price.

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Notes:
  1. Energy Shares Suffer ‘Gas’ Pangs, WSJ [] []
  2. High US gasoline prices hit demand again-Mastercard, Reuters []
  3. Company 10-K, SEC []