One of the apparent paradoxes that the market brings regularly touches on oil. The echoes of an early recession that will reduce the demand for crude () have recently been felt in prices. Although the barrel of Brent, the world reference, regarding the war in Ukraine and has gained 19% so far this year, in the last three months it has dropped more than 15%. This contrasts with the performance of the oil companies on the stock market, especially on Wall Street, resisting standing despite this drop in raw materials.
The best example can be seen in the XLE energy exchange traded fund. Within this ETF focused on oil, there are important companies that have shown a performance in the last three months notably better than that of a barrel of Brent: Exxon Mobil (+5.2%), Chevron (+5.69%), Marathon Petroleum (+9.14%) or Valero (-5%). The ETF itself rebounds more than 7% in the last three months and leaves ‘only’ 1.9% in the last month.
There are several reasons why oil companies have managed to disassociate themselves from oil price adjustments on the stock market, in a complex current context, in which geopolitical and economic factors are mixed. Ben Laidler, Market Strategist at eToro, notes that “oil stocks have been resilient to the drop in oil prices, given their cheap valuations and with current prices still well above four times the average cost of production.”
Oil majors are an attractive hedge against the risk of ‘higher for longer’ oil prices, with the current focus on recession risk and the backward-looking oil futures curve underestimating potential large shocks to supply, consider the analyst. These, he notes, range from a near end to US strategic reserve sales to sustained low drilling activity and Europe’s impending embargo of Russia. The expert also points to risks that go beyond oil: “The drop in crude oil is a key anchor for global inflation, especially as other prices, from housing to wages, are frustratingly sticky.”
Laidler finds up to four key drivers of this trend. First of all, it begins, the US is nearing the end of its huge sales of strategic reserves, with 165 million barrels out of a planned 180 million. The focus will shift to rebuilding these long-term reserves from 38-year lows. Second, global drilling remains low and is still 50% below its previous highs.
The third aspect involves Europe’s December 5 embargo on Russian oil imports, which will be adjusted by seeking 1.5 million barrels per day elsewhere. The fourth is that oil futures markets are heavily corrected, with positive prices.
The Bank of America (BofA) commodity team partly agrees with this outlook. “Global GDP will expand by just 2.5% next year, so global oil demand growth should slow further. The slower growth comes just as strong dollar headwinds and rising interest rates are poised to negatively affect oil demand in the coming months, however we do not expect a big pullback in oil prices as production cuts above $90 a barrel. Statements that the US Strategic Petroleum Reserve could start to fill at $80 a barrel from WTI Texas should also support oil prices, so as spare capacity dwindles and investment lags, we believe $80 a barrel is now the new $60 for Brent,” they write in a note.
And the stock market translation? Even before the summer, Lance Roberts, a strategist at Real Investment Advice, emphasized this performance of the oil companies. “It is no secret that Exxon and the energy sector, in general, have weathered the recent market storm the best. High energy prices are certainly helping Exxon and others, but it is crucial to provide context for the recent outperformance,” he noted.
The analyst included a chart showing Exxon shares trailing slightly behind the S&P 500 despite the recent rally. “Although energy may have gotten a bit ahead of itself in recent months, there is potentially a lot more relative upside if it continues to catch up with the broader markets over the long term,” he concluded.
Plotting the same chart with the XLE ETF and the S&P shows the same trend: valuations are cheap. The estimated PER (times the share price collects the expected profits) for 2022 is 7.33 times for Exxon, 8.28 for Chevron or 4.47 for Marathon, much more modest multiples than those of the S&P 500 (17, 16 times).
But there is more. For Laidler, a key reason for this resilience lies in rising earnings forecasts, up 8% since the start of the third quarter, while crude oil is down 25%, as shares never traded at $120 a month. barrel of petroleum. Consensus now sees earnings growth of 150% this year versus 8% for the S&P 500 plus a hefty 3% dividend yield.
According to the expert, current oil prices represent multiples of $20 a barrel at the average cost of production and producers see $90 a barrel as a “better” and more sustainable price than $120. Furthermore, he adds, energy is the third cheapest of 30 US industries with a forward P/E of nine times earnings, only slightly ahead of telcos and banks.
“Multiples that have never been at oil highs; attractive valuations in relative terms and both structural and short-term changes in production are factors that explain the situation and that lead to the conclusion that the oil majors are an attractive hedge against oil price risk,” concludes the eToro expert.
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