ExxonMobil and Chevron: Structurally Unsound Investments

Alexander is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

ExxonMobil (NYSE: XOM) and Chevron (NYSE: CVX) missed earnings expectations by a very large margin this past quarter. This indicates that all is not well with Big Oil.

What’s going on?

<img alt="" height="413" src="http://g.fool.com/editorial/images/62918/8-2-13-xom-pic-1_large.png" width="735" />

Source: EIA

<img alt="" height="260" src="http://g.fool.com/editorial/images/62918/8-2-13-xom-pic-2_large.png" width="740" />

Source: EIA

Gasoline supplied in 2012, and 2013 is below the five-year average. Just because oil markets can increase total market supply, doesn’t necessarily mean it always does. The market for oil is usually colluded, and total production is increased based on profit maximization. However, one of the things that have made it difficult for OPEC countries to exhibit price control is the improving fuel economy of cars.

<img alt="" height="421" src="http://g.fool.com/editorial/images/62918/8-2-13-xom-pic-3_large.png" width="747" />

Source: University of Michigan

<img alt="" height="421" src="http://g.fool.com/editorial/images/62918/8-5-13-crude-oil_large.png" width="724" />

Source: YCharts

The average fuel economy has improved 17.7% over the past five years; correspondingly the U.S. crude oil and petroleum supplied (used as a proxy for consumer consumption of gasoline) was down 3.74% over the same five year period. Meanwhile, market supply has increased 49.52% while prices have remained stagnant over the past three years. The increase in supply was exported to emerging markets.

In the second quarter of 2013, rising fuel economies started to catch up with two of the major oil giants, as the companies found that reaching an end-market for crude oil was becoming increasingly difficult. The push to more fuel efficient vehicles is starting to take its toll, and the speed at which it is being done is significant enough to materially affect the whole oil industry. 

<img alt="" height="449" src="http://g.fool.com/editorial/images/62918/8-2-13-xom-pic-4_large.jpg" width="721" />

Source: Statista

Hybrid vehicle sales have started to pick back up in 2012. A greater mix of hybrid vehicles will make it difficult for the oil companies to generate higher rates of profitability. By 2016, the Federal government has set a mandate that the average fuel economy for a car has to improve to 35 mpg, and a truck to 28 mpg. The average fuel economy is estimated to be 24.5 mpg as of January 2013.

ExxonMobil bombed

<img alt="" height="148" src="http://g.fool.com/editorial/images/62918/8-2-13-xom-pic-5_large.png" width="741" />

Source: ExxonMobil

On a global basis, ExxonMobil’s refining output declined from 4,982 thousand barrels per day to 4,466 thousand barrels per day.

ExxonMobil blamed its poor performance on declining demand for crude oil. The company’s revenue declined $21 billion year-over-year. The company could not offset falling demand with cost cutting because the oil-industry is notorious for having a lot of fixed costs. The company reported earnings per common share of $1.55 (year-over-year decline of 55%). Analysts were expecting the company to report earnings per share of $1.90. The company missed the consensus expectation by 18.4%.

Chevron gets dismantled

<img alt="" height="226" src="http://g.fool.com/editorial/images/62918/8-2-13-xom-pic-6_large.png" width="726" />

Source: Chevron

The company's reported revenue from the upstream and downstream segments declined. The company could not offset the decline in revenue with cost cutting. John Watson (CEO of Chevron) stated:

The decrease was largely due to softer market conditions for crude oil and refined products. Earnings were also reduced as a result of repair and maintenance activities in United States refineries.

The company reported a $5 billion year-over-year decline in revenue for the second quarter. The reported decline in revenue was partially offset by reduced expenses. The reduction in expenses was not enough to offset long-term fixed costs, and, as a result, the company reported a 25.58% year-over-year decline in net income. The company’s earnings per share came in at $2.80 for the quarter.

Analysts were expecting the company to report earnings of $2.96 per share for the second quarter. Chevron missed analyst expectations by 5.4%.

Oil price outlook

<img alt="" height="408" src="http://g.fool.com/editorial/images/62918/8-2-13-xom-pic-7_large.png" width="734" />

Source: EIA

I think that the price of crude oil will eventually decline. Suppliers of crude oil may eventually ramp up production based on the time frame for extracting crude oil resources from newly discovered oil reserves in the United States. The price of crude oil should also decline due to improvements in fuel efficiency. In summary, investors should avoid investing into crude oil based ETFs like the United States Oil Fund (NYSEMKT: USO).

<img alt="" height="437" src="http://g.fool.com/editorial/images/62918/8-2-13-xom-pic-8_large.png" width="734" />

Source: YCharts

The United States Oil Fund seems overbought. The price of the ETF has improved 14.35% within the past year. I think that the price of oil has gone up temporarily. Given enough time, I think that the oil companies will start to accept lower prices on crude oil in order to generate more volume from idle production capacity. 

Some have been able to benefit

ConocoPhillips (NYSE: COP) grew earnings 15% on a year-over-year basis. The growth in earnings came from increased production.

When one oil company increases production (ConocoPhillips), other crude oil developers will also increase production (OPEC). When commodity markets become over supplied, the price of the commodity declines precipitously.

I’m not going to read too much into the positive results of ConocoPhillips because given enough time, I think that global demand will be affected by improving fuel efficiency standards, paired with the higher rate of discoveries from alternative fuel sources like tar sands and offshore drilling.

Conclusion

The weakness in crude oil is structural. Demand for crude oil has declined and is below the five-year average. The decline in demand came from improving fuel efficiency standards. Certain oil producers will ramp-up production even as other oil producing groups will decide not to. The interest of the various oil producers will be fragmented. But given enough time, I think that the market for crude oil will become oversupplied as the greed from independent oil operators will get ahead of the interests of the whole group.

As a result, my outlook on the crude oil industry is negative.

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Alexander Cho has no position in any stocks mentioned. The Motley Fool recommends Chevron. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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