Oil's Dominance is Secure Far Into the Future

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

The last few weeks I have been reading a lot about natural gas. In this industrial and post-industrial era, the fossil fuels we burn determine what we can and cannot do. Even with natural gas the world will still need oil and lots of it. Having a resource that important available domestically is a great boon to the country. Being a domestic energy source gets me excited, because I see energy as the basis for everything stretching back to early agriculture. The very foundation of society and civilization is energy in one form or another.

Stronger Margins Insulate Against Oil Price Swings

Chevron Corp. (NYSE: CVX) broke $115 a few months ago and is now back below $105. Consider that an opportunity, one that may expand in coming weeks so do not be trigger happy. The problems facing Chevron are not going to vanish in short order. The lawsuit in Brazil, and the judgment in Ecuador are not going to vanish. The judgment in Ecuador has led to Argentina freezing almost $20B of Chevron's assets. Let's hear it for international solidarity. The South American concerns will be on Chevron's head for a while. The real risk is a downturn in the economy.

I feel like some of the doom and gloom has faded from the public consciousness, which is a good thing. Pervasive negativity can create a downward spiral. There are still serious risks in Europe, and I sometimes catch myself waiting for the next piece of horrible European news. If the global economy tumbles and oil prices fall it will be rough for Chevron and all the other oil companies. I think Chevron will be fine in the long term though. While a decline in oil prices is likely to do some damage to the company's earnings its profit margin should be able to handle it.

Exxon Mobil Corp. (NYSE: XOM) has a gross profit margin of 21.93% and Chevron has 35.87%. I normally do not focus on gross margins, but when talking about the impact of oil prices it is a good measure. Exxon is twice the size of Chevron by market cap, and net income ttm is about twice as high at Exxon. However, Chevron has the higher margin meaning it is the more efficient company. So while a downturn would hurt both companies Chevron will probably not be hurt as much as Exxon. Some of the costs are fixed, and will not decrease proportionally with revenues. It takes a longer time to make those kinds of structural changes. Chevron will have more breathing room, also it might also be able to cut costs more effectively since it already runs an efficient ship. Its recent troubles provide a nice opening.

Headwinds for Oil Stocks Favor Dividends

The goal for an investor in oil companies has to be extracting value. I do not think the age of oil discovery is over, however I think it will keep pace with other wells drying up. That is the reason that companies are drilling in the deep water areas. Hopefully we do not get another Gulf oil spill, but as long as we need oil we are going to need to check areas that have not been easily accessible. The low hanging fruit is disappearing. Demand growth is limited as countries try to diversify away from oil. The pie for the whole industry is not growing like it used to, and it will become more about getting a bigger slice at a cost to a competitor.

Developing countries are still increasing demand but they can see the writing on the wall, and are adopting alternative fuels slowly. China is considered to be one the biggest drivers of demand, but it is exploring alternative fuel options as well. This is significant because the developing world is always seen as a replacement from flattening or declining demand curves in the developed world. Natural gas is rapidly becoming the energy source of the new future for countries like the United States but Iran and Pakistan use more natural gas vehicles. Which country is developing? Archaic distinctions aside, oil companies will plod along and might diversify. Some companies begin by diversify the sources they get oil from, and eventually all will have to diversify the fossil fuels they extract.

Consider ConocoPhillips (NYSE: COP), which has a nice dividend at a 4.63% yield and some solid growth prospects, compared with Chevron's 3.42% yield and Exxon's 2.61% yield. ConocoPhillips has been investing heavily in unconventional oil sources adding 700k acres, which are rapidly becoming the convention. So it is likely to improve in share price as the underlying business improves. Once the investments starts paying off revenue and profits should increase. Coupled with the company's commitment to paying dividends it should be a solid long-term investment.

BP plc (NYSE: COP) has a higher dividend than any of the other companies with a yield of 5.23%, but something like the Gulf spill does not just go away in a few years. The costs of that disaster will weigh on the company for a while. The gross profit margin for the company is 17.15%, which is lower than its peers, but at least it is profitable. I would keep an eye on BP for an upward trend, but I do not like the risks right now.

Conlcusion

Chevron is better in the long-term, though it has its share of legal problems. Those problems are not as extreme as BP, and Chevron has lower debt. Lower debt is always a good thing. ConocoPhillips is another good investment with a great dividend and strong expansion plans. Both those companies deserve consideration. ConocoPhillips also produces natural gas, which is a nice way to add a bit more natural gas exposure while focusing on oil.


TheArchivist has no positions in the stocks mentioned above. The Motley Fool owns shares of ExxonMobil. Motley Fool newsletter services recommend 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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