By Jack Hough
My proprietary oil model predicts less price volatility ahead. OK, there’s no model, but a chart of spot Texas crude still makes me shake my J.R. Ewing Stetson in disbelief at how nuts energy trading got over the past five years. OK, there’s no Stetson, either.
Early in the pandemic, near the expiration for May 2020 futures contracts, oil briefly sold for negative $37 per barrel, because highways were empty, storage tanks were stuffed, and there was nowhere to receive the stuff. In summer 2022, with demand restored, and Russia well into its Ukraine invasion, prices topped $120.
More recently, Texas crude sold for $77, down from $90 at the end of September, but up from $72 since the start of this year. The futures curve implies that prices will fall from the high to low $70s from now through 2027. Jason Gabelman, an oil stock analyst at TD Cowen, is more cautious, assuming high $70s for now but $65, on average, in 2026 and 2027. But this past week he upgraded Exxon Mobil to Outperform from Market Perform, predicting a healthy stock gain to go with its 3.7% dividend yield.
Even if oil fell to $65 a barrel, oil companies could still profit nicely — U.S. ones have brought down the break-even price needed to cover their dividends by some $20 a barrel since the early days of the shale drilling revolution more than 15 years ago, says Gabelman. He likes Exxon now precisely because it has done more than rivals to unlock cash flow and improve its financial resilience. Also, the shares, down 13% over the past year, versus a 20% gain for the S&P 500 index, look affordable. More on that case in a moment.
I reached out to Alexandre Ramos-Peon, vice president of shale research at Norway-based Rystad Energy, for his thoughts on oil’s trajectory. Rystad sells data and analysis on worldwide production to drillers, their suppliers, government, and banks. The oil market is likely to be oversupplied in the years ahead, with prices gently declining, but not plunging, he says.
Big drillers are focused on long-term inventory management and cash-flow preservation. “Nobody wants to go back to a model where you win market share just for the sake of growth,” says Ramos-Peon. But wildcatters, or drillers with only a handful of rigs, often backed by private equity, have a different plan. “They want to prove to the investors that they’re sitting on good acreage, that they can grow production fast,” he says. “They will be sold sooner or later.”
Long term, there are other factors that bode well for restraint. Only a handful of places in the world can ramp up meaningful production quickly, including the Middle East, the U.S., Brazil, and Guyana. Costs are up. “You can’t just go drill anywhere around Oklahoma and expect to make a profit because it’s going to cost you 40% more to drill the well today than it did a couple of years ago,” says Ramos-Peon.
Then, factor in continued demand growth and well depletions, plus major oil companies, which tend to score best on environmental metrics, guarding their image. New oil wells often produce natural gas as a byproduct that can’t easily be transported for sale. Releasing it into the air takes a heavy environmental toll. Flaring, or burning it, is better but not ideal, and it’s tracked by satellite images. Oil majors “flare zero mostly, which means that even if they wanted to grow production, it would be very hard to do that without increasing these emissions,” says Ramos-Peon. All of this points to sustained prosperity for the oil industry, even if prices dip.
Back to Exxon. It’s in the middle of a push to unlock more than $25 billion in yearly cash flow by 2027 from a variety of sources. Start with drilling, or what the industry calls upstream operations. Darren Woods, the company’s chief executive since 2017, laid out a countercyclical growth strategy that involves developing low-cost oil sources that can earn nicely in a variety of markets. Chief among these is a massive project in Guyana that, after long delays, is steadily ramping up. It alone could generate $4 billion in yearly cash flow by 2027.
Downstream operations, where oil is refined into fuel and chemicals like plastics, are getting an overhaul, too. By increasing the sophistication of its refineries, Exxon can make use of lower-quality, and thus cheaper, crude. And by co-locating fuel plants with plastics production, it can shift focus between the two according to market demand, while bringing down feedstock costs.
Add to this mix cost-cutting and, I suppose, some clean-energy efforts. Exxon is capturing carbon and, with it, government incentives. It’s also exploring for lithium and building biofuel production. None of these will mint money like oil anytime soon, but Exxon at least looks likely to generate a trickle of cash, not blow gobs of it, from its green-energy efforts.
TD Cowen’s Gabelman is skeptical that Exxon will reach its $25 billion-plus goal. He says $19 billion looks more likely, but that is plenty. The oil price needed to cover Exxon’s dividend payment is likely to fall from $45 now to $40 by 2025, says Gabelman. Peers are at $50. Exxon says it can eventually get to $35. This is less about whether payments are safe than whether oil companies can continue to afford their other shareholder goodies, says Gabelman. Exxon wants to spend more a year on stock buybacks than it does on dividends. Its ballooning cash flow plus $28 billion in estimated balance sheet capacity will help.
Chevron has suffered delays with some marquee production assets. Assuming oil prices dip by 2026, stock buybacks could, too, says Gabelman. This past week, he downgraded Chevron to Market Perform from Outperform. Long term, he says, the company should prosper as delays give way to higher cash flows.
Exxon, notes Gabelman, was recently trading at a free cash yield of 8%, based on his estimates. Leading up the pandemic, a yield of 6% or lower was more typical. Accordingly, he expects shares to trade up to $115 from a recent $102.
Write to Jack Hough at jack.hough@barrons.com