Energy

The Smartest Way to Play the Energy Collapse Is Mega-Cap Integrated Stocks

Lee Jackson

Published: March 26, 2020 6:54 am

Last Updated: March 26, 2020 7:06 am

The biggest story during the collapse on Wall Street was, of course, the COVID-19 pandemic, which has swept across the world with lightning speed. Running neck and neck was black swan number two, the battle that erupted between Russia and Saudi Arabia over oil production. That had cut the benchmark pricing for West Texas Intermediate and Brent crudes by a stunning 65% as of Wednesday.

Saudi Arabia possesses around 18% of the world’s proven petroleum reserves and ranks as the largest exporter of petroleum. The oil and gas industries account for about 50% of gross domestic product and about 70% of export earnings. Clearly Brent under $30 a barrel is not what the leaders want long term. So, a prolonged fight seems very unlikely.

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With prices likely to lift, perhaps in the near term, savvy investors know that there is value in the sector. The big question is where. The answer is simple: stay with the industry giants. We screened the Merrill Lynch energy research universe and three of the biggest players in the world are all rated Buy, and with good reason. The Merrill Lynch team said this in a recent report:

Energy isn’t just facing recessionary demand; it’s facing a supply crisis engineered by Saudi’s decision to maximize output in a direct replay of the 1998 playbook. Spot prices already breach cash costs for many US & International producers and below incremental shale economics. Playing this out, E&P business models are broken in isolation & ripe for consolidation as a necessary outcome is that industry needs to lower costs. Playing this out markets will eventually rebalance; but we are increasingly aware that with so much damage being inflicted on the industry, the ‘next’ Black Swan may well be the risk of a deal that puts production cuts back on the table from Russia, OPEC and possibly the US.

The mega-cap behemoths have the diversification in products, and the ability to slash capital expenditures to fight the incredible drop in pricing. They are really the only way to play the collapse in the sector now as many of the smaller companies, especially those in the shale plays, could be in big trouble.

Chevron

This integrated giant is a safer way for investors looking to stay or get long the energy sector, and it has big Permian Basin exposure. Chevron Corp. (NYSE: CVX) is a U.S.-based integrated oil and gas company, with worldwide operations in exploration and production, refining and marketing, transportation and petrochemicals. The company sports a sizable dividend and has a solid place in the sector when it comes to natural gas and liquefied natural gas.

Chevron, which is among the companies with the largest corporate debt, this week became the latest major oil company to slash spending after halting its $5 billion-a-year share buyback and halving spending in the Permian Basin, which means a large decrease in projected output from America’s biggest shale region.

The California-based oil giant said on Tuesday that it would lower projected 2020 capital spending by 20%, or $4 billion. The Permian will account for the largest single element of that reduction, translating into 125,000 fewer barrels of oil equivalent per day than previously forecast, a quantity equal to about 2.5% of the basin’s total current production.

Shareholders receive a hefty 7.27% dividend, which the analysts feel comfortable will remain at current levels. The Merrill Lynch price target for the shares is a surprising $70, while the consensus target across Wall Street is a much higher $100.14. The last Chevron stock trade was reported at $69.27 a share, up just over 4% on Wednesday.

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This is another safer long-term play for conservative investors, and the energy giant is trading at 17-year lows. Exxon Mobil Corp. (NYSE: XOM) is the world’s largest international integrated oil and gas company. It explores for and produces crude oil and natural gas in the United States, Canada, South America, Europe, Africa and elsewhere.

Exxon also manufactures and markets commodity petrochemicals, including olefins, aromatics, polyethylene and polypropylene plastics, and specialty products, and it transports and sells crude oil, natural gas and petroleum products.

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Exxon has announced spending cuts amid the coronavirus outbreak that caused a price slide significantly aggravated by Saudi Arabia’s decision to start raising oil production. Exxon’s budget for this year and every year until 2025 was set at between $30 billion and $35 billion. Many on Wall Street feel that could be cut 10% to 20% or more. Note that Exxon has one of the highest paid American CEOs.

The supermajor was one of the few international oil companies that had ramped up spending levels over the past two years, aiming to grow production and shareholder value.

The company offers investors a huge 9.68% dividend, which probably will be defended as well. Merrill Lynch has a $59 price objective, which is above the consensus target of $52.50. Exxon Mobil stock rose over 5% on Wednesday and closed at $37.29 per share.

Royal Dutch Shell

This top international energy play for investors has been eviscerated in the energy sector sell-off. Royal Dutch Shell PLC (NYSE: RDS-A) operates as an independent oil and gas company worldwide through its Upstream and Downstream segments. The company explores for and extracts crude oil, natural gas and natural gas liquids.

Shell also converts natural gas to liquids to provide fuels and other products; markets and trades crude oil and natural gas; transports oil; liquefies and transports gas; extracts bitumen from mined oil sands and converts it to synthetic crude oil; and generates electricity from wind energy.

In addition, the company engages in the conversion of crude oil into a range of refined products, including gasoline, diesel, heating oil, aviation fuel, marine fuel, liquefied natural gas for transport, lubricants, bitumen and sulphur; production and sale of petrochemicals for industrial customers; refining; trading and supply; pipelines and marketing; and alternative energy businesses.

Shell says it plans to slash $9 billion from its spending to weather the collapse in oil market prices. The company has set plans to reduce its operating costs by between $3 billion and $4 billion this year, while cutting its planned capital expenditure by $5 billion to $20 billion for the year. Share buybacks have also been suspended.

Investors receive a huge 9.84% dividend. The $54 Merrill Lynch price objective compares with a $53.13 consensus figure. Royal Dutch Shell stock closed Wednesday at $34.34, after a jump of almost 7% on the day.

These three mega-cap companies are trading at super-low prices and, most importantly, offering investors perhaps the safest avenues for what many consider to still be a very contrarian bet. The large dividends that each pays appear to be safe and will help investors if the sector stays flat over the next year or so. One thing is for sure. These premium companies are trading at some of the best entry prices in 15 to 20 years and could offer big-time upside later in 2020 if crude prices lift.