A record quarter for oil companies!

August 5 2022

Large oil firms are seen making record profits with crude oil prices skyrocketing over $100 per barrel this year. Increasing geopolitical uncertainty and a lack of supply in the market are boosting the rally in oil prices. Global Witness, Greenpeace USA, and Oil Change International predict a $37 billion to $126 billion windfall in 2022 for the oil and gas producers in the United States.

Exhibit 1: Crude Oil Price History (in USD)

Source: TradingEconomics, August 3, 2022

But if history is to be believed, crude oil prices have never sustained above $100 per barrel for a long time. Oil prices recently decreased due to a lower gasoline demand during the busiest summer driving season. More importantly, central banks have been hiking interest rates to combat inflation, which stoked concerns that the economy would stagnate and reduce demand for energy.

Geopolitical tensions add to the rally in fuel prices

In the wake of the ongoing geopolitical crisis in Europe, the U.S. President Joe Biden said the country would forbid the import of oil, refined petroleum products, natural gas, and coal from Russia in retaliation to Russia’s invasion of Ukraine in March 2022. Since then, the United States and the rest of the world are experiencing higher gas prices and steaming inflationary pressure as a result of these limits on Russian energy supplies. Energy price hikes have the same effect as a tax on consumers, which reduces demand for other products and services.

As Europe attempts to wean itself off Russian fuel, its reliance on Russian gas and oil poses a potential existential catastrophe. Nearly a sixth of the world’s oil and gas supply comes from Russia- the world’s second-largest natural gas exporter and the third-largest crude oil producer. Russia contributes more than 20% of the oil and more than 30% of the gas used in Europe, making its dominance very evident. A number of European nations, notably Austria, Finland, Poland, Slovakia, and Hungary, import 50% to 100% of their oil and gas from Russia.

Exhibit 2: World’s Dependency on Russia for Oil and Gas

Russia is a major supplier of Europe's oil and gas as shown by their share in the global oil and gas supply compared to Europe’s energy mix and the fossil fuel production and imports.

Source: Accenture, May 2022

Chevron and Exxon post record quarterly profits

Chevron (CVX) and Exxon Mobil (XOM), the top oil producers in the United States, reported record profits in the second quarter of 2022 as strong fuel prices boosted operations and the oil giants kept their spending in control. Chevron recorded earnings of $11.62 billion for the quarter ended June, up from $3.08 billion in the same period last year. On the other hand, Exxon reported second-quarter earnings of $17.9 billion, up from $4.7 billion in the same period last year. Chevron and Exxon both exceeded analysts’ expectations.

Exhibit 3: Key 2Q2022 Earnings Highlights

Source: Company Financials, CNBC, July 2022

Cash flowing in for the energy sector

Exxon Mobil announced that after paying for capital expenditures and shareholder distributions, its cash flow from operations was $20 billion during the second quarter, boosting its cash balance by $8 billion. The company had a $16.9 billion free cash flow in the same period. According to Bloomberg, Exxon Mobil is now the third free cash flow generator for the S&P 500 Index, behind only Apple Inc. (AAPL) and Microsoft Corp. (MSFT). For the first time since 2018, it outperformed Alphabet Inc. (GOOGL) in terms of cash flow. On the other hand, Chevron reported $13.3 billion in operating cash flow during the quarter. Chevron also advanced in the rankings with a free cash flow of $10.6 billion.

Exhibit 4: S&P 500 Companies with the Biggest Quarterly Free Cash Flows

Source: Bloomberg, July 2022

Oil companies announce bumper share buybacks

Oil companies are using the excess cash to satisfy investors looking for bigger returns. Earlier in the year, Exxon more than doubled its buyback program to $30 billion in 2022 and 2023. During the quarter, Exxon distributed $7.6 billion to its shareholders. Chasing the bandwagon, Chevron also increased the top end of its annual share repurchase range to $15 billion from $10 billion earlier. In June, Biden criticised the industry for using extra funds on share buybacks rather than sharply increasing capital spending.

Pressure from the White House

The record-breaking quarter of the oil giants has caught the attention of the White House. While taking a dig at Exxon Mobil and its record earnings, Biden said, “We’ll make sure that everyone is aware of Exxon’s earnings. Exxon made more money than God this year”, pressurising the company and its peers to ramp up the production and increase the supply to bring down the consumer price.

Meanwhile, the two companies haven’t used the mountains of money from higher prices to considerably increase capital spending that is still below the pre-pandemic levels. In their defence, oil and gas corporations claim they are increasing output on their end. The first quarter of 2023 will see the addition of 250,000 barrels per day of refining capacity at ExxonMobil’s Beaumont, Texas facility, which will be “the industry’s greatest” single capacity addition in the US since 2012. But the companies also blame macro challenges like a tight labour market for hampering production increase.

Exhibit 5: U.S. Crude Oil Production (in thousand barrels per day)

U.S. Oil Production Rises, Matching Pandemic High - Natural Gas Intelligence

Source: U.S. Energy Information Administration, July 2022

Energy sector performance in relation to crude oil price

Despite record numbers, the second-quarter earnings came amid recent weakness in oil markets. Fear of recession and what it would mean for the market of oil and petroleum products have affected the sector. In June 2022, the energy sector reached a multiyear high, but it has fallen 18% since then. The price of crude oil affects the movement of stock prices of oil and gas companies. Nevertheless, energy stocks are the top performing sector so far this year, jumping 35%, while the benchmark S&P 500 index declined 13% year-to-date. The rise in energy stocks coincides with an increase in the cost of crude oil as Europe looks to wean itself off of Russian fuel.

Exhibit 6: Comparison between Crude Oil and Stock Price YTD Performance

Source: Yahoo Finance, August 3, 2022

Exhibit 7: Chevron Stock Price Performance History

Source: MSN Money, Data as of last close on August 3, 2022

Exhibit 8: Analyst Ratings on Chevron Stock

Source: Benzinga.com, August 3, 2022

Exhibit 9: Exxon Mobil Stock Price Performance History

Source: MSN Money, Data as of last close on 3 August, 2022

Exhibit 10: Analyst Rating on Exxon Mobil stock

Source: Benzinga.com, August 3, 2022

Final thoughts

Timing crude oil prices is always tricky and investors should be wary of that before making any investment decisions. Even though the market between oil supply and demand is very tight right now, oil prices may come down in the long run. Investors may look at some of the profitable companies whose stocks are currently undervalued.

Exhibit 11: Key Valuation Metrics of Energy Stocks