Oil's Big Players Have an Edge

Dow Jones Newswires

NEW YORK (WALL STREET JOURNAL via Dow Jones Newswires), October 28, 2008

If oil-industry executives were stars on reality TV, right now they would be making the jump from "Joe Millionaire" to "Survivor."

The price of Nymex crude oil has fallen from a high of $145 a barrel in July to below $64 today. From the perspective of oil producers, however, the drop is far worse.

Paul Sankey, an analyst at Deutsche Bank, reckons that some smaller, mature onshore U.S. fields need a price of about $80 a barrel to meet their running costs. In effect, they have seen their profit drop from $65 a barrel at the market's peak to less than zero.

Such oil producers are small in the grand scheme of things. But every producer has to cope with the fallout of the rapid collapse in crude-oil prices, twinned with the crunch in financial markets. As a result, investors need to focus less on growth and more on survival prospects.

"Until two months ago, money wasn't a differentiator in this business," says Robin West, chairman of PFC Energy, a consultancy. "Now it is."

The relative performances of Chesapeake Energy and Exxon Mobil this year illustrate the point perfectly. Until early July, Chesapeake was on a tear, with its stock up almost 80%. Exxon's had fallen 7%.

Chesapeake, however, was dependent on liquid capital markets and strong energy prices to make its bet work on unconventional gas resources. Since then, its stock has dropped 63%, the company has slashed spending plans and it now looks vulnerable to a takeover.

Exxon, in contrast, is only down 24% from that point. It benefits from net cash of $30 billion, twinned with a rare triple-A credit rating.

In addition, lower oil prices hurt Exxon less than they do the small-capitalization names that have outperformed in the past few years. Exxon's portfolio is more diversified and lower cost. Crucially, investors never gave it the full benefit of the doubt on commodity prices anyway.

On the plus side, falling energy prices ought to take the heat out of industry cost inflation.

If sustained, the slide might also help roll back some of the resource nationalism that has blocked off access to new reserves.

Well-capitalized companies also can take advantage of the current market panic to snap up assets and companies trading at fire-sale prices, another route to increase production and reserves.

Panic also has left the majors looking relatively cheap. Using Mr. Sankey's "low case" estimates -- average oil price falls to $50 and the weighted average cost of capital rises to 15% -- Exxon is trading at 10.6 times 2010 earnings per share.

Longer-term, the oil industry still faces big strategic problems, not least in terms of public relations. But it isn't likely to disappear anytime soon.  

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