Chip Cummins thinks Exxon’s shareholders face the risk of low profits:
U.S.-benchmark oil hit a record of nearly $80 a barrel this summer. (In inflation-adjusted terms, oil was at its most expensive in 1980.) Since July, though, crude prices have fallen about 25%, sapping the momentum from short-term profit-growth potential at a time of rising costs and higher taxes. And if oil prices continue to drop, that could drive new thinking among oil executives over whether to pursue big tie-ups. BP, which reports earnings Tuesday, estimates West Texas crude, a benchmark oil type in the U.S., averaged about $70 a barrel for the quarter. That is still higher than the average price a year ago of about $63. But current prices are now hovering around $58 … U.S. natural-gas prices and gross profit margins from making refined products such as gasoline are also sharply lower than a year ago. Even before the steep drop-off in prices, earnings had been blunted by side effects of the commodities boom. Oil-field costs have skyrocketed for many projects because of higher demand for everything from steel to software among energy companies eager to cash in on the boom. Competition for new prospects has heated up, ratcheting up auction prices for fresh exploration acreage. If oil prices stabilize or drop further, cost inflation could also subside. But costs generally take time to catch up with swings in commodity prices. That poses a growing challenge to profitability in the short term.
Brad Setser shakes his head in disbelief:
If you invested in a lot of oil fields that were expected to be profitable if oil averaged $20 a barrel, you will certainly make more money if oil is at $80 – or even $70 – than if oil is at $60. But I am pretty sure that you will be making money even if oil is hovering around $60 a barrel. Equity markets are not my thing. But given the change in the trajectory of oil prices, I cannot imagine that anyone holding an oil companies’ stock would expect oil companies to be able to sustain the kind of revenue growth they enjoyed when oil was steadily climbing up now that oil is falling. So, unlike Cummins, I would hardly define a slowdown in oil profits as a “big problem”
Let’s take a peek at some of Exxon’s financial information. During fiscal year ended December 31, 2005, its revenues were $370.68 billion and its operating profits were $60.27 billion. Its reported return on assets exceeded 20% and its reported return on equity was around 35%. Yahoo/Finance is also suggesting that its CAPM beta was only 1.03, which suggests a rather modest cost of capital relative to its actual return on equity. Maybe this is why the market price of Exxon stock exceeds $70 a share for a Price/Book ratio near 3.7.