Oil Shares' Valuations Under Pressure, But Dividends Safe

Though hard to stomach for existing shareholders, the pullback in oil companies' share prices continues to offer an opportunity to buy quality franchises at a discount

Allen Good 3 December, 2014 | 9:59AM

Oil production and exploration stocks are selling off in the aftermath of OPEC’s decision to maintain existing production quotas, dashing the market’s hope that OPEC would step in and remove excess crude oil supply from the market. By our estimates, oil markets are oversupplied by roughly 1 million barrels a day, which may increase into early 2015 absent a production response. We think that the market’s reaction is overdone, particularly if you consider that 1 million to 2 million barrels a day of excess supply is equivalent to 1.1% to 2.2% of daily consumption, and depletion alone removes roughly 4% of total production each year. Moreover, the supply surge from US shale oil has been well anticipated by markets, leaving us to wonder what has changed fundamentally in the market’s awareness that has dropped the energy sector as a whole by 20% since September 1st.

We suggest investors pay attention to oil demand, as any further weakness could spark another leg down in oil markets. That said, over the medium term we’d expect lower crude prices to stimulate demand, supporting our expectation of higher prices in the future.

While we plan to update our fair value estimates to reflect current crude oil strip prices, reductions should be modest for the oil majors. We think the market reaction among integrated firms has been overdone based on our long-term outlook. The integrated oils group is generally more insulated from oil price movements because of their large gas production and downstream operations, which can act as an earnings offset. Also, we do not think dividends from the higher-quality firms will come under threat thanks to relatively strong balance sheets and managements' aversion to cuts.

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Securities Mentioned in Article

Security NamePriceChange (%)Morningstar
BP PLC291.75 GBX-4.20
Exxon Mobil Corp54.37 USD-2.49

About Author

Allen Good  Allen Good is a senior stock analyst covering the oil and gas industries.

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