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Big Energy Starting to Feel the Burn

Low energy prices taking their toll — and Q3 could be the same

As we’ve said before, the integrated oil majors truly are in a league of their own. Responsible for the bulk of the world’s energy production, the group includes some of the largest and most profitable corporations on the planet. Their huge scale provides cost savings and other advantages many smaller firms could only dream of.

So when it comes to figuring out just how the energy sector as a whole is doing, it is important to focus on the group. With the last earnings reports for the quarter now trickling out, we can figure out what took hold last quarter and — more importantly — see where we are headed for Q3.

Lower Oil Prices

If there’s one thing that could sum up the second quarter in the energy sector, it would be lower prices for hydrocarbons. Across the board, the majors felt the one-two punch of falling average oil and natural gas prices throughout the quarter.

Prices for the international benchmark Brent crude declined by more than 7% during the quarter — in stark contrast to the same period last year, when turmoil in North Africa and the Middle East caused a huge spike in oil prices. Analysts peg the average lower Brent prices to dwindling economic activity in Europe and in key emerging markets, like China and India.

At the same time, the hydraulic fracking and shale revolution is continuing to wreck havoc on natural gas prices. We’ve explored how this abundance of gas could be leading America toward a more energy independent future. However, from an E&P point of view, those lower natural gas prices hurt their bottom lines. Overall, natural gas prices in the United States during the last year have plummeted by more than 50%. That has affected a wide range of the majors as shale gas has become a source of production for the firms.

Exxon Mobil (NYSE:XOM) — whose forward-thinking purchase of XTO Energy in 2010 made it one of the largest natural gas producers in the nation — recently highlighted its struggle with lower prices. Exxon CEO Rex Tillerson remarked that the firm was “making no money” on its natural gas assets, and the giant’s earnings reflect that. Earnings from U.S. oil and gas production tumbled by more than half during the quarter to just $678 million.

While not as dependent on natural gas as Exxon, both Chevron (NYSE:CVX) and Royal Dutch Shell (NYSE:RDS.A, RDS.B) also saw lowered profit due to falling energy prices and lowered production. Profit for the two firms fell, 7% and 13%, respectively.

But perhaps the worst victim of lower energy prices was ConocoPhillips (NYSE:COP). The firm — which just completed its spin-off of its refining assets as Phillips 66 (NYSE:PSX) — saw profit decline more than 32% because of lower energy prices.

Downstream a Bright Spot?

However, it isn’t all bad news for majors. Those lower prices for hydrocarbons are benefiting one sector of their businesses — downstream refining. After years of struggling, refining is finally catching a break. Cheaper oil and natural gas has helped the sector by lowering overall input costs.

Additionally, Gulf Coast refinery margins have also been lifted by rising U.S. gasoline exports. According to the Energy Information Administration, exports have run at a rate of 56,000 bpd this year — more than double the five-year average. Analysts at Edward Jones estimate that downstream was the primary cushion in Chevron’s report.

It now looks like Conoco perhaps should have hung unto Phillips 66. The newly independent refiner reported a 14% jump to profits during the second quarter as refining margins surged 53%. The company’s report highlights just how much refineries and chemical businesses benefited from the lower-priced feedstocks in the second quarter.

Then There’s BP

Beleaguered British Petroleum (NYSE:BP) can’t seem to catch a break.

The firm’s quarterly earnings fell 35% on weaker energy prices and falling production. That fall in production stems from the company’s “planned maintenance program” it launched in the wake of the Deepwater Horizon disaster in the Gulf of Mexico. An additional drag on the firm’s profits was TNK-BP. Net income for the joint venture was $700 million lower than a year ago. BP said this was because of the lag in Russian oil export duty, which was based on earlier higher oil prices.

BP announced back in June that it would pursue a sale of its 50% stake in the joint venture as corporate battles with the group of billionaire oligarchs has intensified. However, that sale could prove costly to BP’s future profits and earnings.

The Look Ahead

The main takeaway for investors is that falling energy prices are starting to have their way with the larger firms. That could spell trouble for those smaller E&P firms that do not have the same kind of cost efficiencies as the majors. Any continued trouble from Europe or slowing growth in emerging Asia could signal continued lower profits from the energy sector in Q3.

While there has been some bullish news with regards to natural gas pricing as of late, the overall tone of the third quarter should be muted. Investors should expect more of the same and use the time to double down on any long-term bargains that might arise during the next earnings season/quarter.

Focusing on exploration & production companies with strong cash flow and low relative debt remains the key to energy sector victory.

As of this writing, Aaron Levitt was long RDS.A and RDS.B.

Article printed from InvestorPlace Media,

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