Global oil markets got the jitters over the past few days following coordinated attacks on critical Saudi Arabian oil infrastructure. As a result, production capacity in these oil fields were initially down by 50%, representing about 5% of the world’s oil supply.
The day before the weekend attacks, on September 13, benchmark Brent crude closed at about $60. By Monday, September 16, the price went over $69. As markets prepare to open in New York this morning, that’s pared back to just below $65.
It may take several days or even weeks for the markets to figure out the extent of the damage of these attacks which may potentially lead to further volatility in the price of oil. There might even be a risk of political or military escalation in the Middle East.
Therefore, I see value in holding an oil company in a long-term portfolio. My choice for both capital gains and passive dividend income would be Exxon Mobil (NYSE:XOM), one of the largest oil and gas producers in the world. Here is why.
Effect of Rising Oil Prices on Stocks
The short-term fortunes of holders of XOM stock as well as other oil stocks have always been closely linked to the price of oil. In short, higher oil prices help increase revenue, cash flows, and profits, fueling the stock price.
Unsurprisingly, the news of drone attacks on the Saudi oil-processing facility sent oil and energy-related stocks flying on Monday. In addition to XOM stock, shares of BP (NYSE:BP), Chevron (NYSE:CVX), Halliburton (NYSE:HAL), Marathon Oil (NYSE:MRO), Royal Dutch Shell (NYSE:RDS.A, RDS.B), Schlumberger (NYSE:SLB), Suncor (NYSE:SU) were several of the standout winners at the start of the week.
And while those gained on the oil price surge, others felt the brunt of the potential production loss.
For example, if you held shares in airlines, where the largest variable expenses are fuel costs, you would have see that the carriers ended ended Monday down. Shares of American Airlines (NYSE:AAL), (NASDAQ:JBLU), Southwest Airlines (NYSE:LUV), and United Airlines (NYSE:UAL) were under stress throughout the day. AAL stock was one of the biggest losers, falling 7.3% on high volume.
Oil is a commodity whose price can fluctuate widely within a short period of time. Higher oil prices tend to have an inflationary effect over the long term. All of us have expenses tied to the price of oil.
Going into the last quarter of the year, if higher oil prices were to become a long-term phenomenon, the average consumer would have less disposable income available for non-essential goods and services such as entertainment, luxury goods, or non-essential travel. Such a change in consumption levels would of course hurt company revenues. Therefore, rising oil prices may also adversely impact the price of other shares, like consumer cyclical stocks.
How Exxon Mobil Stock Makes Money
With a market cap of $310 billion, Exxon Mobil is one of the largest publicly traded integrated energy companies. The group has diversified businesses that include oil drilling as well as refining and chemicals.
Four main divisions contribute to XOM stock’s revenue:
- Natural Gas and Power Marketing.
Upstream activities include oil and natural gas exploration, field development, and production, while Downstream manages Exxon Mobil’s manufacturing, distribution and marketing activities for oil products and chemicals.
In other words, the downstream production process involves processing the materials collected during the upstream stage into a finished product. As the largest refiner in the world, the majority of the group’s refining capacity is integrated with Exxon Mobil’s lubricants and chemical businesses.
With a large portfolio of commodity and specialty businesses, ExxonMobil Chemical is one of the largest chemical manufacturing companies in the world.
Finally, Exxon Mobil is trying to use its expertise in the three segments to capitalize on expanding its share in natural gas and power markets.
Exxon Mobil Stock Earnings Have Been Improving
Exxon Mobil is a cyclical stock with earnings that are highly dependent on the price of oil.
There are several main factors that drive the price of oil: demand, current supply (i.e., output), and access to future supply, which is dependent on oil reserves. As we have witnessed over the weekend, geopolitical developments that may affect output levels can push the price up fast.
Because of the interplay of these factors, quarterly results as well as investment returns in the sector tend to be non-linear. XOM stock is no exception. In general, the higher energy prices increase, the larger the earnings and free cash flow impact for the shares.
Right after the bear market of 2008/2009, Exxon Mobil management played defense for several years. And earnings went nowhere for a while. However, for the past three years, XOM stock’s revenue and earnings have been on the rise.
On Aug. 2, Exxon Mobil reported better-than-expected Q2 earnings numbers. Upstream business was robust, offsetting weakness in the downstream and chemical divisions.
In Q2, earnings from XOM stock’s upstream business increased 7% YoY to reach $3.3 billion. The segment got a boost from higher average oil prices in the quarter.
CEO Darren Wood earlier in the year had already highlighted challenging downstream and chemical margin environments as exploration costs and heavy maintenance expenditure brought headwinds.
Since 2018 Exxon has been implementing a growth plan, especially in U.S. oil production. As part of this growth plan, Exxon Mobil management aims to double operating cash flow and earnings by 2025. In Q3 results which are expected in early November, analysts will want to see positive updates on the company’s strategic plans.
Reinvesting XOM Stock’s Dividend Yield
Income investors know that they can compound their returns by reinvesting dividends from high-yielding shares. Therefore shares like Exxon Mobil usually belong in a capital-growth long-term portfolio.
Analysts believe that XOM stock will continue its position as a reliable high-dividend staple as it is likely to generate enough free cash flow in the coming quarters to support its dividend yield.
Moreover, the Texas-based firm has a healthy balance sheet with long-term debt at about 10% of its capital structure. Even if oil prices fall or demand stays modest, Exxon Mobil can continue to pay its highly coveted dividend.
Should You Buy Into XOM Stock Now?
Year-to-date, XOM stock is about 7% and currently hovers around $72. Exxon Mobil stock trades at about 17.6x trailing earnings, making it reasonably priced for new investors who may think of hitting the buy button.
As the U.S. and Iran exchange words of war, oil prices have once again become volatile in the last quarter of the year. Yet with its diversified businesses and financial resilience, Exxon Mobil’s fundamental story remains intact.
However, there will likely be increased stock price volatility in the near-term that current and potential XOM stock investors should anticipate. Long-term investors who would also be interested in the passive income that XOM stock’s dividends offer may see any decline in share price as opportunity get long Exxon stock.
As of this writing, Tezcan Gecgil holds covered calls in BP (September 20 expiry).