Thursday, July 31, 2008 0 comments ++[ CLICK TO COMMENT ]++

Oil Potentially Topping Out

Don't put much weight into my oil calls, but it does look like oil is topping out. I felt the same thing late in 2006 and that turned out to be temporary thing. Who knows for sure but I notice a few things.


First of all, price is off quite a bit...


Then ExxonMobil misses earnings for the second time in as many quarters. Missing earnings is not usually a big thing, except when it is a bellwether missing it during a huge bull market.

For the quarter, Exxon Mobil posted net earnings of $11.68 billion, or $2.22 a share, up from $10.26 billion, or $1.83 a share, a year earlier. The results narrowly eclipsed its previous record of $11.66 billion, set in the fourth quarter of 2007.

Despite the staggering numbers, Wall Street was underwhelmed. Investors polled by FactSet had been looking for a profit of $2.46 a share. It was the second consecutive quarter in which Exxon fell short of their lofty expectations. In a period during which crude-oil prices doubled, Exxon's profit was up a mere 14%.

One of my views has been that the bull market in oil, like other bull markets, will end as they always do. Namely, too much lofty expectations. Since oil&gas is a commodity business, its P/E ratio looks low but there is massive expectation built into these stocks (mostly resting on huge demand increase from China, India, et al.) Cisco became the largest internet networking company with billions in profits but the market expectations in late 90's was way too high.


The final signal is word that Marathon is trying to split its business:

Separately, the company said its board of directors is "evaluating the potential separation of Marathon into two strong, independent, publicly traded companies."

As for the separation plan under consideration by directors, one entity would encompass the company's E&P, integrated gas, and oil sands mining businesses, while the other would be made up of Marathon's refining, marketing and transportation business.

I'm generally not a fan of financial re-engineering just because things don't look rosy in the short term. It's obvious why they want to split. The refining business has been a total disaster of late--as Bill Miller alluded to, you would have lost more money investing in VLO or TSO over the last year as you would have on MER or C--and a split will get rid of the bleeding. Who wouldn't love to own an E&P that will be rolling in the cash from high oil prices? Indeed, who wouldn't? That is until oil prices drop and the E&P starts posting losses and ends up bankrupt. Isn't this like looking in the rear-view mirror? Isn't it obvious that integrateds dominate the world because they have economies of scale? What will happen if oil actually turns out to be cyclical and these companies face a downswing?

I find this splitting idea to be risky. There is even pressure to split ExxonMobil. I will bet that if they split, they will be far worse off in 10 years than an existing major integrated oil&gas company.

(On another note, it wasn't even an year ago when some were calling for free money to be handed out (i.e. subsidies) to refiners because there weren't any refineries built in America in a decade. Some even wanted to fast-track changes in law allowing refineries to be built almost everywhere. Well, not only do we not need any more refineries, the existing ones aren't even making much money. As far as I'm concerned, the only refineries that need to be built are ones that handle sour crude but no one wants to build those here.)


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