ExxonMobil: End Of An Era Or End Of A Business?
“The stock of ExxonMobil was dropped from the DJIA last week. This move reduces the energy weighting in that index, bringing it more inline with the S&P 500. The move is not surprising given energy’s poor financial performance and the current investor love-affair with technology. The outlook is not as bad as the market says.”
August 31 was a noteworthy date for the global oil and gas industry. It was the day the stock of ExxonMobil Corporation was removed from the Dow Jones Industrial Index (DJIA) and replaced by the stock of Salesforce, Inc., a cloud-based enterprise software provider. The reason for the switch is related to the 4-for-1 stock split by Apple Inc. on August 28th, and the mechanical composition of the index. The DJIA is a price-weighted index, therefore, the drop in Apple’s share price from its August 27th price of $500.04 to $125.01 reduced the index’s technology sector weighting. According to Howard Silverblatt, senior index analyst at S&P Dow Jones Indices, “Basically Apple — by itself — took the technology [weighting] within the Dow down from 27.6% to 20.3%. It’s a significant decline,” he told CNBC. “By adding Salesforce, you can come back to 23.1% of the Dow being in technology.” The rationale for this switch is a telling omen for the energy industry.
The ExxonMobil stock swap was only one of three made to better reconfigure the venerable DJIA. It is a statement that the index needed to be changed to more closely reflect the relevance of various business sectors. Created in May 1896 by Charles Dow and his business associate Edward Jones, the DJIA was composed of 12 stocks representing mainly industrial companies associated with gas, sugar, tobacco, railroads and oil. Two years earlier, Mr. Dow developed his first stock index, the Dow Jones Transportation Average, which is acknowledged to be the best representation of the U.S. transportation sector.
Exhibit 10. DJIA changes Since 2015 And Energy SOURCE: PPHB
In Exhibit 10, we have listed the 30 stocks that compose the DJIA. We have highlighted those stocks added to the index since 2015. Chevron, which was added to the index in 2008, is now the only energy stock.
The DJIA was expanded in 1916 from 12 stocks to 20, and the number of stocks increased to 30 in 1928, the year that Standard Oil of New Jersey, one of the three oil companies that were the founding components of the Standard Oil Trust, organized in 1882, was added. The Standard Oil Trust included Standard Oil of New Jersey (Jersey Standard) and Standard Oil of New York (Socony), along with the foundational business, Standard Oil of Ohio, that had been formed by John D. Rockefeller and several associates in 1870. That company had been created by combining the facilities of the various participants to create the largest refining enterprise in the world for making kerosene. The name Standard was selected to signify the high, uniform quality of the product.
In 1911, in a landmark decision, the Supreme Court declared that the Standard Oil Trust needed to be broken up on antitrust grounds. The Trust was broken into 34 unrelated companies, including Jersey Standard, Socony and Vacuum Oil, a company purchased by the Trust earlier. That year also marked the first time that Jersey Standard's kerosene sales were surpassed by gasoline, a by-product previously discarded as a nuisance. That development is one of many cases throughout the history of the oil and gas business when a nuisance eventually transformed itself into a significant contributor to the industry’s future growth.
The history of Standard Oil of New Jersey shows the role the company, and the oil business, played in the growth of the American economy and improving living standards. The 1919 purchase of 50% of Humble Oil & Refining Company of Texas changed the future of oil exploration. Humble’s chief geologist, Wallace Pratt, was revolutionizing oil exploration with his use of micropaleontology, the study of microscopic fossils contained in cuttings and core samples from drilling, as an aid in finding oil resources.
In 1927, Humble geophysicists, capitalizing on micropaleontology, used a refraction seismograph to discover a large oil field in Sugar Land, Texas. One of the most significant exploration breakthroughs was the 1963 development of 3-D seismic technology that revolutionized how geoscientists could model the subsurface to find hydrocarbon resources that were not obvious from seeps or surface observations. Another significant E&P breakthrough was perfecting the drilling of long lateral horizontal wells. In 2007, Neftgas, an ExxonMobil subsidiary based in Russia, drilled the Z-11 well in the Sakhalin field, which was the longest measured extended reach well in the world. The well measured 37,016 feet, a seven-mile distance. Extended reach drilling helped open up the exploitation of shale resources in the United States and elsewhere.
On the product side of petroleum, Jersey Standard was the first company to produce isopropyl alcohol (rubbing alcohol). It is utilized in the manufacture of a wide variety of industrial and household chemicals and is a common ingredient in chemicals such as antiseptics, disinfectants, and detergents. Seventeen years later, the company produced artificial rubber (butyl). This proved very significant as a substitute for natural rubber that was dependent on imports from Southeast Asia and was limited during World War II. Today, the majority of the global supply of butyl rubber is produced by two companies, with ExxonMobil being one of them. Finally, in 2001, the company developed the SCANfining process, involving a new catalyst, that removed more than 95% of the sulfur from gasoline while minimizing octane loss. This was a major contributor to cleaner air.
As the popular warning in the financial industry goes: past performance is not a guarantee of future performance. Thus, everything ExxonMobil has contributed to the success of the global oil and gas industry and to vastly improved living standards means nothing in today’s stock market. People forget how significant was the oil and gas industry’s contribution to the economic recovery from the 2008-2009 financial crisis and recession. A study by economists at the Dallas Federal Reserve Bank showed that oil and gas was a meaningful force in that recovery. A summary paper stated:
“How did the shale boom affect the rest of the economy? Our model indicates that cheaper fuel prices allowed households to consume about 3.6 percent more fuel. Households also increased their consumption of other goods because the decline in fuel prices increased their disposable income, leading to a 0.7 percent increase in overall consumption.
“The decline in fuel prices increased firm fuel use in the energy sector and in non-oil sectors, according to the model. Our model shows that lower fuel prices led to higher output in non-oil sectors and higher U.S. aggregate investment. Altogether, these effects led to a GDP increase of 1 percent in 2015 relative to 2010.
“Given that the actual increase in U.S. GDP was 10 percent over the period, the shale boom accounted for one-tenth of the overall increase. Although the oil sector makes up less than 1.5 percent of the economy, our results suggest that the shale boom generated significant positive spillovers.”
The significance of the shale boom was summarized by the authors of the working paper. They highlighted how shale production has reduced the nation’s oil imports and export.
“In 2006, before the shale boom, the U.S imported about twice the oil it produced. That share has declined to two-thirds of domestic production. As a result, the U.S. petroleum trade balance narrowed from negative $492 billion in 2005 to negative $136 billion in 2018.
“U.S. exports of petroleum products have steadily risen, increasing fivefold to 5.0 mb/d since 2006. In recent years, the U.S. has also become a major exporter of crude oil, with exports rising from less than 0.5 mb/d in December 2015 to 3.0 mb/d in July 2019.”
The significance of the shale revolution is shown in its contribution to U.S. oil production from 2000 to 2019. From 2010, shale output exploded, while non-shale production declined. As Exhibit 12 shows, Gulf of Mexico production began increasing in 2013, and surpassed its prior high of 2016. That output increase was directly tied to the ending of the 2010 Gulf of Mexico moratorium on drilling and the natural lag time from the industry restarting activity until production began rising. We also see Alaska oil production in a steady decline throughout the entire period.
Exhibit 12. Shale Production Growth Dominates Oil Output SOURCE: Dallas Fed
Another contribution of the oil and gas industry was turning the United States into an oil exporter. While the Dallas Fed working paper pointed out shale’s impact on U.S. oil imports, the role of growing exports was only briefly touched on. The growth in U.S. exports disrupted the functioning of the global oil market and its control by OPEC, as well as its leader Saudi Arabia. U.S. exports helped drive down global oil prices, a decline amplified by the actions of Saudi Arabia and Russia in boosting their output and exports just at the moment Covid-19 was destroying oil demand. The growth of U.S. oil exports altered the geopolitical balance, boosting our influence, especially in the Middle East. Those changing dynamics likely contributed to the recent Israel-United Arab Emirates peace agreement, known as the Abraham Accord.
Exhibit 13. Shale Boom Boosted Oil Exports SOURCE: Dallas Fed
In the thinking of the stock market, none of the importance of the oil and gas industry’s economic or international geopolitical contributions matters. The disdain of investors for oil and gas stocks has been evident for years. We can see that in several charts. The first (Exhibit 14) shows, by color, which sectors of the Standard & Poor’s Index preformed, ranked from best to worst, from 2007 through the first half of 2020. What one sees is that of the 14 time periods, energy ranked in the bottom three sectors eight times, of which it was the worst performing sector five times. Looked at by performance versus that of the S&P Index, energy outperformed five times, with top performance in 2007 and 2016. Obviously, this record for the energy sector is not positive for attracting new investors, let alone retaining investors.
Exhibit 14. Energy Has A Dismal Investment Record SOURCE: S&P, PPHB
Another measure of energy investor abandonment of the sector is seen through the long-term record of sector weighting in the S&P 500 Index. The energy sector is now at an all-time low weighting at slightly under 2.5%. What Exhibit 15 shows is that from the all-time peak in 1980, with brief upticks in the interim, the weighting bottomed around 5% of the index in the early 2000s. At that time, the soaring oil price and the perception of global oil shortages signaled that energy’s fortunes were changing. That upturn lasted until the Great Recession, which seems to have marked the next shift in investor sentiment toward energy’s future that has led to the extremely low level of today.
Exhibit 15. Can Energy Recover Positive Investor Sentiment? SOURCE: S&P, PPHB
It is interesting to examine the relationship between the S&P 500 Index energy weighting and the real price of oil. Exhibit 16 shows how closely the energy weighting decline during 1980-2003 was a reflection of the trend in real oil prices. What is interesting is that for
Exhibit 16. Recent Oil Price Collapse Hurts Energy Weighting SOURCE: S&P, EIA, BLS, PPHB
much of the post-2007 period the relationship hasn’t existed. When oil prices soared from $40 to $100 per barrel between 2009 and 2014, the energy sector weighting declined, other than for a brief uptick in 2010. The rate of decline in the weighting appears to be steady from 2010 to late 2019, but the recent drop appears to reflect this spring’s oil price collapse.
The removal of ExxonMobil from the DJIA is a reflection of investor views of energy’s future, or at least that of traditional oil and gas. It is also a reflection of the current “love affair” of investors with technology stocks, and in particular a small number of prominent tech companies. Investors may be underestimating the resiliency of oil and gas, and its history should be a reminder. Moreover, stocks removed from the DJIA have often outperformed after the event. The following observation is intriguing:
"According to the WSJ Market Data Group, the average performance one year after being added to the Dow is minus 8%, while the return is almost flat — negative 0.6% — after ejection. The performance differential is especially notable more recently: The last five changes have seen a 3% rise for additions and a 43% rise for those stocks exiting."
Oil and gas will continue playing a significant role in meeting the world’s energy needs for decades. That fact is ignored by investors, but every realistic projection shows it to be the case. However, the industry is unpopular with many in today’s society, and especially a number of leading investment professionals. The media’s approach of conjuring up images of wildcatters and an industry that is arrogant, cares little about the environment and the little guy, and is only interested in profits, doesn’t help. People fail to understand the amount of technology imbedded in the oil and gas industry, and how it can be used to create a cleaner energy world and lift people from poverty. None of that helps energy’s image or share prices. The reality is the industry’s future is not as dire as portrayed in the stock market, but investing in energy stocks is swimming against the tide. There are scenarios where the industry recovers and the stocks do better, but at the moment those scenarios are given little chance of happening. Only optimists or real contrarians are interested in energy stocks at the moment, but stay tuned.