Exxon Mobil Stock: Inflation And Biden’s Petroleum Reserve Release (NYSE:XOM)

Group of barrels of oil with graphs of the stock market as a concept of raw material. Financial world crisis concept. 3D Render

Iván Jesús Cruz Civieta/iStock via Getty Images

The investment thesis

Inflation surged to 8.5% in March 2022, the fastest 12-month pace since 1981. A main contributor to the surge was oil and gasoline prices. On the other hand, treasury rates stand below 3%. Against this backdrop, our thesis is that Exxon Mobil (NYSE:XOM) is an excellent candidate to help you survive and thrive in this high inflation and low-interest rates environment. In particular:

  • We see Russia’s invasion of Ukraine only as a trigger for the recent sharp surges in oil and gasoline prices. We think the underlying reasons are more structural and long-term – they are due to the underinvestment in oil production and supply shortages accumulated over years.
  • At the same time, we see both gasoline and oil prices overdue for a catch-up. Oil prices have been rising faster (about 5.9% CAGR) than inflation (about 3.9%) over the past 50 years or so. Yet despite recent surges, both crude oil and gasoline price today are still where they were about 10 years ago.
  • XOM earnings and stock prices both correlate strongly with gasoline prices and oil prices. As such, even our conservative projection shows a double-digit return, which handily beats even the worst inflation projections. Further, a large part of the return (about 4%) is supported by XOM’s current dividends (BTW, XOM is also one of the 65 Dividend Aristocrats in 2022).

Long-term issues and short-term fixes

According to the latest fuel data from the American Automobile Association (“AAA”), the average gasoline price at gas stations in the US has risen to $4.2 per gallon as you can see from the following chart, the highest in the United States since about 2007. The gas price has already been on the rise before the Russian/Ukraine war broke out, and the war just exacerbated it. You can also see that XOM stock prices (its earnings too, just not shown in this plot) correlate strongly with gasoline prices

President Biden is working hard to curb the rise in oil prices, for both political and economic reasons to be elaborated on later. Early in the year, Biden was trying to keep crude oil at around $80 and gasoline at around $3.30. With the breakout of the Russian/Ukraine war, his choices narrowed. A significant amount of Russian oil is not making it to the global market, and he also banned the import of Russian oil into the U.S. Now with gas prices standing near $4.2, he had to make the decision to release the Strategic Petroleum Reserves (“SPR”) to fight the surging oil prices and inflation.

Current and historical prices Gasoline

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The SPR is a U.S. Government complex of four sites with deep underground storage caverns created in salt domes along the Texas and Louisiana Gulf Coasts. On Mar 31, 2022, the President announced the largest release of SPR in history (highlights are added by me):

The release will put one million additional barrels on the market per day on average – every day – for the next six months. The scale of this release is unprecedented: the world has never had a release of oil reserves at this 1 million per day rate for this length of time. This record release will provide a historic amount of supply to serve as bridge until the end of the year when domestic production ramps up.

To me, this is at best a short-term fix to a long-term issue (as already suggested by the highlighted wording of the statement itself). According to the Department of Energy inventory, the current SPR inventory is not that high to start with. It is only at 587 million barrels. To put things under perspective, releasing a million barrels a day for six months will reduce the SPR to be just above 400 million barrels, the lowest level since ~1983.

Then we will face the issue of replenishing the SPR and also very likely, the persistent high oil and gas prices too – as detailed next.

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Strategic Petroleum Reserves based on Wiki data

Oil prices on XOM’s earnings

As a leading global integrated oil company, XOM will undoubtedly play a central role in this episode. Its downstream segment constitutes about 78% of the overall business, with chemicals and upstream constituting the rest 22%. Its current production of oil at 2.3 million per day. As a result, as aforementioned, both its stock prices and profits correlate strongly with both gasoline and oil prices.

To estimate the impact of oil prices on its profits and prices:

  • We will assume it maintains its current production of oil at 2.3 million per day.
  • We will also assume oil prices stay well above the breakeven production price (which is around $35). Its operations in the Permian Basin feature the lowest production cost only around $15/barrel. XOM’s CEO Woods commented that the overall production cost is about $35 per barrel. In any case, as long as the oil prices stay well above the breakeven price, we only need to consider the differential change.

Looking forward:

  • As long as the oil price is above the breakeven point, every $1 increase in oil price would contribute $2.3M of additional income per day for XOM at its current production rate. And on an annual basis, this translates into about $0.84B of additional income or $0.2 per share.
  • As a result, when the oil prices increase by another $5 (i.e., to ~$105 per barrel), the increase alone would cause about $1 of a boost to its EPS, representing a 15% increase relative to its current EPS of $6.5 or about 3.0% per year when annualized for the next 5 years. If the oil prices increase by another $10 (i.e., to ~$110 per barrel), it would cause a ~6% EPS growth in the next 5 years.
  • We see the above analyses to be on the conservative side for at least two reasons. First, we ignored XOM’s other earnings drivers (e.g., chemical, natural gas, its renewable energy initiatives, et al). Second, we see both gasoline and oil prices overdue for a catch-up. Despite recent surges, crude oil price today is still where it was about 8 years ago. Oil price should be about $130 now if just to keep up with inflation over the past 8 years or so.

Oil price should be $130 now

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XOM’s valuation and double-digit return potential

Finally, XOM is undervalued as seen below. The stock is valued at about 7.7x cash flow, while its historical average had been about 10x. Assuming a reversion to the mean in the next 5 years or so, valuation expansion would contribute another 5.5% to the total return.

Combined with the earnings growth aforementioned, our conservative projection shows an upper-single-digit to double-digit return (between 8.5% to 11.5%), which handily beats even the worst inflation projections.

Furthermore, XOM pays a current dividend yield of around 4%. As a result, about 1/3 to ½ of the total return is supported by a current dividend, adding another layer of safety to fight inflation.

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Risks

  • The COVID pandemic. The pandemic is still not over yet and can trigger another wave of travel restrictions and contraction of fuel demand.
  • Another near-term risk involves domestic political uncertainties. Research from Bank of America shows that Biden’s approval ratings are being impacted by inflation: they are showing a divergent trend as seen. Such political uncertainties can lead to legislation that could negatively impact XOM. A recent example involves the Windfall Tax proposed by Congress on big oil companies such as XOM.
  • In the longer term, our world needs to, and is, moving away from fossil fuels. It is uncertain how effective XOM can adapt in the meantime.

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Bank of America

Conclusion and final thought

Investment in XOM here not only provides good odds for a sizable return but also serves as a hedge against inflation. In particular:

  • President Biden’s ability to influence oil prices using SPR is at best temporary. The shortages are caused by more structural reasons and will persist longer. The release will reduce the SPR to be just above 400 million barrels, the lowest level since ~1983. And then we will face the issue of replenishing the SPR.
  • Oil and gas prices are overdue for a catch-up and inflation adjustment.
  • Lastly, XOM’s valuation is also compressed. Combining earnings growth and valuation reversion, even a conservative projection supports a double-digit return to handily beat inflation. About 1/3 to ½ of the return will be supported by the current dividends, adding another layer of safety.

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