$XOP: Contrarian Outlook

The past 10 years have not been kind to the majority of companies that make up the S&P Oil & Gas Exploration & Production ETF ($XOP). Neither has the past 5, 3, or 1 year periods. And these companies include such burnished yet now bygone stalwarts such as Exxon, Marathon, Valero, and Phillips 66. What once were massive blue chip companies that were drivers of the S&P 500 are now turning into a footnote of capitalism. Because currently, as the price of oil goes, so does the fortunes of these companies.

But I wouldn’t be writing about this if a bunch of people hadn’t gotten super bullish and turned it into the best-performing sector of 2021. Because who doesn’t like to speculate in the short term?

The driver of the recent bullishness comes from the 50 percent recovery in the price of oil from the pandemic lows experienced back in April. The price recovery is due to a combination of production curbs agreed to by OPEC + Russia, a drawdown in inventories that had accumulated at the start of the pandemic, and some improvement on the demand side of the equation from an economy that is fighting its way back from the dumpster fire of 2020.

And since the oil trade hasn’t converted to pricing itself in bitcoin but still trades in dollars, there’s a lot of speculation that inflation is on the horizon, which will further boost commodity products.

But in the long term… we’re all dead

There are endless reasons why the majority of the companies that make up $XOP will not survive the next 3 decades. There will be a handful that make it, but at a much smaller size. Maybe I’m still somehow an optimist, but it appears we’ve reached a tipping point in what countries and companies are willing to do to reach carbon neutrality by 2050. While petroleum products go into a ton of things, slashing the demand from energy and transportation will massively change the calculus for the scale these companies can operate at. Ultimately, the world will end up buying all of the remaining oil it needs from Saudi Arabia, Iran, and Iraq as they are the lowest-cost producers by far.

New Oil & Gas Permit Moratorium

But 2050 is like 3 to 7 investing careers or blown up funds from now. The near-term contrarian call on this is the moratorium the Biden administration has put on new oil and gas permits for federal land. This ban would impact the production in the Gulf of Mexico first, which would force the oil majors to go elsewhere to maintain volume. And most other places they have leases or permits for represent higher production costs, which would ultimately squeeze margins and profitability.

While the current higher oil prices will help offset the decline in production, I don’t see the higher oil prices being sustainable. As we’ve seen so many times before, OPEC will ultimately open the taps back up to try to plug government devastated budgets, this time caused by the pandemic.

“I’m a tech company! Watch me pivot!”

Given the long-term need to decarbonize the world these companies are ultimately going to have to pivot to a new source of revenue. Some companies are already diversifying into renewable energy. Some are trying to push carbon capture (although ironically using the captured CO2 to revive depleted oil fields). Hopefully at least one of them will figure out a way to translate their drilling expertise into delivering geothermal-anywhere energy plants.

Given the energy needs of modern society, maybe the sector can sustain itself. And maybe in the short-term the sector is able to ride higher on the back of higher oil prices.

But on this one, don’t buy and hold for the long-term.

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