With the price of crude recently at $49.17 Tuesday, investors -- especially those who are long on several large energy plays including Chevron (CVX) - Get Chevron Corporation Report , ConocoPhillips (COP) - Get ConocoPhillips Report and Royal Dutch Shell (RDS.A) -- are asking, "What's the new normal?"
With oversupply still hurting oil prices, is the "new normal" for demand enough to warrant you investing in energy companies, and at what point does production begin to play a role on how profitable the large oil majors can remain?
Can Chevron, ConocoPhillips, Royal Dutch Shell survive in the "new normal?" These companies were once seen as less vulnerable to weak oil prices. No one is thinking that anymore, and growth investors have to wonder what's going on here.
Take a look at the chart.
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As of Tuesday, Chevron was down 5%, Conoco was off 6.8% and Shell was lower by 5.5% in value.
Despite the current oversupply, the Organization of the Petroleum Exporting Countries won't cut back on output, saying the "market will fix itself." Industry experts aren't ready to predict when or where the price of oil will bottom, suggesting things can still get worse before it gets better. So the oil majors will be forced to adjust their projections and rethink their production projects.
Doug Leggate, analyst at Bank of America, recently downgraded Chevron shares to underperform, saying the company's growth projection assumes oil prices at $110. With the price of Brent crude now at $49.17, Chevron will have to find a way make up the 55% difference. Not to mention, its net debt position of roughly $2 billion, which is being used to fund various production growth projects like the Australian Gorgon, Wheatstone and various shale plays.
Investors once bet on Chevron's ability to produce more oil. Chevron previously projected it would achieve 20% higher growth in production in the next three years, climbing to over 3 million barrels per day, up for 2.55 million. Today, higher production is the worst thing to bet on. Analysts don't believe Chevon can make money at these prices.
Conoco, world's the largest independent oil and gas company, is in the same boat. While the company has taken steps to trim its exploration and production budget for next year, its net debt position of around $15 billion puts in a worst financial shape than Chevron.
In an October interview with Reuters Jeff Sheets, Conoco's CFO said, "We have the flexibility in our capital program to reduce it [spending] without giving up any opportunities." In addition the company has "room to slow spending" on exploration projects such as Western Canada, Permian Basin and the Niobrara in Colorado.
Following the company's third-quarter report in October, CEO Ryan Lance said Conoco will make investments at its current level in Eagle Ford and Bakken. But like Chevron, Conoco's focus has to be on the current prices of oil and how much sense it makes to spend any money at all until prices stabilize. The company disagrees.
Monday, Conoco announced its first oil production from the Eldfisk II project in the Norwegian North Sea. Matt Fox, Conoco's executive vice president of Exploration and Production said, "These projects will increase ultimate resource recovery and extend the field life of this premier legacy asset for years to come."
That may very well happen. But until oil prices creep higher, Conoco won't know the real value of this investment.
With a net debt position of more than $23 billion as of the most recent quarter Royal Dutch Shell stands out among the three. Last year, the company projected it would increase spending by 50% on various production projects. At the time this was 13% higher than its initial guidance.
Today, Royal Dutch Shell is "on the hook for risky, high-cost projects that don't make sense," says Citigroup analyst Alastair Syme. Syme listed Royal Dutch Shell as one of several producers in danger of an impending writedown that could wipe out as much as $1.6 trillion in earnings for many oil producers. And the bloodbath is likely to start this month. Royal Dutch Shell reports fourth quarter and full-year earnings on Jan. 29.
All told, the production growth investors are paying for today may not matter in the future for these large oil majors. With the industry already suffering from oversupply, any increase in production won't help their interests, and spending too much for it makes things worse.
TheStreet Ratings team rates CONOCOPHILLIPS as a Buy with a ratings score of B+. TheStreet Ratings Team has this to say about their recommendation:
"We rate CONOCOPHILLIPS (COP) a BUY. This is driven by a number of strengths, which we believe should have a greater impact than any weaknesses, and should give investors a better performance opportunity than most stocks we cover. The company's strengths can be seen in multiple areas, such as its increase in net income, reasonable valuation levels, expanding profit margins, good cash flow from operations and largely solid financial position with reasonable debt levels by most measures. We feel these strengths outweigh the fact that the company has had somewhat disappointing return on equity."
You can view the full analysis from the report here: COP Ratings Report
This article is commentary by an independent contributor. At the time of publication, the author held no positions in the stocks mentioned.