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Is It Time To Rotate Out Of Big Oil?

 May 07, 2012 10:07 AM

(By Kevin Donovan)  Oil prices took a tumble last week, and so did the shares of the super major exploration & production companies.  On Friday, Exxon Mobil (XOM) slid 1.26%; Chevron (CVX), 2.14% and Conoco-Philips (COP) 2.01%.

Is it time to rotate out of big oil?

The biggest reason to own these companies is the expectation that the price of the commodity they search for and produce will continue to rise.  However, we see several signs that point to a peak in oil prices, the least of them domestic, the biggest abroad.

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First, it's the economy.  The payroll data for April released Friday suggests decelerating growth in the U.S., but with still enough oomph to maintain escape velocity.  Europe is contracting and has political and debt issues that are retarding any rebound.  There, too, though, the French presidential election results signal a rejection of austerity as a viable road to recovery.  Chinese growth has slowed but the latest indication hint at stabilization.

Taken together, modest, but hardly rapid, worldwide growth seems reasonable.  The last thing the world economy needs is a punishing energy bill.  Just ask the fellow who just landed a job but has to commute 50 miles a day to get to it.

You can ask that charity known as OPEC as well.  We think its recent publicly expressed concern that oil prices have been verging on demand destruction deserves to be heeded.  Indeed, we believe this is the biggest reason to believe oil prices have peaked in this cycle.

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"We are not happy with prices at this level because there will be destruction as far as demand is concerned," OPEC Secretary General Abdullah al-Badri recently told an energy conference.  "We're working hard to bring down the price. We're not comfortable." 

Badri said OPEC is pumping 32.3 million barrels per day (bpd), 2.3 million bpd more than OPEC's target of 30 million bpd and higher than most estimates of OPEC output in April.  He cited a price of $100 a barrel for brent, which translates into a much lower price for WTI crude in the U.S.  On Friday, brent for June delivery closed at $113 a barrel and WTI for June delivery was at about $98 a barrel.

On the domestic front, we believe the latest monthly data from the American Petroleum Institute point to supply keeping up with and exceeding demand.

According to the API:  "Supplies of refined products remained ample, with U.S. gasoline production of 9.3 million barrels per day setting a record for any March and for any comparable year-to-date period. Distillate fuel production at 4.4 million barrels per day also set March and year-to-date records. Refinery utilization increased in March, compared with March a year ago. Total refinery inputs rose 2.3 percent in March.

 "With U.S. refinery production at high levels and overall domestic demand falling, exports of refined petroleum products increased by 2.6 percent."

Crude oil stocks in the U.S were up 4.5% in March from February, though gasoline stocks were down slightly from February, according to the API.

Though the specter of higher margin requirements at the Chicago Mercantile Exchange was cited as the reason for crude's recent downtrend, we think the fundamentals point to a further cascade down in oil prices, despite the onset of the summer driving season. The cheapest big U.S. oil company based on EV/EBITDA is Conoco-Philips at 3.05, vs. 3.72 for Chevron and 5.81 for Exxon-Mobil.  Conoco-Philips sports the highest dividend yield at 4.9%.  If you want to stay invested in the oil sector, this is our pick.  Otherwise, it's time to sell.



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