Bargains abound among oil supermajors

With uncertainty surrounding the oil and gas sector between falling commodity prices and potential regulation changes, investors may take comfort in the size and safety of what are considered the supermajor oil companies. Diverse in their operations and geography, these global players are a bright spot among the doom and gloom in the energy sector where many smaller energy companies are drastically cutting back growth plans. Valuations of these once-lofty supermajor oil stocks are now rather attractive, making it a good time to possibly add to your portfolio some core energy holdings, such as ExxonMobil, Chevron, BP and Royal Dutch Shell.

Oil supermajors cruise ahead with growth plans
Well-stocked cash reserves and ample liquidity allow the supermajors to be undeterred by the drop in oil and gas prices and troubled financial markets. These supermajors are keeping their sights set on the long-term horizon, cruising ahead to develop new fields, refining facilities, and alternative energy ventures.

Recent business strategy meetings held by many of the oil supermajors reveal some common themes and strategies on how these firms plan to negotiate the current tough market.

Dividend preservation
Many major oil firms remain committed to returning value to shareholders via a dividend. Even amid low oil and gas prices, these firms have all reiterated their desire to maintain their dividend. Some, including Chevron, BP, and Shell, indicated their intention to continue dividend growth even if it meant taking on more debt. With little leverage now, additional debt on the balance sheets would still leave these companies with historically low debt levels.

No major cuts in capital spending
In contrast to many independent oil and gas producers, most supermajor oil companies are keeping 2009 capital-spending programs flat, or in some cases, increasing them above 2008 levels. In order to adequately grow its production base, a major oil company must focus on long-term projects that develop larger, world-class oil and gas projects. Many of these projects were sanctioned for startup when oil and gas prices were even lower than today's levels. By managing through the cycle, these majors are proceeding with growth plans for new production- and refining-capacity startups over several years, long enough to take advantage of an eventual recovery in the global economy and oil and gas prices.

Partnerships with NOCs will be key
With a majority of the world's remaining resources in the hands of National Oil Companies (NOC), it is imperative International Oil Companies (IOC) strike deals that will ensure future access to these resources. These deals can be mutually beneficial as IOCs add to reserves while host countries counting on oil-export revenues to fund fiscal budgets gain the technical expertise to extract difficult-to-reach reserves. Major integrated firms will likely push more aggressively to secure these types of deals because they offer the few opportunities to really acquire production growth that moves the needle. Host countries are likely to be receptive as the larger firms offer the integration, size, and scope of services to fully optimize their resource base. Sticking points could arise, however, as contract terms conflict over pure service deals versus sharing in equity production.

Aggressive pursuit of growth opportunities
In their pursuit to expand production, major operators find themselves pushing the boundaries further. Exploration success has spawned major new discoveries to drive global oil-production growth, while higher commodity prices have made the discoveries economically viable. Deep-water drilling is now a major focus for majors to secure deposits with heavy investment in Nigeria, Angola, the Gulf of Mexico, and the recent discoveries in Brazil. These investments continue despite the geopolitical risks involved, evident in the frequent troubles Shell and Chevron have had in Nigeria.

Another significant tenet of growth for the majors is investment in stranded natural gas resources and LNG infrastructure. LNG resources allow companies to capture the trend toward global natural gas usage and direct resources toward the highest-value markets. Developments in Qatar, Australia, and Nigeria are just an early indication of a continued effort by the major operators to tap natural gas deposits.

Refining turnaround and growth projects stay on track
Often overlooked in their asset profile are the refining assets of the major integrated companies. Meanwhile the integrated companies encompass the majority of the global refining capacity. Although we believe a weak refining environment will persist for the foreseeable future because of economic weakness, the majors are slightly insulated because of their integrated models. As such, major oil's downstream projects are several years in the making, requiring major infrastructure development that can't be easily stalled. Like with their upstream operations, large integrated players maintain their investment plans throughout the cycle and take long-term views of product demand. With this view and the available capital, majors are continuing their investments in upgrading their refineries to lower crude costs and increase diesel yields.

Investors in alternative energy
With ample cash on hand, some major oil firms were active investors in alternative energy ventures. Other firms cite the early-stage nature of alternative energy projects and have become more selective with their investments. More than many of its peers, BP invested over $1 billion in 2008 in wind, solar, biofuels, and other alternative energy projects in 2008 and is planning more in 2009, targeting wind power in the United States and biofuels in Brazil. Shell plans to narrow its focus to biofuels, while holding off from new investments in other alternative energy options. The firm has sold much of its solar business and eased back from a wind project. In contrast, Exxon is focusing on less-developed technologies which are not reliant on government subsidies because it does see any current opportunities as attractive for shareholders.

Acquisition appetite still good
The fall in asset values and energy stock prices plays into the hands of cash-rich oil majors. Acquisitions could be on the rise soon as major oil firms try to beef up property holdings in major fields. Total made a bid for a Canadian heavy oil producer and may not stop there. BP purchased large US gas shale parcels from Chesapeake Energy in 2008. Shell acquired a Canadian tight gas acreage holder, Duvernay Oil and added exploration licenses in Australia, Canada, Libya, Sweden, and the US last year. Meanwhile, Exxon and Chevron decided to hold back somewhat in their acquisition strategy as oil prices rose last year, but deals with NOC's or smaller exploration and production firms could now be in the works. ConocoPhillips will likely not participate in any further acquisitions as its aggressive strategy during the last decade resulted in $34 billion goodwill impairment at the end of 2008 and saddled the company with a higher debt load than its peers. Also, in an effort to high-grade their project portfolios, many firms are looking to sell noncore assets and slow the pace of new projects, notably higher-cost unconventional oil projects. Although it's still early in 2009, acquisition and divestiture activity may take hold in the coming months.

Attractive valuations
Valuations of some major oil companies have now come down to attractive levels amid uncertainty over a weakened global economy, a drop in oil and gas prices, and concerns over global demand. Additionally, we believe that a few of the major operators are in a better position to negotiate the current environment given the themes we discussed above.

ExxonMobil
Of all the supermajor integrated companies, Exxon is the most likely to deliver value by executing on all the themes we mentioned above. Historically Exxon has shown it is the leader in delivering superior returns and operational results. With its strong cash flow, large cash balance, and little debt, the company will have little issue funding its capital program, increasing its dividend, and potentially continuing an aggressive share-repurchase program.

Meanwhile, management has shown the discipline to wait on the sidelines during the recent runup in commodity prices, leaving the firm in the ideal position to invest in a lower-cost environment. Also, Exxon has repeatedly demonstrated its value as a partner with NOCs which should lead to further deals.

Chevron
Like Exxon, Chevron has shown similar discipline in investing throughout the cycle and now is in an advantageous position. Chevron plans to maintain capital spending at 2008 levels in order to develop current projects in what should be a lower-cost environment. Its low debt and substantial cash position ensure funding for the capital program, while dividend growth will likely continue. Its partnership with Chinese firm CNPC to develop the Chuandongbei project, exhibit Chevron's ability to secure deals with NOCs. Positions in the lower tertiary of the Gulf of Mexico and LNG assets in Australia offer immense future production-growth potential.

BP
BP is heading into its 100th year in 2009 with plans to set its long-term growth strategy in motion. The firm plans to keep capital spending flat with 2008 to develop new oil and gas fields while continuing to revamp downstream operations. BP is the third-largest integrated oil company behind ExxonMobil and Royal Dutch Shell and like its peers, has a full global pipeline of long-term oil and gas projects to drive annual 1-2% production growth to 2013. Projects slated for startup in 2009 to 2013 hail from as far as Angola, the North Sea, and Russia to the Gulf of Mexico. A new agreement with Russian partners at BP's TNK-BP venture sets the stage for progress in Russia. The firm is focusing not just on volume growth but also efficiency gains. BP has more to prove than its peers in boosting safety and operating efficiency, and marked 2008 with the return to full capacity of its Texas City, Texas, and Whiting, Ind., refineries. BP's renewed interest in North America was evident with major US gas shale purchases and a Canadian oil sands venture. BP's cash generation allows the firm to remain committed to sustain and increase its dividend.

Royal Dutch Shell
Shell plans to keep 2009 growth plans intact for long-term projects already under way. The dividend remains on the forefront as management views dividends as an important statement of confidence in its future. Shell has already announced dividend-growth plans in 2009 with a 5% increase for the 2009 first quarter over year-ago levels. The firm is moving ahead with major investments under way to drive 2-3% annual oil and gas production growth into 2012. By targeting technology plays, Shell has ample oil- and gas-producing prospects to drive long-term growth. These include heavy oil fields in Australia, Nigeria, and Alberta, and North American tight gas fields. Tapping into deep-water oil- and gas-producing skills, Shell has three development projects under way in the US, Brazil, and Malaysia. Refinery expansions in the US and Singapore, new liquefied natural gas projects, and renewable energy projects help to round out Shell's growth potential.