Exxon Mobil Corporation (NYSE: XOM) is one of the most successful oil stocks in history. The recent market crash, however, has crushed the company. Today, Exxon stock trades at 1999 prices! This is truly a rare event.
But why has Exxon been so damaged by the downturn?
The biggest reason is pricing. A disagreement between Saudi Arabia and Russia resulted in a price war that saw oil plunge from US$60 per barrel to just US$20 per barrel. While prices have rebounded a bit in recent weeks, they’re still under US$30 per barrel.
Few large oil producers can make money in today’s environment. Saudi Arabia understands that very well. The country breaks even at prices below US$10 per barrel, so although its profitability has been killed, it won’t be forced to shutter production any time soon.
High-cost producers, meanwhile, are in a completely different boat. Just look at Imperial Oil (TSX: IMO)(NYSEMKT: IMO).
Meet this Canadian oil stock
Since the oil crash began, Imperial stock has been cut in half. While it still has a $13 billion valuation, that’s peanuts compared to Exxon’s $175 billion price tag.
The issue with Imperial is that it produces a large amount of oil from oil sands projects. This type of production requires more refining to reach the market, resulting in higher costs along the way. Imperial controls its own refineries, which softens the blow, but the fact remains that Imperial Oil is not a low cost producer.
Management states that its cash operating costs are between US$15 and US$30 per barrel. But that’s simply the price of oil needed to replace its short-term cash spend. To generate a net profit overall reflecting all investment dollars, the company likely needs oil to remain above US$30 per barrel.
Fortunately, this company isn’t completely focused on upstream assets like oil production. Imperial Oil also owns significant refining, chemical, distribution, and end-user assets.
For example, the company owns enough refinery infrastructure to process 100% of its oil production, which means it doesn’t have to cede refinery profits to another company, a big advantage considering refining margins often rise when oil prices fall.
The company also owns a large number of petrol stations like Esso and Mobil, meaning that it captures all of the profits from first production to final sale.
Will Exxon be a buyer?
It’s not difficult to connect the dots here: It’s growing more likely that Exxon will buy out Imperial Oil, which wouldn’t be a huge feat given the company already owns nearly 70% of Imperial Oil shares. Exxon could purchase the remaining stock with ease considering its investment-grade credit rating and sizeable annual cash flow generation.
But why would Exxon want to completely acquire Imperial Oil?
In today’s pricing environment, energy companies will be hesitant to make major acquisitions. They will also be risk-averse when it comes to growing their reserves. But here’s the thing: To survive long term, oil companies need to replace their reserves over time — otherwise they’d run out of oil to pump.
With Imperial Oil, Exxon gets a plug-and-play way to boost its reserves overnight. Imperial Oil already operates a fully-integrated business model, the same strategy that Exxon employs. And due to Exxon’s existing ownership, both firms already share resources, technology, and expertise.
The most important factor is valuation. Exxon Mobil stock currently trades at 93% of its book value. Imperial Oil, meanwhile, trades at just 53% of book value. By acquiring the company, Exxon can grow its global operations in a seamless way, all while paying a bargain price.
There may be some regulatory hurdles, but don’t be surprised to see Exxon pull the trigger this year.
