Big Oil Is Back. Now, Let's Get A Piece Of The Pie...

"A billion here, a billion there. Pretty soon you're talking about real money."

I was reminded of this line when evaluating fourth-quarter results in the energy sector. That's because the big multinational producers are generating profits that aren't just huge by corporate standards -- they dwarf the GDP of some small countries.

Exxon Mobil (NYSE: XOM ) hauled in $6.4 billion in adjusted net income in the fourth quarter. BP (NYSE: BP ) shattered expectations with a profit of $3.5 billion. Royal Dutch Shell (NYSE: RDS-A ) banked earnings of $5.7 billion. That's $15.6 billion from just three companies -- in a single quarter. For the year, the combined earnings of the five super-majors -- this trio plus Chevron (NYSE: CVX ) and Total (NYSE: TOT ) -- reached an incredible $80 billion.

Indeed, we are talking about real money.

Even more impressive than the raw results are the triple-digit growth rates. Chevron's fourth-quarter profit of $2.06 per share was an increase of 182% from a year ago. Anadarko Petroleum (NYSE: APC ) reported earnings growth of 111%.

According to FactSet Research, the S&P energy sector increased earnings by 96% last quarter -- versus 12% for the overall market. The upstream exploration and production (E&P) sub-sector led the way with impressive growth of 133%.

That figure is even more impressive considering oil prices plunged 40% last quarter. Crude started sliding from a peak of $75 per barrel in October to a trough below $45 on Christmas Eve. But that decline didn't put too much of a dent in industry earnings.

Plus, that price decline is already behind us. OPEC production cuts and other supply disruptions sparked a sharp rally in oil prices last month (the best January on record, actually). Domestic West Texas Intermediate ( WTI ) has bounced back above $50, while foreign Brent crude is north of $60.

So big producers are not only flush with cash, but also anxious to go hunting for new discoveries to boost production and reserves.

Now, given this information, you might be tempted to simply go and buy shares of the oil majors. I can't fault you for that. But in just a second, I'll tell you how we plan to profit over at High-Yield Investing , my premium income investing newsletter.

Keeping An Eye On Costs

You've probably heard me say that oil producers have become more disciplined with their capital spending. In the past, there was a "growth at any cost" mindset. The return-on-investment bar was set pretty low; if a project moved the production needle, it got a green light.

But companies are more circumspect these days -- getting burned by a severe multi-year downturn will do that. Between June 2014 and January 2016, oil prices tumbled from $100 per barrel to around $25. That prolonged slump forced producers to tighten their belts and learn to make do with less.

The days of oil at $25 per barrel are over -- but the cost-cutting initiatives took permanent hold. Strategic goals have also changed. Instead of maximizing production, producers now seek to maximize returns. It's not how many barrels can be pulled from the ground, but how efficiently they can be extracted. That effort has been aided by technological advances and a better understanding of reservoir optimization techniques.

As a result, breakeven levels have come down dramatically. Occidental Petroleum (NYSE: OXY ) can now maintain dividend distributions and meet CapEx spending even with oil as low as $40 per barrel. BP (which once needed $60 oil to stay afloat) will be able to get by with oil as low as $35 within the next two years.

Believe it or not, Shell's net profit margins are higher today than they were in the days of $100 oil prices.

In other words, these leaner companies are gushing cash right now, at levels where they might have once been in the red. ConocoPhillips hauled in $12.3 billion in operating cash flows last year at an average selling price of just $53.88 per barrel. Exxon Mobil generated $36 billion in cash flow, the highest in four years.

Record CapEx Spending

That's not to say that spending levels aren't sensitive to commodity prices. They absolutely are. Between 2014 and 2016, when oil plunged, industry CapEx spending was cut in half from $520 billion to just $200 billion. But projects that wouldn't have been economically feasible in the past make sense now. And after years of scrimping, the time has come to start restocking the pantry.

Keep in mind, oil basins are naturally depleting as millions of barrels are pumped out each day. Output declines of 3% to 6% annually are normal among older fields. So producers must spend a certain amount on drilling and exploration each year just to offset declines and maintain current output -- let alone increase it.

After several years of playing it safe, this group is expected to invest almost half a trillion dollars this year on exploration and development. ($425 billion to be exact -- about $25 billion more than we've seen on average the past few years.) That number might be even higher were it not for a newfound commitment to return more capital to stockholders through dividends and buybacks (can't really argue with that).

But corporate boards are under pressure to replenish their CapEx budgets as well. And they are doing just that.

Chevron, for example, plans to increase CapEx spending for the first time since the 2014 crash -- earmarking investments of $20 billion in 2019, versus $18 billion in 2018. Morgan Stanley estimates that spending among the world's seven top producers will jump to $136 billion in 2020, up from $105 billion in 2017.

The number of new large projects (those with 50+ million barrels of reserves) under development is expected to reach 50 worldwide this year. That's five times what we saw just a few years ago.

Needless to say, all of this will have a noticeable impact on output.

Just in the United States, production has already surpassed 11 million barrels per day and will swell to 12 million per within the next three months, according to the Energy Information Administration (EIA). As it stands, there is a record number of drilled but uncompleted wells (DUCs), simply because we currently lack the pipeline capacity to haul any more to regional hubs and refineries.

All of this points to a long-overdue turnaround for oilfield equipment and service companies.

How To Invest

When spending dried up, this group was hit hard. Halliburton (NYSE: HAL ) went from a profit of $3.5 billion in 2014 to a painful loss of $5.8 billion in 2016. But the pendulum is swinging. As any good salesman will tell you, it's much easier to close deals when your customers have more cash in their pocket. And as we just discussed, big oil producers have $425 billion locked, loaded and ready to fire.

That spending is aimed directly at companies like Ensco (NYSE: ESV ) , which operates offshore drilling rigs, and National Oilwell Varco (NYSE: NOV ), which sells everything from fracking fluids to rig instrumentation systems. Both have rallied sharply off their late-December lows, 38% and 20%, respectively. But they are still more than 70% below previous highs from the last up-cycle and could have room to run if business fundamentals continue to brighten.

If Baker Hughes (NYSE: BHGE ) is any indication, we may already be seeing the beginning of the turnaround. The company jus t report ed sequential revenue growth in all four business segments and received $6.9 billion in new orders last quarter -- the best in several years.

Any of the names I just mentioned are worthy potential candidates for your portfolio. But my favorite pick in this sector is for High-Yield Investing subscribers only. During the last up-cycle, it changed hands north of $100 per share. Today, you can buy it for less than $50.

With tens of billions pouring into this sector, this stock is primed to deliver big gains in 2019. If you'd like to learn more about my newsletter and how to get the name of this pick, go here .

Related Articles

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

© Copyright 2001-2016 StreetAuthority, LLC. All Rights Reserved.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

More Related Articles

Info icon

This data feed is not available at this time.

Sign up for Smart Investing to get the latest news, strategies and tips to help you invest smarter.