Torsten Asmus
In the last few weeks, the prices for oil and natural gas have been declining mostly due to the hawkish monetary policy of the Federal Reserve, which will continue to raise interest rates to tame the inflation that could lead to a recession in the following quarters. However, at the same time, Russia’s latest decision to escalate the war in Ukraine by mobilizing its male population and organizing sham “referendums” creates a possibility of further disruption of oil supplies to the global markets, as Europeans are now unlikely to abandon an oil embargo that’s going to be implemented later this year. At the same time, the latest sabotage of both Nord Stream pipelines in the Baltic Sea already disrupted the flow of natural gas to Europe and there’s a real possibility that the pipelines won’t be fixed anytime soon.
All of this creates an opportunity for Exxon Mobil (NYSE:XOM), which would be able to benefit not only from the possible increase in oil and natural gas prices but also from more tight cooperation with various European countries, which are currently decoupling from Russia and are looking elsewhere to fulfill their energy needs. While last month I already wrote an article on how Exxon will be able to benefit from an upcoming European oil embargo against Russian oil and oil products, the latest developments in Moscow suggest that the upside for the company is even greater now as additional supply disruptions will be able to minimize the downside from demand destruction. Therefore, the goal of this article is to describe how those developments directly benefit the company and how they are also strengthening the bullish case for Exxon.
More Supply Disruptions On The Way
After the successful counteroffensive of the Ukrainian army on the Kharkiv front earlier this month, in which the Ukrainian forces liberated 8000 square kilometers of land, Kremlin decided to go all-in and announced a mobilization of a Russian male population. While there were talks that the mobilization would be partial, in reality, the text of the decree that was enacted is relatively vague, as it gives Russia’s Ministry of Defense to decide at its own discretion how many people to mobilize. As a result, there are reports, that state that the Kremlin aims to mobilize up to 1 million citizens, while Russia’s own Minister of Defense Sergei Shoigu was saying that the mobilization pool consists of nearly 25 million people.
At the same time, there are already reports that people, who never served in the army, started to receive conscription notices that urge them to visit the military commissariat or risk receiving a penalty of up to 10 years in prison for avoiding the mobilization. In addition to this, the U.S. State Department has been urging its citizens to leave Russia immediately, as there’s a risk that Kremlin will enact martial law and would fully close the Russian border.
All of this would undoubtedly have a negative effect on the Russian fuel and energy industry, which employs 2.5 million Russians, a large portion of which are young men that work in oil fields and are eligible for the mobilization. In addition, let’s not forget that the Russian invasion has already inflicted serious damage to the country’s oil industry. Russia’s oil production continues to be below the pre-war levels to this day, its oil is sold at a significant discount to Brent, and the upcoming European embargo against Russian oil that is expected to be implemented in December would make it significantly harder for Moscow to fund its war efforts.
On top of that, back in August, before the mobilization was announced, the EIA estimated that Russia’s oil production would decline by 1.6 million barrels per day between Q4’22 and Q4’23. As a result, there’s a possibility that the mobilization will disrupt production even more if additional oil workers would leave their job and join the army, creating a greater supply disruption than previously expected in the following months.
At the same time, we could also expect additional disruptions of supplies of natural gas from Russia to Europe to occur in the upcoming weeks. Just a few days ago, it was discovered that the natural gas pipelines Nord Stream 1 and Nord Stream 2, which directly connect Russia with Germany via the Baltic Sea, were sabotaged and are currently leaking methane into the sea. As a result of this, the natural gas prices in Europe once again increased and there’s a possibility of a further rise in prices as Russian Gazprom (OTCPK:OGZPY) openly threatened to stop delivering natural gas via the Ukrainian pipeline as well.
Considering all of this, it’s safe to assume that in such an environment full of supply disruptions, prices for oil and natural gas will remain at relatively high levels for the foreseeable future.
New Opportunities For Exxon Mobil
Making Fortunes From The Volatile Oil Market
As one of the biggest oil and natural gas producers in the world, Exxon stands to benefit the most from the current situation. The company already expects to generate record profits in decades this year and there’s a possibility that with additional supply disruptions the business would continue to deliver top-notch results beyond 2022.
Let’s not forget that while the oil prices have declined in the last few weeks, Europe continues to decouple from Russia and it expects to fully implement an oil embargo against Russia in a couple of months. Once the embargo is implemented, the EU will be required to buy over 2 million barrels of oil per day that it imported from Russia in 2021 from other suppliers on an open market, creating buying pressure in the oil market. At the same time, the upcoming sanctions would also prevent insurers from insuring ships that transfer Russian oil, which could lead to the possibility of Russia failing to honor its obligations to countries such as China and India, as western companies account for the majority of the ship insurance market.
As a result of this, there’s a real chance that the supply disruptions will outweigh the demand destruction, which will lead to oil prices staying at a relatively high level. One of the latest EIA reports forecasts the price of Brent crude oil to average $105 per barrel in 2022 and $95 per barrel in 2023. Considering that Exxon’s breakeven price was ~$41 per barrel in 2021, it’s safe to assume that the company will continue to thrive going forward.
On top of that, let’s not forget that Exxon has been increasing its oil production in the latest quarters, but such an increase is unlikely to significantly drive prices lower due to the supply disruptions that are described above. Therefore, Exxon is more than likely to continue to generate record returns and create additional shareholder value for its investors in the following quarters.
All Eyes On Natural Gas
Since the beginning of the Russian invasion of Ukraine earlier this year, members of the European Union started to fill their storages with natural gas in order to hedge themselves against the possible supply disruptions from Russia. It was a wise decision since the latest sabotage on the Nord Stream 1 and Nord Stream 2 pipelines suggests that natural gas won’t flow through those pipelines to Germany and the rest of Europe anytime soon. As of now, the EU storages are filled by nearly 90%, which will make it easier for the union to survive this winter. At the same time, the reliance on Russian imports decreased from 40% to only 9%, mostly thanks to the increase in imports of liquefied natural gas from the United States.
Despite this, the decoupling from Russia in the natural gas space comes at a high price, since Europe’s decision to actively look for suppliers elsewhere created buying pressure in the natural gas market as well. In its Q2 earnings report, Exxon reported that the natural gas margins are significantly above the 10-year averages and this will likely continue to be the case in the following quarters until the EU fully decreases its overreliance on Russia and hedges itself against the possible additional supply disruptions in the future. As a result, Exxon stands to benefit from the higher price environment in the natural gas market in the short and near term.
As for the long-term, Exxon has all the chances to increase its presence in the old continent and greatly benefit from closer cooperation with Europeans. Earlier this month, the company has already signed an LNG deal with Slovakia, and it’s currently in the middle of accelerating the launch and expansion of Golden Pass LNG and North Field East LNG projects in partnership with Qatar, with whom Germany recently signed an LNG deal as well.
Risks
There are two major risks to the bullish thesis at this stage. First of all, there’s a risk that sanctions won’t be properly implemented or they would be dropped whatsoever, while the mobilization won’t be able to significantly disrupt supplies. In such a scenario, Russian oil would likely continue to be sold on international markets, which could result in the depreciation of oil prices from the current levels.
At the same time, there’s also a risk that the demand destruction will nevertheless outweigh supply disruptions, as it seems that Fed is committed to taming inflation by aggressively increasing the interest rates and continuing to engage in quantitative tightening. If that’s going to be the case, then there’s also a possibility that the oil and natural gas prices will depreciate from the current levels. However, even in both of those scenarios, Exxon would likely continue to generate significant profits thanks to its relatively low breakeven levels.
The Bottom Line
My bullish thesis for Exxon is based on the idea that the latest and the upcoming supply disruptions of oil and natural gas would have a greater effect on the markets than the demand destruction that decreases the overall consumption, and would keep the prices for oil and natural gas at relatively high levels. That’s why I continue to believe that Exxon trades at a discount as my DCF model from the latest article on the company shows that the company’s fair value is $104.77 per share. Time will tell whether my thesis is correct. Currently, I’m bullish on the stock and I will undoubtedly update the model once the Q3 results come out next month.
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