Will Big Oil Smack Down the Dow?

By Markets Fool.com


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Monday morning brought another round of new lows from the crude oil markets as prices of domestic crude hit $46 per barrel and international Brent oil dropped below $48, both marking the worst levels since the financial crisis in early 2009. Yet the damage to the stock market has been minimal: The Dow Jones Industrials were down just 73 points shortly after noon EST, having bounced back from worse losses earlier in the day. Even though ExxonMobil and Chevron were among the Dow's worst performers, each falling 1.5% to 2%, the oil giants haven't seen declines anywhere near the scope of the drop in oil prices. That has some people questioning whether big oil stocks may still catch up with crude oil's drop -- and bring the Dow crashing down with them.

Why big oil hasn't crashed
Losses of 10% to 15% for ExxonMobil and Chevron over the past six months are certainly nothing to celebrate, but they pale in comparison to the much steeper 50% haircut that crude has seen over the same time frame. The disparity reflects the difference of opinion among market participants about the nature of oil's decline and how long it's likely to last.

WTI Crude Oil Spot Price Chart

WTI Crude Oil Spot Price data by YCharts.

Commodities traders all have a very short-term focus, as their markets are driven by immediate needs for products. The oil prices we see every day reflect the demand in the spot market or for future delivery within the next month or so, leaving them extremely susceptible to short-term supply and demand movements. Moreover, commodities markets can be sensitive even to small disruptions in a particular market, exacerbating the extent of moves in both directions.

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By contrast, the value of shares of Exxon and Chevron reflect long-term considerations, as it will take decades for the two companies to use their existing reserves, and they'll undoubtedly find new sources of oil in the future. Although the market discounts future revenue sources, assigning them less value than immediate sales, investors in oil stocks already take into account the changing conditions of the oil markets. Indeed, for companies with market caps in the hundreds of billions of dollars, the double-digit percentage declines they've already suffered show just how unprepared shareholders were for this big of a market disruption.

Moreover, the integrated oil majors don't just get profits from production. Refinery operations drive a substantial amount of revenue for both Chevron and Exxon, and with oil coming in at a cheaper cost, the potential for profits is actually magnified in a low-priced oil environment. Admittedly, falling gasoline prices haven't allowed the two companies to reap all the benefits of lower crude costs, but their downstream divisions do serve as a buffer against the full impact of oil-price changes.

Nevertheless, looking at investor expectations for 2015, the unanswered question is whether projected annual revenue declines of 10% at Exxon and 17% at Chevron will prove to be optimistic. If crude prices hit bottom and start to bounce, as many people expect, then the relatively small declines in the Dow's oil stocks will appear warranted in hindsight. If oil keeps falling, though, there could be plenty more room for further drops in Exxon and Chevron ahead, and that could weigh on the Dow's prospects for a seventh straight year of gains.

The article Will Big Oil Smack Down the Dow? originally appeared on Fool.com.

Dan Caplinger has no position in any stocks mentioned. The Motley Fool recommends Chevron. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.