Profit In The Pipeline

By Mark Whistler | March 27, 2008 AAA

As I'm sure all my readers are abundantly aware, the price of oil is sky high. In the last week of February, oil traded above $100 a barrel for the first time ever, based on fears of decreasing global demand and supply side woes. Adding fuel to the fire, the U.S. dollar was also in a tailspin, further adding upward pressure to oil. However, in the past weeks, the U.S. dollar began finding its legs again, something that helped ease oil prices earlier in the week. (For more information, read What do the terms weak dollar and strong dollar mean?)

Everything seemed to be calming down, then on Thursday, a key Iraqi oil-export pipeline was bombed, creating worry that supply from the key crude nation would make matters worse. As the Associated Press reported on Friday; trader tension was easing, "after fears of a major disruption of Iraqi oil exports dissipated" (i.e. the pipeline was fixed). Up down, up Down.

Oily Rollercoaster
Lower crude prices aren't a "sure thing" though, especially with the Fed potentially cutting rates again in June. As a general rule of thumb, low interest rates kill currency chutzpah. If the U.S. dollar were to turn south once again, the event could give traders another opportunity to drive oil even higher. It's also important to note that $100 is now key and whole-number support, something that could easily become a technical headache for bears. (Learn more in our articles Trading On Support and Support & Resistance Basics.)

What's more, with the national averages for gas at $3.25 gallon, just ahead of the summer driving season, consumers are feeling the pressure of higher fuel charges. Rumors have been swirling in the market lately that pump averages could come in at $4.00 a gallon in the months to come, something that would not be good for the economy. (For related reading, check out Getting A Grip On The Cost Of Gas.)

Big Oil Profits Regardless
One thing is for sure during this time: big oil is raking in cash. When the price of oil is high, many tend to think that filling stations and distributors are rolling in cash. And while they're not poor by any accord, there's also something else happening. In Steve Hargreaves' March CNNMoney article "Who gets rich off $3 gas - who doesn't", the profit breakdown is:

$3 Gas Means
Gas Stations: 7-10 cents profit
Taxes: 40 cents (18 cents for feds and an average of 22 cents for states.)
Transport: 23-26 cents
Refining: 24 cents
Crude companies: $2.07

As you can see, roughly 30% of the profits from crude go to big oil exploration companies. The income can be even higher when big oil also doubles as a refiner.

Are Big Oil Companies Robber Barons? Surprisingly, no. Well, let me rephrase that: yes and no. Yes, there are some overpaid corporate executives within the industry, but big oil shares the wealth, too. According to Ben Stein of the New York Times, "When Exxon Mobil earns almost $12 billion in a quarter, or $41 billion in a year, as it did in 2007, that money does not go into the coffers of a few billionaire executives quaffing Champagne in Texas. It goes into the pension and retirement accounts of ordinary citizens. When Exxon pays a dividend, that money goes to pay for the mortgages and oxygen tanks and in-home care of lots of elderly Americans." (For related reading, check out Understanding Supply-Side Economics.)

Picking An Entry Point
So, is now the time to buy? Again, yes and no. Even if the price of oil were to decline 20% or 30%, big oil is going to keep making big bucks, and keep paying dividends. Therefore, for long-term income investors, big oil companies are a good bet. However, chasing stocks near highs can lead to portfolio devaluation if the share prices decline rapidly.

It's common sense not to buy into near-term hype of oil prices and stick to the old Wall Street safety strategy of buying the dips. Many with this mentality never buy a stock unless it's on the 200-DMA, which provides a solid long-term entry for patient investors.

It's important to note that Exxon Mobile (NYSE:XOM) is presently trading right on the 200-DMA in the $87.35 area, while Chevron Texaco (NYSE:CVX) is doing the same in the $86.61 area. Both stocks have retreated from December all-time highs. Additionally, investors should never buy based on technical analysis alone, fundamentals always matter. The industry average PE ratio for big oil is 9.7. Chevron Texaco is currently trading with a PE of 9.7, while BP (NYSE:BP) has a PE of 9.3. ExxonMobile is trading with a PE of 11.9. (Learn to combine strategies, in Blending Technical And Fundamental Analysis.)

Bottom Line
There is risk in oil right now, but big oil has been good to long-term investors over the years and will likely continue to do so over the long haul. The key is not to let short-term fears, like the pipeline bombing last week, cloud your vision or skew your expectations.

To read more on how oil and gas companies make their money, read Oil And Gas Industry Primer.

You May Also Like

Related Analysis
  1. Stock Analysis

    Chevron Cancels Arctic Drilling Project, Ukraine to Suffer - Analyst Blog

  2. Stock Analysis

    Oil Prices Crashing: Will It Hurt These Chemical Plays? - Analyst Blog

  3. Stock Analysis

    Stock Market News for December 18, 2014 - Market News

  4. Chart Advisor

    Cocoa Prices Setting Up For A Move Lower

  5. Stock Analysis

    Handicapping the Q4 Earnings Season - Earnings Outlook

Trading Center