ExxonMobil’s (XOM) Gains are About Much More than an Upgrade from Goldman Sachs (GS)

After a week of year-end selling-off, exacerbated by fears of what changes the Fed could make to its fiscal stimulus regime, oil giant ExxonMobil (XOM) was leading the Dow higher on Monday on gains of nearly 3 percent by midday.

The major integrated oil and gas company is one of the world’s largest publicly-traded entities,and with a market-cap of nearly $420 billion, larger than the budgets of many small-to-medium sized nations, making Monday’s price-movement especially significant. The gains have been attributed to a upgrade on the stock issued by Goldman Sachs (GS) from “neutral” to “buy”. Furthermore, the salutary effect for shares of ExxonMobil were felt by most super-majors, with substantial gains for giants such as Total SA (TOT) , Petrobras Argentina (PZE) , and Italy’s Eni SPA (E) .

Why the Upgrade?

Goldman analyst Arjun Murti explained the upgrade in terms of the increasingly widespread expectation that oil and gas prices will take a severe cut as global energy markets become flooded with the spoils of a rather sudden and massive increase in US production, resulting from the ongoing “shale boom”. According to the Energy Information Administration, US production of crude oil will top the 1970 record of 9.6 million barrels per day by 2016, with a peak sometime in 2020 before a gradual let-off. Increased production of natural gas will continue for much longer, according to the report from the EIA, until about 2040.

The fact that Goldman did not issue an upgrade on any other major oil stock was also explained in Murti’s note: “On the company-specific front, we are gaining confidence that a positive inflection in Exxon’s production profile may be at hand. For 2014, we see respective oil/BOE volume growth of +5.0%/+2.4%, which would mark the first year of organic growth since 2006.” Production volume has been ExxonMobil’s Achilles' heel in recent years, as securing production-sharing contracts and booking reserves has become an increasingly more complicated task, particularly with the rise of massive state-operated oil companies (a phenomenon often referred to in industry parlance as “resource nationalism”).

Mexico Opens Up To Foreign Energy Companies

The Goldman upgrade is only the most overt of a number of reasons for ExxonMobil’s price-action. On Thursday Dec. 12, the government of newly elected Mexican president Enrique Pena-Nieto ended the country’s 75-year state monopoly on its oil and gas industry. Despite significant nationalist opposition, the move will allow foreign companies an entry point into Mexico’s energy sector, where a lack of investment has seen declining production in recent years, despite the enormity of the country’s reserves of oil and gas, onshore and offshore.

ExxonMobil shareholders have become accustomed to a certain standard from the company, and production increases alone are not enough. Indeed, these investors want to see their company’s reserves replaced each year, if not increased. It’s a tall order, and one that has in the past led the company to controversial and deliberately misleading reserve-counting practices.

The opening of Mexico could change all of this though. ExxonMobil presumably has the cash and the know-how to bring Mexican oil and gas to the surface, which is a good thing because much of the country’s energy infrastructure is badly in need of development.

Supply-Glut Shrugged

The high value placed on production-sharing contracts and bookable reserves, such as will now be available in Mexico, can be surmised by XOM’s price-spike on Monday. In the most optimal conditions, a revitalization of the Mexican oil industry could add about 2.5 million barrels per-day to the global supply. While this will contribute to an expected cut of around $20 in the price of Brent crude from 2013’s average of some $108 per barrel by 2017, it will all the same guarantee ExxonMobil the ever-important guarantee of reserve-replacement.

Super-majors have struggled throughout 2013 to keep up production, and have been seen from the investment perspective largely as defensive plays. The opening up of Mexico (and perhaps also Iranian reserves in the unlikely event that a deal is achieved), could put big oil back on the path to growth.

In the long-run, it could even turn the tables on the smaller, independent operators who have so far benefitted the most from US shale production. While Mexican reserves of oil and gas are at least two years off in the best-case scenario, the flood of gas in particular that could be unleashed by Mexican plays would surely send global prices lower, making it difficult, if not economically impossible, for diminutive US shale drillers to do business.