Gas mask

Exxon Mobil’s third-quarter profit of $10 billion was a 41 per cent improvement over the same period in 2010. That’s nothing to complain about. But, the $400-billion energy group’s quarterly report also showed further rise in natural gas output relative to oil. That may set Exxon up for the future. For now, though, it could help explain the company’s declining valuation premium to oilier Chevron.

Around 47 per cent of Exxon’s output now comes from gas, up a percentage point from last year and a full 10 points since the end of 2009. The shift partly reflects the difficulty private-sector multinationals have laying their hands on new oil reserves. Yet, Exxon has also made a virtue of it, predicting that global gas demand will grow at more than twice the pace for crude. The company has invested heavily in gas, including the $31 billion purchase of XTO Energy announced two years ago.

So far, a glut in the US has kept gas prices low, raising questions about the value of the XTO purchase. Still, global trends bear out some of Exxon’s optimism. Demand has jumped sharply since Japan’s nuclear accident in March, pushing Asian gas prices up 50 per cent, according to consultancy IHS. With nuclear energy in the doghouse, Exxon’s vision of a more gas-dependent world is plausible. Tighter US air quality controls should also boost demand for relatively clean-burning gas.

Investors aren’t, however, buying it just yet. At the end of 2009, Exxon — the biggest company in the world by market value — traded at a forward price-to-earnings ratio of 13.1 against a ratio of 10 for Chevron. That 31 per cent valuation premium has since been cut in half. Currently, Exxon stock trades at 9.6 times estimated earnings for 2012, against 8.4 times for Chevron.

At least for the time being, the shrinkage in the premium is justified. Chevron still gets 70 per cent of its output from oil. It makes a profit of around $28 a barrel of oil equivalent, against $21 for Exxon, according to Argus Research. Exxon still has a valuation edge. But, until gas demand and pricing catch up with the company’s vision, investors can reasonably ask whether the premium is merited.