Exxon or Chevron: Which Company Will Go Shopping in Europe?

U.S. oil companies are feeling the pinch as Chevron's stock prices continue to fall. CVX is down 0.52% and many investors are concerned about the company's future.

Exxon Mobil and other oil companies are swimming in cash. Meanwhile, their stock-valuation premium over European peers is becoming wider. At what point should they acquire a peer rather than buy back their own comparatively expensive shares?

Chevron announced last week that it would increase its dividend by about 6%, and authorized a share buyback of up to $75 billion.

Mobil announced on Tuesday that it would repurchase up to $35 billion of its own shares over the next two years. This is enough to buy British oil company BP.

Major European oil companies have been cheaper than U.S. peers for some time, in large part because European equities have been trading at a discount that has only widened since the Brexit referendum in 2016. Still, while the Euro Stoxx 50 index is 28% cheaper than the S&P 500 on the basis of enterprise value as a multiple of expected earnings before interest, taxes, depreciation and amortization, the three major European oil companies trade at an even steeper discount of 42%—compared with Exxon and Chevron. That gap used to be smaller: 38% at the end of 2021 and about 32% on average from 2009 to 2019.

According to a recent Citi report, part of the difference in performance between U.S. and European oil companies can be explained by the fact that U.S. companies have more exposure to high-return assets such as shale. European companies, on the other hand, have been investing more in green technologies such as wind and solar, which have steadier but less exciting returns. Another factor is that European investors are generally more reluctant to own energy stocks in an environment that is becoming increasingly hostile to the fossil fuel industry.

According to a report from Citi, cross-border deal activity may be the only way to close the valuation gap. The report notes that a trans-Atlantic merger-and-acquisition deal has significant potential synergies and could hypothetically reduce operating expenses by as much as 15-30% of the target company’s market capitalization. Major U.S. oil companies certainly have the balance sheet to consider it: Exxon and Chevron ended the year with net debt around 5% and 3% of capital, respectively.

A tie-up between Exxon and Chevron doesn't seem that far-fetched, considering that the two companies were contemplating one just over two years ago. Of course, one significant difference is that oil prices are buoyant today. Previous tie-ups tended to occur when oil and gas prices were weak: The initial demand shock of Covid-19 preceded Exxon and Chevron's talks, and Asia's financial crisis preceded Exxon's merger with Mobil in 1999 and Chevron's merger with Texaco in 2001.

Although there would be antitrust scrutiny, it is not insurmountable. Upstream assets are less likely to pose an issue because the oil majors have such diverse global asset positions. According to Citi's analysis, the five major oil companies combined produced just 9% of the world's oil and gas in 2022, a far cry from their 32% market share in 1971. Refining operations could get more scrutiny, but companies could meet regulatory requirements by divesting themselves of certain assets. And, while the EU and U.K. have instituted energy-windfall taxes, they apply to profits in the region, which don't account for a significant share of production for any of the major oil companies.

Exxon and Chevron's CEOs have both said that they are open to acquisitions, though neither has mentioned any specific companies. When asked about potential M&A opportunities on Exxon's earnings call, CEO Darren Woods mentioned the Permian Basin and the low-carbon-solutions space as areas where the company could benefit from acquisitions. Chevron CEO Mike Wirth said on his company's earnings call that the bid-ask spread is still wide for oil-and-gas and clean-energy companies. Both Exxon and Chevron have made progress in "high-grading" their portfolios by selling non-core assets, so a trans-Atlantic megamerger would be a significant change of direction for both companies.

Even though the valuation gap between Exxon and Chevron and their European peers is widening, it will be difficult for the former to resist the temptation of the latter's large, attractive targets.