Jim Chanos says oil is a value trap for investors

'The economics are clearly deteriorating,' the famed short seller says.

By MSN Money Partner Nov 20, 2013 1:25PM
Jim Chanos, Founder and Managing Partner of Kynikos Associates LP, speaks at the Reuters Global Investment Outlook summit in New York on November 19, 2013 (© Mike Segar/Newscom/Reuters)By Katya Wachtel and Ernest Scheyder, Reuters

NEW YORK -- Short-seller Jim Chanos (pictured) said on Tuesday that shares of international oil majors like Exxon Mobil (XOM) increasingly look like a value trap for investors as cash flows decline and return on capital slides.

His comments at the Reuters Global Investment Outlook Summit in New York came a week after Warren Buffett disclosed a large position in Exxon, the world's largest publicly traded oil company.

Chanos said his Kynikos Associates fund was bearish on both national oil companies and the integrated majors.

"The costs of finding this stuff (oil) has gone through the roof," Chanos said. "The economics are clearly deteriorating."

"It isn't the same cash flow-generating business it used to be."

Exxon Mobil and other oil producers like it continue to spend heavily not only to find new reserves but also to pay dividends and fund buyback programs, prompting concerns the companies have limited growth potential, Chanos said.

As recently as 2010, Exxon Mobil's free cash flow, a measurement of cash flow minus capital spending, eclipsed the cost of share buybacks and dividend payouts. Yet executives have been buying back stock at a breakneck pace in recent years. In 2012 the company spent $30.97 billion on dividends and buybacks, with $21.9 billion in free cash flow.

Last week, Buffett's Berkshire Hathaway (BRK.A) disclosed that it acquired 40.1 million shares in Exxon Mobil for $3.45 billion.

"He's got his reasons but unmistakably the returns are dropping," Chanos said of Buffett's bet on the oil giant. "It increasingly looks to us like a value trap."

Exxon Mobil spokesman Alan Jeffers declined to comment.

Exxon Mobil shares, as well as those of many other multinational firms, have badly lagged the S&P 500 this year despite generous buyback and dividend programs. Additionally, Exxon Mobil was late to develop U.S. shale assets, and has had to boost spending in remote and politically unstable parts of the globe to try to find oil.

It's the smaller, nimble producers in U.S. shale plays and other niches, such as Continental Resources (CLR) and Whiting Petroleum Corp (WLL), that have become Wall Street darlings.

Exxon Mobil's return on capital, a measurement of how well cash for growth projects is allocated, fell to 18.7 percent last year from 27 percent in 2008, according to Thomson Reuters data.

"The dropping return on capital is really ominous," Chanos said.

Chanos, who specializes in making money when stock prices decline, said he is also "very bearish on coal" and is "pretty much short" all the large leveraged U.S. coal companies, with the exception of one.

"We're even seeing slipping demand for coal in China due to pollution concerns," Chanos said. In the United States the coal companies are facing pressure since the U.S. Environmental Protection Agency is "on the case here pretty stringently."

U.S. coal producers have come under withering competition from shale-derived natural gas, regulatory pressure and slipping demand for steel, especially in China.

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