Big Oil companies Exxon Mobil Corporation (NYSE: XOM) and Chevron Corporation (NYSE: CVX) have suffered massive drops in their profits and stock prices over the past year.

Of course, the crash in oil and gas prices is the key reason for this. WTI crude oil currently hovers near $45 per barrel, down 55 percent from last year’s peak of $110 per barrel. In response, Big Oil is cutting capital expenditures and spending less on stock buybacks. But so far, Exxon Mobil and Chevron have not cut production. The same is true for most of the world’s oil producers.

In fact, it looks like they may continue to increase production, which may be a short-term measure hoping that others will feel the pinch and cut production, before they have to. Growing production at such uneconomical pricing cannot continue forever that is if each individual producer (acting like an independent agent) keeps doing the same. It only exacerbates the low-price environment. As a result, there is a strong possibility Exxon Mobil and Chevron may need to make meaningful production cuts going forward. Investors should watch Big Oil carefully. Once one of these companies cuts production, it might suggest a tradable bottom for oil prices. 

Spending Cuts Not Enough to Keep Earnings Afloat

Both Exxon Mobil and Chevron have significantly reduced costs in a number of areas this year. Exxon Mobil cut capital expenditures by 12 percent in the first half of 2015, year over year. Moreover, Exxon Mobil reserved just $2.7 billion for share buybacks over the first six months, down from $6.8 billion in the same period last year.

Meanwhile, over the first half of 2015, Chevron cut capital expenditures by 13 percent compared to the same period last year. In addition, Chevron sold $3.9 billion of assets just last quarter, and has realized nearly $11 billion in asset sales over the past 18 months. Lastly, Chevron won't buy back stock this year, which will save another $5 billion of cash.

And yet, these measures have not stemmed the declines in revenue and earnings so far this year. Exxon Mobil’s profits fell 52 percent last quarter, year-over-year, to $4.1 billion. Earnings per share fell 51 percent to $1.00 in that time. Clearly, the collapse in oil and gas prices was the primary culprit for this, as upstream operations are being the hardest hit this year. Exxon Mobil’s upstream exploration and production business, which is highly dependent on supportive underlying commodity prices, saw profits decline by 75 percent. Similarly, Chevron earned just $571 million last quarter, down from $5.6 billion in the same quarter last year.

Why a Production Response May Be Next

As stated previously, Exxon Mobil and Chevron have employed significant cost-cutting efforts to streamline expenses. This has included selling off assets, reducing workforces, and cutting stock buybacks. One step they have not taken thus far, is to cut production of oil and gas. Exxon Mobil increased oil-equivalent production by 3.6 percent last quarter, due to an 11.9 percent increase in liquids production. Chevron boosted its total production by 2 percent.

So far, the integrated oil majors have grown production in an effort to support revenue. With oil currently sitting at $45 per barrel, oil companies can help keep revenue intact by producing more. The downside to this strategy is that with energy prices so low, margins are collapsing, resulting in significantly reduced profitability.

But with commodity prices at uneconomic levels, it stands to reason Exxon Mobil and Chevron will eventually look to production as the next area to make cuts. Looking at it from market perspective, that may be the only way for the oil industry to spur an increase in energy prices, as OPEC has signaled little willingness to cut production perhaps for similar reasons. Going forward, both Exxon Mobil and Chevron have significant upstream projects that are set to ramp up production soon.

For example, last quarter, Exxon Mobil made a significant oil discovery in Guyana on the 6.6-million-acre Stabroek Block. And Exxon Mobil’s huge Kearl oil sands project in Alberta, Canada, has started production ahead of schedule and doubled gross capacity last quarter. Total Kearl production capacity now stands at 220,000 barrels per day. The Kearl project holds approximately 4.6 billion barrels of resources, over an expected project lifespan of more than 40 years.

In Chevron’s case, it is counting on two massive liquefied natural gas (LNG) projects in Australia known as Gorgon and Wheatstone. The Gorgon Project includes a 15.6 million tonnes-per-annum liquefied natural-gas facility. The project is more than 90 percent complete. Management stated on last quarter's conference call with analysts that they expect Gorgon to start up in the third quarter this year, and have first gas by the end of the year. The Wheatstone development is almost 60 percent complete, and includes two LNG trains with a combined capacity of 8.9 million tonnes per annum. First shipments are expected next year. 

These two projects are extremely important to Chevron's future. Collectively, the investments Chevron made in its Australian projects accounted for $7.1 billion, or 46 percent, of its investments in oil and gas producing activities last year. The reason for such huge investment is because Australia holds a vast amount of discoverable reserves. Furthermore, Australia accounts for 64 percent of Chevron's proved undeveloped natural gas reserves.

Companies to Watch

ExxonMobil and Chevron are two of the biggest mega-caps in the stock market, and shares of both company have underperformed the S&P 500 Index this year. Watching these companies may provide a more transparent view into the oil markets generally. 

Other integrated oil majors include Royal Dutch Shell (NYSE: RDS-B) and BP plc (NYSE: BP). Investors should closely monitor these companies as well, as their earnings have sharply declined this year.

Energy industry research firm Entelligent is about to release a lengthy report on Chevron and will be issuing the company an E-Score. Entelligent’s E-Score is a model analysis using financial and environmental metrics to estimate a company’s standings against an industry benchmark composite score.  This Entelligent Report is designed to help investors make more informed decisions about the world’s most influential energy companies. 

Bob Ciura is an independent equity analyst. Since 2012, his work has focused on fundamental investment analysis of publicly-traded companies in the energy, technology, and consumer goods industries. Bob has a Bachelor's degree in Finance and an MBA in Finance.