Chevron and Exxon beat expectations. Lower oil prices can still hurt.

It is a sign of the ceiling the shares now face with oil and gas prices falling from last year’s levels. Oil has recently traded below 80 dollars per barrel, compared to prices above 100 dollars last year at this time.

Chevron (ticker: CVX ) reported earnings per share of $3.55 compared to the consensus call of $3.40. The stock fell 0.5% in pre-market trading on Friday.

Exxon Mobil (XOM), the largest U.S. oil company, reported earnings of $2.83 per share, compared to the consensus estimate of $2.60. The shares rose 0.7 percent.

There are signs of cost growth that could cause concern among investors.

Chevron’s capital spending rose 55% over last year’s levels, even as production fell 2.6%. CFO Pierre Breber said in an interview with Barron’s that the decline in production had to do with some discontinued operations, including a concession in Thailand that it no longer operates. Investments increased mainly because it is expanding in the US, with the expectation that production in the Permian basin will increase significantly in the second half of the year. Breber said a small part of the increase had to do with inflation.

“There’s a lag between using capital and seeing production,” he said, noting that “our Permian production is back-end loaded. You’ll see that especially in the second half of the year, and you’ll see it in other parts of the portfolio.”

Exxon’s production is on the rise, growing by 150,000 barrels per day last quarter, or 4.2%, year over year. Capital costs increased by 36%.

However, Chevron has been more aggressive than Exxon in its policies for shareholder returns. The company’s goal of buying back $17.5 billion worth of stock per year will reduce its share count more than Exxon’s because Chevron has a smaller market capitalization. And the dividend yield is 3.6% versus Exxon’s 3.1%.

Yet both companies are now dealing with a different market than they faced last year: one with fewer clear opportunities for growth. They will also struggle to top their 2022 performances. Exxon was up 80% and Chevron 53%.

A year ago, the war in Ukraine drove Exxon and Chevron’s earnings to new heights. But oil prices have been falling even as the war drags on, as demand slows around the world amid fears of a recession.

The forces that drove the shares up last year have disappeared, and investors are waiting for the next catalyst.

At a fundamental level, both Exxon and Chevron are in strong shape. They are much more efficient than they were before the pandemic, consistently raising dividends and buying back shares. But they still have trouble attracting new investors because earnings are expected to flatten out over the next few quarters.

Although earnings in the first quarter exceeded last year’s levels, this may be the last quarter in at least a year where the companies have an increase from year to year. This is largely due to the decline in oil and gas prices, a factor the companies do not control.

One of the biggest questions from analysts in the coming quarter will be about mergers and acquisitions. Both companies are flush with cash, and analysts have speculated whether they will make deals to consolidate the industry and increase inventory.

In the interview, Breber said any deal would have to clear a “very high bar” because Chevron has other ways to grow.

“We have multiple growth vehicles – not just in the Permian, but in the Gulf of Mexico growing 50% by 2026; Kazakhstan, where we have invested for a number of years in a very large project, which starts towards the end of the year; and other shale and dense [formations]especially the DJ pool in Colorado and in Argentina.”

That said, he expects the industry to eventually consolidate.

“We’ve talked about now that we think this industry will consolidate over time, as it has in the 34 years I’ve been in the sector,” he said. “For an industry with low growth, there are too many companies. And it’s hard to find another low-growth industry that wants so many companies.”

Analysts expect some deals in the near future.

More producers “could be acquired in the coming quarters given the desire by more companies like Exxon to increase inventory,” Truist analyst Neal Dingmann wrote earlier this month. “2023 has already started as an active year for upstream M&A, and we think things could remain just as busy throughout the year.”

Given its strong balance sheet, Exxon is in a good place to make acquisitions, Citi analyst Alastair Syme wrote. He believes the company could even buy a European oil major.

“We continue to argue that transatlantic mergers and acquisitions can provide a huge economic boost,” he wrote after the earnings announcement. “There are also potential value opportunities through scaling (i.e. acquisitions) in the highly fragmented Permian basin, where Exxo still only sits as the number 4 player (measured by resources).”

Exxon has spoken with shale driller Pioneer Natural Resources (PXD), according to a report in The Wall Street Journal, although neither company has commented publicly on a possible deal. Exxon characterized it as “market speculation or rumor.” Chevron made several acquisitions early in the pandemic, but has been quiet of late – focusing instead on increasing share buybacks and increasing dividends.

Over the past three years, investors have largely been negative about acquisitions because they feared buyers would pay too much. However, that may change if they believe that the big oil companies can buy attractive properties at reasonable prices.

However, not everyone expects deals. Pioneer Natural Resources CEO Scott Sheffield said in an interview with Barron’s this week that he does not expect mergers and acquisitions in the near future, in part because acquiring companies appear unwilling to pay significant premiums.

Write to Avi Salzman at avi.salzman@barrons.com