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West Texas Intermediate crude oil futures fell below zero on April 20, bottoming below $ 38 a barrel negative. In other words, merchants were payment buyers to take contracts. And while yesterday’s mess was in part an odd whim: contracts were for deliveries in early May, and many of the merchants didn’t have warehousing lined up and had to pay others to take the contracts out of their hands, it was also an indicator of how incredibly unbalanced the supply and demand sides of the oil industry are.
Even after yesterday’s bloodbath, oil futures are still heavily defeated. June West Texas futures are trading below $ 14 a barrel at recent prices. Brent, widely considered the most important global benchmark, is down 25% today, with June contracts below $ 20 a barrel at recent prices.
Some of the biggest names in the business are being hit. Oil producer actions. Occidental Petroleum (NYSE: OXY) and ConocoPhillips (NYSE: COP) they fell 74% and 50%, respectively. Oil services giant baker hughes (NYSE: BKR) the stock has dropped by half. Even the integrated giants like ExxonMobil (NYSE: XOM), Royal dutch shell (NYSE: RDS.A)(NYSE: RDS.B) and Phillips 66 (NYSE: PSX) they have lost more than 40% of their value.
Image source: Getty Images.
There are a handful of sayings that investors often repeat during these kinds of tough times. The two most popular are Warren Buffett, who is “greedy when others are afraid,” and one that has been attributed to several people: “buying when there is blood on the streets.” Is it one of those moments now? It sure feels that way.
Is it time to buy oil reserves? My answer is, in most cases, no. Yes, there is often an immense opportunity to make a profit in uncertain times, but the oil and gas industry is a minefield for individual investors today. Until the risk / reward profile improves, it may be best to stay on the sidelines.
Unprecedented supply and demand imbalance
Global demand for oil has fallen catastrophically due to the spread of the coronavirus causing COVID-19, and it is far from clear how soon, or how much, that demand will recover. Estimates are quite broad, but oil consumption is expected to drop more than 30 million barrels per day in April and May, a 30% decrease in oil demand. “Unprecedented” is simply not a word big enough to describe the repercussions of such a dramatic decline in world oil demand.
As a result, the supply side is in complete disarray. Industry is not built to deal with a 5% drop in demand, much less the massive 30% drop we have experienced. We saw it on April 20. When oil traders were left with contracts for oil deliveries in a few weeks for which they had no storage, they were forced to pay others to remove contracts from their hands.
April 20 could become the fund; It is going to be difficult to overcome (or lower) a situation where traders pay almost $ 40 a barrel to get out of contracts. But it is a mistake to assume that the environment will only improve from here. Oil prices are certainly going to improve, but the reality is that oil prices will remain well below profitable levels for many oil companies in the coming months.
It will not improve overnight.
Global oil demand is expected to drop 30 million barrels per day or more from pre-COVID-19 pandemic levels. And while that is arguably the biggest reason that oil prices have collapsed and why so many industry players are at risk of insolvency, it is only part of the picture. Since April 1, world oil production actually increased, after the expiration of a previous production regime between OPEC and Russia.
That could remain the case until May 1, when the historic agreement to take 10 million barrels a day off the market begins. Before that happens, the world will have gone through a potentially full month of production that will exceed consumption somewhere between 30 million and 40 million barrels of oil every day.
Even when the calendar turns May, more oil will still be pumped out of the ground than is being consumed. Oil markets are already pricing this expectation. West Texas futures futures are trading below $ 30 a barrel through February of next year.
What it means for oil reserves
Let’s start with this reality: not all oil produced in North America is listed on futures exchanges, and the prices you see expressed are not necessarily the prices that oil companies get for their production. A large amount of produced oil is sold under private contracts and directly by oil producers to clients such as refineries. Yesterday is an excellent example of when merchants took a beating on oil prices, and not the oil companies directly.
But futures do set the market, and there is clearly very Little appetite for American oil today. It is likely to remain that way for many months. Even as demand begins to recover as the economic impact of the COVID-19 recession lessens, there will be months and months of excess oil through which the industry will work before oil producers can begin to increase production. You can bet that anyone who is storing oil will become increasingly interested in selling it the longer they stagnate paying for storage. Thus, low prices could remain the norm even months after demand begins to recover.
And that, plain and simple, could mean that it takes much, much longer for any overall economic recovery to show up in the bottom line of the oil companies. Frankly, I expect to see a strip of bankruptcies in the sector as this recession continues. And it’s not just onshore oil at risk. Offshore drilling stocks never really recovered from the 2016 collapse, and Offshore diamond drilling (NYSE: DO) You are not expected to make your next interest payment. That means the company will likely default on all of its debts, a precursor to bankruptcy.
Are there any oil stocks worth buying?
Investors would do well to stay away from companies overly linked to oil production. A company like Occidental may seem attractive because its share price is down 75%, but it is going to spend billions of dollars just to stay afloat, and it could be 2021 before oil prices have risen above production costs, let alone be profitable. Baker Hughes and other oil services companies cannot sell oil, but they do have the producers to make a living. That means they will suffer the same, while also potentially stalling waiting in bankruptcy court to award them payment for customers who become insolvent.
If you are determined to invest in oil, the best place to look is integrated specialties. My main two are Shell and Phillips 66. Shell has a large natural gas business that helps offset some of its still substantial exposure to oil production, while Phillips 66 does not produce oil. Both companies will see big losses in their refining operations due to falling demand for motor fuels, but between their strengths in natural gas and petrochemicals, along with considerable cash balances, both are designed to weather the recession. And they should be quite profitable when the recovery finally kicks in.
The big risk here is that the recovery could take much longer than investors expect, and at the cost of missing better opportunities outside of the oil patch.
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