Oil demand could drop as Saudi Arabia AND Russia’s production equivalent: what this means for oil stocks
2020 was one of the worst years for oil that most people have known. Since oil prices peaked in early January, West Texas crude futures have fallen 70% and are threatening to fall below $ 20 for the first time in nearly two decades. We’re on a bad day with US crude prices at their lowest since the 1990s.
This sudden and brutal fall is largely due to Saudi Arabia goes to war over oil against Russian and American producers, with an all-out attack to flood the world with crude and lower prices for an extended period.
And as bad as things are, it could get a lot worse. By April 1, when Saudi Arabia starts increasing its crude exports by 43%, global demand is expected to have fallen by 20 million barrels per day.
It is the equivalent of both Saudi Arabia and Russia’s average oil production in 2019. And with Saudi Arabia and Russia both planning to turn on the taps on April 1, oil prices could continue to decline as the supply-demand balance shifts. any further.
Unprecedented times for American oil companies
American producers in particular are at risk in this environment. Many are already heavily in debt and have minimal access to additional cash. Crude oil is now selling for about half of what it costs many producers to get it out of the ground and put it on the market.
As a result, stocks of oil producers collapsed. The ETF SPDR S&P Exploration and production of oil and gas (NYSEMKT: XOP) has lost more than two-thirds of its value from the 2020 peak.
It could easily get a lot worse. After years of aggressive spending to increase production, producers have started to empty their budgets. Apache (NASDAQ: APA) and Pioneer of natural resources (NYSE: PXD) were among the first to announce plans to cut spending by 40% or more. Other major shale producers such as EOG Resources (NYSE: EOG) and Western Oil (NYSE: OXY) also announced significant cuts, saying their goals were to balance cash flow with oil prices hovering around $ 30.
Oil was trading at close to $ 30 when these spending cuts were announced; they won’t be close to closing the gap now, with Saudi Arabia intending to flood even more oil in a market that not only consumes less, but is on the verge of running out of places to store all of it. excess.
Further spending cuts are starting to appear. Occidental announced last week that it would take more drastic measures, further reducing its capital spending plans and adding $ 600 million in business and operating expense reductions to the plan.
Just the first domino to fall
Independent oil producers are the most exposed part of the energy sector, but not the only part that will be affected by a prolonged period of massive oversupply and falling demand. As oil producers start to run out of money – and it will happen faster than expected – in the months to come, we will see a domino effect as all service providers and suppliers will stop being paid.
This includes drilling contractors, companies that fracture and complete wells so they can be brought online, companies that sell everything from drills to frack sand to pipes, truck drivers who deliver. goods and a multitude of others.
Even many mid-market companies, the so-called “secure” sector of the petroleum industry, will feel the effects. It doesn’t matter how firm your contract is if the oil producer is insolvent. As a result, many have already started cutting their dividends, joining companies in the oil and gas value chain by reducing payments. Following intermediate stocks will be forced to reduce their dividends in the near future as well.
What should an investor do? Invest with caution and avoid pure-plays
I went on the folder that there will be winners in the 2020 oil crash. And I still expect many of the best companies in the industry to survive, and many will thrive for years to come. Those with the best prospects are diverse giants like Chevron (NYSE: CVX), Royal Dutch Shell (NYSE: RDS.A)(NYSE: RDS.B), and Phillips 66 (NYSE: PSX) (my choice for the biggest winner). These companies all have substantial cash balances and have plenty of extra cash and manageable debt levels that should help them weather what could be a very ugly year ahead.
Most importantly, all three have something that independent producers and most companies that work in the oilfields don’t: diversification. Chevron and Shell will report huge losses in their oil production segments this year, but unlike outright independent producers, they will be able to rely on their other segments, such as petrochemical manufacturing, to help offset some of those losses.
This does not mean that they will not suffer; my expectation is that at least one of the three will likely end up cutting dividend payouts, and I expect them all to lose money for several quarters in 2020. But they have the strength of the balance sheet and several segments in their business to. help to avoid the worst losses to happen in the oil zone.
I’m not willing to predict when things will start to improve, but when they do, it’s the biggest, best-capitalized, and most diverse companies in the oil and gas industry that will come out on top. side. If you do decide to invest in oil stocks, I suggest you keep this in mind – and accept that there is huge risk ahead – before you buy.
This article represents the opinion of the author, who may disagree with the “official” recommendation position of a premium Motley Fool consulting service. We are heterogeneous! Questioning an investment thesis – even one of our own – helps us all to think critically about investing and make decisions that help us become smarter, happier, and richer.