I’m Not Buying the Pullback in Oil. You Shouldn’t, Either

I had a reader write to me the other day, asking: “Are you positioning for the bull run in oil?”

My reply: “Nope.”

I realized I probably should give a longer explanation. And I’ll share it with you. I’ll also share some potential good news from an oil crash. And a way you MIGHT be able to profit. Might.

But, let’s start at the beginning with …

What’s Wrong with Oil?

I probably don’t have to tell you that on Monday, U.S. oil prices crashed as much as 34% to a four-year low of $27.34 a barrel. The oil price has since “stabilized” around $33 a barrel.

You know who makes money at $33 per barrel? Just about nobody.

So why did this happen? Well, the fear of the COVID-19 coronavirus has caused global oil demand to tank by about 3 million barrels per day. Saudi Arabia, acting as the head of OPEC, met with Russia to discuss cutting production in a big way. Russia said no.

The Saudis are well known for being even-tempered. And yes, I’m kidding when I say that. Anyway, they responded to the Russians by saying: “Fine! We’ll crank up production and see how you like that!” Thus, oil prices swooned.

One babbling head after another has gone on CNBC to talk about the Saudi-Russki stalemate and how this will impact both oil-focused economies. What boobs! I don’t think the Russians give a flying bowl of borscht about what impact this has on Saudi Arabia.

Russia Targets America’s Shale Patch

No, the nation squarely in their sights is the United States. Specifically, our shale oil patch.

Here’s a chart from Reuters that shows what was obviously on Russia’s mind when it said “nyet” to proposed cuts.


 

As you can see, the up-and-coming global oil producer is America. Major U.S. companies have boosted production to a record near-13 million barrels per day (bpd). Heck, U.S. oil production went up 5.8 million bpd from 2020 to 2019.

Every barrel we pump undermines efforts by OPEC nations to cut supply. Our surging production is threatening the stability of both Russia and the sand-kings of Saudi Arabia.

But America’s production surge isn’t possible without high prices. Shale oil operations tend to be very expensive. Many U.S. operators need AT LEAST in the low $40-per-barrel-range to break even. Some need higher … potentially much higher. Meanwhile, the Saudis can lift a barrel at about $20 a throw.

Those are just the prices to lift oil out of the well. There are other expenses — operations, exploration and more. On average, oil companies need $50 per barrel to break even, if you include dividends and buybacks. We are now at $33.

If crude stays at these levels, U.S. oil producers will lose about 80% of the cash flow that they counted on this year. And you know what? It gets worse.

In Debt Up to Their Eyeballs

To pump all that oil, U.S. oil companies went into debt up to their eyeballs. About $936 billion worth! Now, $110 billion worth of bonds sold by energy companies are in “distressed” territory.

Almost $40 billion of U.S. oil and gas debt comes due this year, according to S&P Global. I think there are a lot of companies that will have to merge or go out of business.

The White House is strongly considering pushing federal assistance for oil and natural gas producers. That might help. It also might just delay the inevitable and allow “zombie” companies to keep walking and leech up investor dollars.

This all sounds bad. But there is good news, too. To reach it, first we need to hit these important developments …

  1. U.S. Oil production must go down. And to that point, the Energy Information Administration (EIA) has already lowered its forecast for 2020 U.S. crude oil production by 1.6% and slashed its target for 2021 production by 6.6%.
  1. Weak companies must merge or go out of business.
  1. The global economy needs to recover and start using more oil.

When these things happen — or look like they’re about to happen — I might turn bullish on oil again. But not before.

Waiting on Opportunities

Wait! I promised good news, right? And here it is …

Firstly, lower oil prices are a boon to consumers. According to Morgan Stanley, if consumers spend all their gas savings, that will boost economic growth by 0.6%.

We’ll have to balance that against the negative impact of oil companies laying people off and going out of business. But it should be a net positive.

Secondly, when oil stocks bottom, some of them are going to be ridiculously cheap. AND many will still pay fat dividends.

I’m looking at pipelines specifically. Many are laden with debt, sure. But not all are. And the pipeline business works on long-term contracts. Many of them will be getting paid whether oil and gas flows or not.

So, I’m not a buyer just yet. But I’ll be looking at members of the Alerian MLP ETF (NYSE: AMLP) when the time comes.

All the best,

Sean

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