Burying Oil With No Resurrection In Sight
Summary
- Russian and Saudi oil price war will crush oil stocks again.
- Here's a quick examination of the hedging several oil companies have and the implications for each.
- I am not buying any oil stocks on crash as secular headwinds are overwhelming.
- Investors should still be looking to exit oil stocks opportunistically if possible.
- This idea was discussed in more depth with members of my private investing community, Margin of Safety Investing. Get started today »
Russia and Saudi Arabia got into a spat Friday that turned into an oil price war. Oil prices are plunging in futures markets below $30 per barrel.
While the oil stocks we own are the best of the patch, but that's not saying much. It's hard to sell when there is blood in the streets, but that is what I plan to do.
Russian Roulette
Nobody knows for sure what probable richest man in the world, election messer wither, murderous oligarch, skim king Vlad Putin, has up his sleeve with oil, but here is my thought process.
Not agreeing to a production cut with OPEC backed Saudi Arabia into a corner. Saudi Arabia had only two choices: once again shoulder the burden of oil cuts themselves or decide to go the complete opposite direction and "drill, baby, drill."
Prince Mohammed Bin Salman, presumptive ruler of Saudi Arabia, not one to take to being pushed around, has chosen to raise oil output. He has essentially green lighted OPEC members to flood the market with oil.
What's in that for Russia? Well, about the same thing that is in it for all of OPEC. An outright assault on U.S. oil, shale in particular.
Burying Shale Again
There is around $200 billion of high yield debt tied to shale stocks. Sending the price of oil careening lower is going to impact much of that debt. There will be bankruptcies from this. Several will happen quickly.
Hedges on oil production will protect some companies, but not completely. Few oil companies are completely hedged because they always want some upside in the event of a price surge.
Come April, many oil companies have their loans and debt facilities evaluated by the banks that lend to them. Given the pressure that banks already face from concerned shareholders and the divestiture movement, I do not expect there to be much generosity.
With banks unlikely to come to the rescue again, we should expect several oil companies to declare bankruptcy by summer.
The Next Shale Resurrection
Private equity and management will then come in to take over from destroyed shareholders.
Why would management and private equity buy the corpses, sometimes warmed over from a previous bankruptcy, of the oil industry? It comes down to conventional production and rational expectations of future unconventional production.
Companies with conventional production have ongoing revenue streams that cost little to support. Fracking is going to come under increasing EPA pressure at some point, whether 2021 or later, and companies have to factor that in.
The companies with the best profiles for riding out the end of the oil age over the next two decades will get a bid. That bid will not be terribly high though. Expect vulture pricing. The management and PE firms will then control production to maximize profits and line their pocketbooks.
What that means to oil stock investors is that there is likely no coming back from this for many oil stocks. The SPDR Oil And Gas E&P ETF (XOP) has already been on the slide to oblivion. It is there now. And will likely sink further in, with little hope of rising again. Holders of XOP should sell, take their losses and remember this old Wall Street adage: "you don't have to make your money back where you lost it."
Oil Hedges Among Permian Focused Oil Companies
As you know, I believe that Chevron (NYSE:CVX) and Exxon (NYSE:XOM) especially are doomed to massive shrinkage and possible breaking up. So, I don't really even care what their plans are. They are both value traps as I'll write about separately.
The only companies in the oil patch that I am interested in are those with a Permian focus or at least major Permian operations. Those companies, especially those with some conventional cash flows and pending new natural gas revenues due to new pipelines, have a chance to thrive as U.S. oil production ebbs, intermediate term demand settles onto the "peak oil plateau" and the potential for Middle East conflict exists.
Briefly, here are the hedging positions (generally found in company presentations on their websites) of five companies that some of us have small positions in:
- Devon Energy (DVN) - has about 40% of oil production hedged at $53 per barrel, leaving about 60% exposed to crashing oil prices. Devon's break even is $46.50 per barrel. Oil crash could dent share buyback program.
- Occidental Petroleum (OXY) - set up hedges to be able to pay dividend in 2020 with oil at $40 per barrel. They are essentially not hedged in 2021 and need an oil price rebound to avoid the fire sale Carl Ichan warned about.
- Ovintiv (OVV) - 70% hedged in 2020 at $52/bbl. They do own short puts at $43.44/bbl offsetting long puts at $53.44, meaning they are making $10 on that spread, but will have to either buy oil or make up the price difference below $43.44 if there is one later. One of the better hedge books relatively speaking.
- Parsley Energy (PE) - most production is hedged with break even near $40 for 2020, though they are not hedged for 2021 yet.
- Pioneer Resources (PXD) - has approximately 50% of 2020 volumes hedged with break even in the low $40s per barrel.
What you can see with the hedging positions of these companies, which are among the best hedged, is that they are only hedged to break even prices in the lower $40s per barrel. What if oil stays in the $30s per barrel through summer of 2021?
It is very possible that there isn't a single profitable oil company this year.
Oil Investing Approach
For companies that stay in business, which I believe all of those above will, the outlook is still murky at best. Unless oil prices rise significantly, most oil companies will see ongoing major debt obstacles. Occidental is clearly on that list of at risk for a debt crisis.
About the only thing that is likely to push oil prices up soon, would be a conflict in the Middle East. As you probably know, I am on record as saying that a conflict involving Saudi Arabia and Iran during the Trump administration was likely. Well, that means it either happens soon or I was wrong. I still put the odds at better that 50/50 that a conflict happens by autumn, but it is no sure thing.
Because I have years of experience in oil related investing, I am likely to take a stab at speculating on an oil recovery at some point. I will trade oil however, not oil stocks. I have been following ForexAnalytix for 3 years now. They do a regular morning webinar that is outstanding. I have appeared on it a few times to boot.
ForexAnalytix research has been spot on and I am likely to look for an entry in line with their trading approach. But, that is what it is, trading. Oil investing is dead.
A few last thoughts on oil investing. I covered "why oil stocks are priced for Armageddon" almost a year ago. All those reasons still hold. And now, we have a Russian inspired oil price war.
Oil is a very manipulated market. Oil executives have been irresponsible in the U.S. The divestiture movement is successful. It's a very hard market to navigate without a supernatural compass.
I believe that oil investing is dead. There is only trading left.
There is an old Wall Street saying: "you don't have to make your money back where you lost it." For most people who want a less speculative approach, I would head that advice. I think most folks are better off and will experience less volatility investing in the "smart everything world."
Send a direct message through Kirk Spano's profile page with the words "half price" in the subject line to receive your first year with Margin of Safety Investing for 50% off.
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25+ years of beating markets with less risk. Margin of Safety Investing. "The three most important words in investing are margin of safety." - Warren BuffettÂ
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I own and operate Bluemound Asset Management, LLC - a boutique registered investment advisory that manages and consults on 9 figures of wealth. I was lucky to have several mentors who managed billions of dollars, including, one who literally helped write the book on option selling. I have now managed money since the middle 1990s through several major market cycles.Â
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Analyst’s Disclosure: I am/we are long OXY, OVV, PE, PXD. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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Comments (106)
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@Kirk Spano @PT Larry @RS055
Mar. 10, 2020 10:39 AM ET•DVN, OVV, OXY, PE, PXD, KMI•Comment!
Summary
The Tony Seba oil scenario is playing out.Only a Middle East conflict meaningfully helps U.S. oil stocks.Better to own alternative energy stocks and speculate on oil prices if you are so inclined.Oil burningA few years ago I discussed Tony Seba, EVs, Solar And $25 Oil. The Seba argument was that technology for EVs and ride sharing would adopt so fast that oil prices crashed. While his thesis is not perfect, it is closer than most bullish oil thesis. With Saudi Arabia and Russia effectively agreeing to disagree on oil cutbacks, the second coming of OPEC "drill, baby, drill" policy is here. U.S. oil companies are once again facing crashed oil prices throwing them into unprofitably. Approximately half of all oil drilled in the U.S. is unprofitable. We are about to see a wave of U.S. oil company bankruptcies and mergers of the broken. U.S. production will fall by roughly a million barrels per day by early next year, if not sooner. The junk debt of oil companies is quickly becoming toxic. There is an old Wall Street saying: "you don't have to make your money back, where you lost it." I think that is good advice. Sell your oil stocks and find better ideas in the fast growing "smart everything" and alternative energy world.Selling Oil Stocks Today
Without equivocation, I am selling all of my oil stocks today on the "hope rally" that something might be different for oil stocks soon.This includes: Devon Energy (DVN)
Ovintiv (OVV)
Occidental Petroleum (OXY)
Parsley Energy (PE)
Pioneer Resources (PXD)
I recommend selling any other E&Ps that you have. I am keeping Kinder Morgan (KMI) as that is a primarily a natural gas pipeline company, in good financial health, natural gas demand is firm, the company is making large stock buybacks and paying a good dividend.The odds of a substantial rebound in U.S. oil stocks that are slim. Here's why:Oil demand growth was almost flat before Coronavirus.
All major car companies are coming to market with EVs by 2025 and most are eliminating their sedan and small SUV pure ICE powered vehicle lines outright by 2026.
Saudi Arabia, OPEC and Russia have lower costs of production for conventional oil than America does for unconventional oil. Why would they be the ones to cut production? I have wondered why about that in print and in webinars before.
U.S. shale companies, with the exception of in the Permian, have already run through the high-graded portion of their inventories. Every U.S. oil basin, ex-Permian, is facing production decline within the next few years.
Environmental regulations are likely to become more stringent in the short or intermediate term, making fracking less economic.
Millennial investors, who are gradually becoming America's new investor class, have little to no interest in oil stocks. So, even if the companies regain profitability, it will be management and private equity that benefit, not shareholders.
Once again, I am selling all my oil stocks, cleansing my soul and moving onto greener pastures.As I discussed in last nights presentation, I want the growth and profitability of the "smart everything" and alternative energy worlds that are going to change the world with more impact that all the technology upgrades since World War II combined, in just the next decade. Disclosure: I am/we are long KMI. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.
My Capitulation And Confessions On Oil Stocks
- Account Management: drive.google.com/...By mid-February 2009, i could no longer control my GREED with capital G.R.E.E.D. and started panic buying despite knowing i was too early in the game of contrarian bottom fishing.--------------------Wanna know how it's like to Bottom Fish with Both Feet?From mid-February to March 6, 2009 bottom:- Citi worst buy fr $6+ to 97cents - almost bk'ed in March 2009;
- BAC from 9+ to 2.52 - almost bk'ed during 2011 EU debt crisis;
- STT from 24+ to 17 and STI among others the less risky;
- etc. overweight in financials; XLF = 85% max discounts.- TEN from $4+ to 67cents;
- DAN from 57cebts to 17cents;
- SIRI from 33cents to 10 cents;
- etc. mid-cap Zombies with more than 95% discounts.- GM from $2 in March 5 to $1 in March 6 bottom;
- Ford from 2 to 1 ditto;
- etc. that collapsed more than 30% in just one day.I feverishly DCA'ed lots of mid- to large cap stocks and ETFs in about 3 weeks out of 150 listed on my radar, prepared from 2006 to 2008 after learning the Grand 1-2-3-4-5 Theory from 2 master traders in 2004 to 2007.SA was flooded by sell Sell SELL!!! recommendations of numerous economists and financial analysts in March 2009 for ZOMBIES with negative balance sheets destined to the chopping block. I bought 3 dozens of mid-cap zombies that became penny stocks @ more than 95% discounts. Many didn't have enough cash to pay employees/electricity/etc. much less to survive for weeks/months on ends, but miraculously they did survive despite seemingly impossible odds.Then doubled down from 70% load 130% leveraged load when i was almost certain the bottom was in in May 6, 2009 using intraday charts with i-ii-iii-iv-v pattern hitting bottom run by 10:30am. Finished buying nonstop by 2:30pm for lunch while SnP500 was still spiraling upwards till closing time. Then added another 15% leverage in March 9 intraday a-b-c pullback down for good measure. ,After SnP500 bottomed in March 6, 2009 bottom of $666.67:- Zombies jumped 300% to 500% within weeks;
- sold 1/3 positions immediately to make sure 2/3 = FREE!- 1+ dozen zombies jumped 10x or more w/in months;
- sold another 1/3 at 1,000% profits or more;
- more than half dozens rallied 2,000+% for years;
- sold most of them over the years;
- except few hundreds/thousands of shares each as memento.
- more than a dozen eventually went bk'ed = inconsequential.- Banks jumped 2x to 3x within w/in months to few years;
- XLF eventually rallied 450% to Jan2018 high vs. 330%/Spx.TEN DAN SIRI MU and ATTU were/are the best performing zombies with more than 2,000% to 18,400% max gains by DAN. GM bk'ed but i sold 1/3 at 3x to 5x profits - ditto for others that bk'ed. AMR later acquired by AAL catapulting my $2.50 average costs to more than $45, i sold them off toward Jan2018 high except a few hundred shares.,This time around, Oil Black Swan = 32+% overnight gap down. Worst than October 1987 Black Swan with 27% gap down that sets the final bottom back then.- Crude Oil Max Loss = 82.22% fr 2007 ATH to 2016 $26 bottom;
- Intraday bottom today = $27.30 before markets opened;- Compq max loss = 80% during 2000/02 Tech Wreck;
- NK225 max loss = 82% during 1989/2008 Lost Decades;
- Gold max loss = 71% during 1980/1999 Lost Decades;Those were some of the best Bottom Fishing Opportunities.- Crude Oil monthly: drive.google.com/...
- daily: drive.google.com/...Don't know if daily chart will work since Oil can be controlled by OPEC unlike SnP500 or Dow Jones. But better be prepared than sorry, know your tolerance level(s) before bottom fishing the oil patch.- myself:First time I experienced a Giant Black Swan bigger than October 1987, henceforth panic bought XLE XOM with hefty dividends of 6+% to 8+% including MEI, AMLP, and MLPA with yields north of 14% to up 20+% to get my hands bloody wet. Not as good as PFF bought in Feb/March 2009 with 15% to 25% yields, but if they kept collapsing might rival PFF soon enough.* also bought some not-yet-Zombies this time around: OXY with whopping 20+% dividends and 90+% discounts + penny stock GTE at more than 95% discounts w/ no dividends. They still got some cash/cash flows and can survive for months/years unlike dead-meat zombies of Feb/March 2009.Hopefully, a lot more SA financial analysts will be shouting sell Sell SELL!!! to high heavens in the weeks/months ahead so I can bottom fish with gusto - like what i did in Feb/March 2009 GFC; during 2011 EU Debt Crisis; during 2015/16 Global Commodity Crisis; and during 2018 Trump Trade Wars.- DJ Reversions to the Mean: drive.google.com/...
- SnP500 Mean Reversions: drive.google.com/... - the FOMO Runs: drive.google.com/...vs.- always Different This Time: drive.google.com/...I got addicted to crises over the years, can't help it after learning how compounding works via 'Buy Low then HOLD' sage advice of Warren Buffett; and of course how profitable Momentum Trend Trading could be - learned from expert/master traders in 2003 to 2009 when i was still a rookie trader with a (dull) ax to grind.Let's see how current events are 'Different This Time' around.
-------I have been working and analyzing entire value chains of this industry for 20+ years .. Do you actually know what these companies do ??? serious question.
