If we do see a recovery in oil price in the short term, there are LOTS of oil stocks that can go up by several hundred percent. And one thing I have grappled with in my mind, is whether I am being overly pessimistic. Even if oil prices will probably stay low, if (to use entirely hypothetical numbers) there is a 30% chance that they could recover to $60 by june, then it may be worth buying stocks that would go up by 300% under that scenario, even if they might go to zero under another scenario. We may be reaching the point of maximum pessimism. In not buying, I accept that i am likely to miss the bottom, but I am waiting for some sort of concrete sign that oil prices are likely to stabilize.
Below are my views on the various equity segments. I haven't been spending any time on this really so I would caution that these are impressions as opposed to any sort of deep analysis:
1) E&Ps- LOTS of them will most likely go bankrupt, and they are generally carrying too much debt to be attractive as acquisition targets. They are running out of rope for several reasons. Their scope for further cost reductions and efficiency gains is probably limited. Their hedging programs, which have hugely helped them in the past year, will provide less and less benefit as they run out. The inventory of uncompleted wells have provided cash flow as they reduce capex and kept production level. At some point these will run out, and production rates will start to decrease. Finally, and perhaps most importantly, with debt trading at distressed levels, they will have trouble rolling it over, and at the very least will have to accept much higher interest costs as they issue new debt to roll over the old. A huge number of companies would eventually go bankrupt if oil prices stay at this level.
2) Integrated Companies- Exxon, Shell, Total, Chevron. These guys have been shielded by the declines in several ways. Refining margins and chemicals have been terrific in North America, but with the end of the export ban, and regional differentials the lowest they've been in years, many of the drivers of North American refining profits are abating. they still have low cost natural gas to give them a cost advantage vs Asian and European refiners, but its hard to see how profits in refining don't come down. Secondly in the upstream sector, the nature of production sharing contracts (typical for oil majors operating overseas) is such that capex gets paid off before the government starts taking their lion's share of the profits, this insulates risk for the majors. So while the price declines can make a north american tight-oil well a big money-loser, large overseas projects won't necessarily be hemorrhaging money for the majors since the capex costs will still be recovered. But the majors' core expertise has become doing high cost technically complex projects, often offshore. These projects simply don't make sense going forward, unless we see a significant price increase. Its unclear how they will replace declining production, unless they can buy shale assets in bankruptcy, as the E&Ps go bust. I'm not sure that Exxon trading 20% off its peak levels, and 20x 2015 earnings, truly reflects their change in circumstances since $100/bbl oil. The big dividend yields of the European companies like Shell are tempting, but these are payout ratios of well over 100% at this point, and not at all sustainable. All of these companies are pricing in a significantly higher oil price, a dangerous situation for investors.
3) Offshore drillers- These were always a bit of a suspect business to me. In the good times, people order new-builds. In the bad times, all but the newest drill-ships become almost worthless. And after decades of deepwater experience costs are still very high. Meanwhile on-shore tight oil costs have come down dramatically in just 6 or 7 short years. Capex budgets for onshore can be rapidly cut, while offshore they have to plan for many years into the future. A bad accident offshore can result in a $50b charge (see BP Horizon spill) unlike onshore drilling. I'm not saying that offshore drilling will die entirely, but it would not be surprising to me if we see an excess supply of rigs for a decade or more in the future, and essentially no new builds.
4) Refining- High North American refining margins were supported by large regional differentials. These differentials were caused by rapid production growth in certain regions like North Dakota and West Texas. With supply declining, logistical constrains will ease. Already the famous WTI-Brent spread, which first blew out in 2010, has now collapsed. Its hard to see how refining margins don't contract significantly, but I must admit this is not an area that I know a ton about.
5) Pipelines- 2015 was a horrendous year for pipelines and MLPs. Kinder Morgan, the poster child for MLP related financial engineering, has crashed from a peak of $44 down to $14. MLPs were billed as being insulated from price changes, but that apparently was not the case. I wonder if this crash has now been overdone. I really don't feel qualified to make a recommendation here without doing some extensive work.
Below are my views on the various equity segments. I haven't been spending any time on this really so I would caution that these are impressions as opposed to any sort of deep analysis:
1) E&Ps- LOTS of them will most likely go bankrupt, and they are generally carrying too much debt to be attractive as acquisition targets. They are running out of rope for several reasons. Their scope for further cost reductions and efficiency gains is probably limited. Their hedging programs, which have hugely helped them in the past year, will provide less and less benefit as they run out. The inventory of uncompleted wells have provided cash flow as they reduce capex and kept production level. At some point these will run out, and production rates will start to decrease. Finally, and perhaps most importantly, with debt trading at distressed levels, they will have trouble rolling it over, and at the very least will have to accept much higher interest costs as they issue new debt to roll over the old. A huge number of companies would eventually go bankrupt if oil prices stay at this level.
2) Integrated Companies- Exxon, Shell, Total, Chevron. These guys have been shielded by the declines in several ways. Refining margins and chemicals have been terrific in North America, but with the end of the export ban, and regional differentials the lowest they've been in years, many of the drivers of North American refining profits are abating. they still have low cost natural gas to give them a cost advantage vs Asian and European refiners, but its hard to see how profits in refining don't come down. Secondly in the upstream sector, the nature of production sharing contracts (typical for oil majors operating overseas) is such that capex gets paid off before the government starts taking their lion's share of the profits, this insulates risk for the majors. So while the price declines can make a north american tight-oil well a big money-loser, large overseas projects won't necessarily be hemorrhaging money for the majors since the capex costs will still be recovered. But the majors' core expertise has become doing high cost technically complex projects, often offshore. These projects simply don't make sense going forward, unless we see a significant price increase. Its unclear how they will replace declining production, unless they can buy shale assets in bankruptcy, as the E&Ps go bust. I'm not sure that Exxon trading 20% off its peak levels, and 20x 2015 earnings, truly reflects their change in circumstances since $100/bbl oil. The big dividend yields of the European companies like Shell are tempting, but these are payout ratios of well over 100% at this point, and not at all sustainable. All of these companies are pricing in a significantly higher oil price, a dangerous situation for investors.
3) Offshore drillers- These were always a bit of a suspect business to me. In the good times, people order new-builds. In the bad times, all but the newest drill-ships become almost worthless. And after decades of deepwater experience costs are still very high. Meanwhile on-shore tight oil costs have come down dramatically in just 6 or 7 short years. Capex budgets for onshore can be rapidly cut, while offshore they have to plan for many years into the future. A bad accident offshore can result in a $50b charge (see BP Horizon spill) unlike onshore drilling. I'm not saying that offshore drilling will die entirely, but it would not be surprising to me if we see an excess supply of rigs for a decade or more in the future, and essentially no new builds.
4) Refining- High North American refining margins were supported by large regional differentials. These differentials were caused by rapid production growth in certain regions like North Dakota and West Texas. With supply declining, logistical constrains will ease. Already the famous WTI-Brent spread, which first blew out in 2010, has now collapsed. Its hard to see how refining margins don't contract significantly, but I must admit this is not an area that I know a ton about.
5) Pipelines- 2015 was a horrendous year for pipelines and MLPs. Kinder Morgan, the poster child for MLP related financial engineering, has crashed from a peak of $44 down to $14. MLPs were billed as being insulated from price changes, but that apparently was not the case. I wonder if this crash has now been overdone. I really don't feel qualified to make a recommendation here without doing some extensive work.
