Long before the pandemic of the virus hit the world, it was drowning in a pool of excess oil. The oil index ($XOI) declined 500 points in 2018 from 1600 level to a low in December of that year. Then, it was range bound from the lows of 1100 to a high around 1300 until February of this year.
60% decline
Yes, in one month the index fell below 500 from the 1300 level. The flu arrived and it showed its effects. Since that dangerous level, it has staged a rally, if you want to call reaching the 800 point level a rally. It is like a baseball game (since this would be that season) where you are losing 12 to nothing. Then, your team scores six runs to make the final look competitive. It wasn't. It was a rout.
Asset value
At its present price, oil is trading below its asset worth. What does this mean, you ask? Could it go lower? These are good questions. It means that to find and produce a barrel of oil, a certain level of investment is required. Remember, we all need energy every day and oil with its by-products are in many, many consumer items. In a way, it is almost like water at least to our way of life. We have to have it. The present price of crude on Friday was $19.78 for US sweet and $26.44 for Brent sour. No oil firm can survive with those prices.
If you believe that market price tests its high as well as its lows, then we have tested the 1969 lows just prior to the first Arab Oil Embargo. You can do the math, but keep in mind the value of the dollar has declined due to inflationary forces and debt. Also, state and federal taxes have been increased. Charting is a necessary tool.
So, what price should it be?
Basically, oil has too much invested in it by too many influential firms, people and nations to disappear. It is the world's most important commodity for the present deviation to radically change its need and importance. When all is said and done, oil should trade from $42 to $64. However, many price changes will occur before that stability is reached. Then, one must consider the rise of electric cars into the equation. At the moment, every oil firm and producer is cutting back production to minimize the losses because oil is selling for less than it costs to produce.
In related industries, both the trucking and airlines lockdown has deepened the hurt for oil firms. The need for trucking has declined considerably. Flightrader 24 reports the number global flights for April was 33,500. The normal number is around 100,000 flights per month. Together, this lack of demand has added to the glut. This will take time to change, especially with public demand.
A closer look...
Exxon reported its first losing quarter since 1997. As a result they are cutting spending by 30%. They are not alone. The other American giant, Chevron also announced it is cutting spending. However, both firms declared that their dividend is safe. This will add some stability for its share price. The two big boys were joined by another conglomerate, Conoco-Phillips. Together, the three will trim production by 600K barrels a day this month. Exxon and Chevron will cut production another 800K barrels a day in June. This is a serious decline in energy. When you add the agreement between Russia and OPEC to cut production, the present oil glut will be razor cut, little-by-little. Global usage was about 100 million barrels a day before the virus. It dropped 30 million barrels in April.
These production cuts take time for their effect. If the world economy begins to racket up by December along with the US and Chinese economies, I foresee another oil spike come next early in 2021. Why? Because the demand will exceed the supply. You should know this from the recent financial crisis of 2008. The playbook of production cuts work, but it comes with a heavy price.
In the meantime, as stated, there will be many obstacles to climb Mt. Normalcy before stability returns. For instance, Royal Dutch Schell announced a dividend cut from 47 cents down to 16 cents. Sweden's giant, Equinor eliminated its first quarter dividend. Many, many other smaller firms have cut their dividend completely. This will continue to wreck oil share prices. Even with all producers seeking to trim production, Mt. Normalcy has other roadblocks like bankruptcies (WLL-Whiting), job cuts and possible consolidation. I think the last point is a positive. Acquisition is cheaper than exploration. Estimates of capital expenditures is around a whopping $100 billion for 2020.
World suppliers in seeking to cut production will find it harder than US firms. They have sharing agreements (UK and Sweden), government partners (socialist nations) and unions. Yes! At least they respect workers rights, especially skilled workers in this field. However, this respect has a costs.
Deep Water Rigs
Any driller of offshore wells faces a serious dilemma. By shutting down these wells, it means a total loss of investment. Even though the driller knows there is oil, the process needs to begin all over again to capture that oil.
The rigs on land do not have this problem. They are closer to a light switch. They can be shuttered and reopened with little investment costs. There are also many firms who hedged their production like my favorite, Encana now called Ovintiv (hate that name). They should survive. If you speculate, the big boys will have no trouble surviving this downturn and they come with a dividend. I would wait until a better perspective is known about the virus and its possible second wave. Don't let that stimulus check burn a hole in your pocket - save it or pay off personal debts. Peace.
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