One of our industry’s top analysts has discovered a troubling fact…
If you’ve been reading the Dispatch, you know the oil market has collapsed. The price of oil has plunged as much as 75% since June 2014. In February, it hit its lowest level since 2003.
From February to mid-March, oil staged a big bounce, rallying 53% in less than a month. On March 17, it closed at $41.67, its highest price since November. That same day, we warned you the oil crisis was far from over…
Since then, oil went on a nine-day losing streak. It closed at $36.56 yesterday.
• The world still has too much oil…
Even with oil’s recent rally, it’s down 1.4% on the year. It’s trading where it was in 2004. As long as there’s a big oil surplus, prices should stay low.
To understand how we got to this point, recall that the price of oil soared more than 1,200% from 1998 to 2008. Oil companies responded by investing in new technologies. Methods like “fracking” unlocked billions of barrels of new oil.
U.S. oil production nearly doubled over the past decade. Last year, U.S. oil production hit its highest level since the 1970s. Global production has reached record highs, too. Oil companies currently produce about 1.9 million more barrels a day than the global economy consumes.
• Oil stocks have plunged…
Exxon Mobil (XOM), the world’s largest oil company, has dropped 20% since June 2014. Chevron (CVX), the second-largest, has dropped 30%.
European oil giants Royal Dutch Shell (RDS-A), BP (BP), and Total S.A. (TOT) have plunged 39% on average.
Oil services companies, which sell “picks and shovels” to the oil industry, have plummeted, too. Schlumberger (SLB), the world’s biggest oil services company, has dropped 36% since June 2014.
• Oil companies have cut spending…
They’ve laid off more than 250,000 workers since June 2014.
According to investment bank Barclays, oil and gas producers cut spending by 23% last year. Barclays warns spending could fall another 15% this year. This would mark the first time in two decades that oil spending has fallen in back-to-back years.
• The oil industry is cyclical…
It goes through big booms and busts. During the last boom, companies hired too many workers…bought too much equipment…and built too many rigs. Financial Times reported last month:
From 2004 to 2013, annual capital spending by 18 of the world’s largest oil companies almost quadrupled, from $90bn to $356bn.
In short, oil companies over-expanded when times were good. Now they’re producing too much oil, which has caused prices to collapse.
• Oil and gas company debt has nearly tripled over the past decade…
In 2006, the industry owed $1.1 trillion in debt, according to the Bank for International Settlements. Debt jumped to $3.1 trillion by 2014.
Oil companies borrowed money to pay for new projects, buy equipment, and fund acquisitions. When oil prices were high, companies were making enough cash to pay their lenders. That’s no longer the case.
You see, many oil companies can’t make money when oil is below $50. As we mentioned, oil closed around $36 yesterday. At current prices, many companies are bleeding cash.
• Low oil prices have already put many companies out of business…
At least 67 U.S. oil and gas companies filed for bankruptcy last year. According to CNNMoney, that’s 379% more than in 2014. According to The Wall Street Journal, one-third of U.S. oil producers could go bankrupt this year.
We recommend staying away from oil stocks for now. A wave of bankruptcies would likely trigger another leg down in oil stocks. This could give us an opportunity to buy world-class oil companies at the best prices in years. But until the world works off some of its surplus, the crisis in oil will continue.
• Our friend Chris Mayer has identified six oil companies that won’t survive this year…
Chris is one of the most respected analysts in our industry. Most investors have trouble beating the market in a single year. Chris has beaten the market by more than 2-to-1 over the past ten years.
Chris developed his “edge” by working as a corporate banker for decades. Today, he’s the lead analyst at our affiliate Bonner & Partners.
Last week, in Bill Bonner’s Diary, Chris warned of six oil companies that will go broke this year. You can read Chris’s short essay below.
There are six oil stocks that are almost surely toast by the end of 2016…
You can tell by their bond prices.
Bond prices are a clue to financial health. Firms usually issue bonds at face value, or par. But if the company gets in trouble, the market might discount the bonds.
For example, a $100 bond that paid 5% at issue might later sell for $10 if the market thinks the odds of repayment are very low. The firm still pays 5%, or $5. But because the bond trades for $10, it yields 50%.
“Once bond yields surpass 50 percent,” writes Scott Fearon, “the chances of a default and reorganization approach near certainty.” Reorganization usually wipes out the value of the stocks. Bondholders get first crack at salvaging whatever value remains.
Fearon is a hedge fund manager and the president of Crown Capital Management. His fund averaged 11.4% annually since its inception in 1991. And he had only one down year. His specialty is short selling, or profiting when a stock falls.
Today, he points to six energy stocks where the bonds yield 50% or more: Basic Energy (BAS), Gastar (GST), Energy 21 (EXXI), Exco Resources (XCO), Stone Energy (SGY), and W&T Offshore (WTI).
“Unless oil prices rally quickly back toward $90 or more,” Fearon writes, “every energy stock mentioned above will almost certainly finish 2016 at or near zero.”
I agree with him.
• Chris is hosting a free training event with Bill Bonner…
If you haven’t heard, Agora founder Bill Bonner is committing $5 million to Chris’s astonishingly successful investment strategy. It’s the same strategy he’s used to beat the market by more than 2-to-1 over the past decade.
Bill and Chris are holding a free investment training event on April 14 to explain the secrets of this strategy. There’s no obligation. It doesn’t cost a cent. But attending it will give you the chance to invest in the same companies Bill Bonner’s family trust is investing in.
Chart of the Day
Oil stocks could get much cheaper…
Many of the world’s “blue chip” oil companies have plunged more than 30% since June 2014. Many smaller oil companies have plunged 50% or more. Dozens of other oil companies have gone out of business.
Yet, oil stocks are still “expensive” according to a key ratio.
Today’s chart shows the price of oil compared to the SPDR S&P Oil & Gas Exploration & Production ETF (XOP). This fund tracks 60 major oil companies. The higher the ratio, the more expensive oil stocks are relative to the price of oil.
You can see this ratio has come down a lot since peaking in 2015. But it’s still 25% above its historic average. We recommend avoiding oil stocks for now. We’ll likely see much better buying opportunities in the near future.
Delray Beach, Florida
April 6, 2016
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