Oil, at the time of writing, is headed down towards the mid $30s. As markets tend to overshoot on the downside, mid $20s is not out of the question. How long it stays there is anyone’s guess as only a few players (OPEC, Russia, supply & demand, etc) have the power to drive it back up. Consequently no one knows where the bottom is. What we do know however is, as Baron Rotschild succinctly put it over 200 years ago:

The time to buy is when there’s blood in the streets

Make no mistake about it, there will be plenty of blood at this price level. So here’s my plan of action. I hold British Petroleum (BP) and Seadrill (SDRL) in the oil sector already. I will likely add to my BP position with 6 month intervals. The upside potential is tremendous once a recovery begins as it’s more beat down than its peers. That could take many years though so patience is a virtue.

ExxonandBPlowcostproducers

Source: Exxon Mobile

Other solid companies that will likely deliver stellar returns in the vicinity or excess of the 50-100 percent range over the next 5-10 years are Exxon (XOM) and Chevron (CVX). At some stage I will likely open up a position in Exxon as it has the greatest staying power and lowest production cost per barrel. For now I simply prefer BP due to its bad public image and stake in Rosneft (ROSN), which will give it a big boost once (or if) Russia comes in from the cold.

At the speculative side of the spectrum we find offshore drilling companies. They’re justifiably more beat down than the oil majors and many will go bankrupt. Vantage already filed for bankruptcy earlier this week. It’s thus about relative safety as no company in this sector is guaranteed to survive.

Ensco (ESV) and Transocean (RIG) are two of the safer but I’m not buying. Seadrill is the best candidate for bankruptcy amongst the former big three. I’m sticking with it and will likely add to my position if it hits $2. The longer the downturn the higher the likelihood of it going to zero. I will not bet the farm on that trade.

 

When will oil turn?

No two cycles are exactly the same but one can still take some lessons from the past. As Bloomberg writes, oil hit $10 in the late 1990s in what looks eerily similar to the current downturn. Then as now, a price war broke out between major producers. Venezuela, a high cost producer was then Saudi Arabia’s target when it raised production, ensuring the price of oil plummeted to a level only they could turn a profit. This time it’s the United States, Iran and possibly expensive northern offshore fields that are the enemy.

The main culprit is thus simply too much supply in the market

Prices won’t recover before something or someone does what it takes to get rid of said excess supply. Saudi Arabia and Russia can likely take the pain for now. How other oil addicted economies fare is a whole other story. At some stage something’s gotta give. Oil consumption in the West has been in decline in recent years whereas it’s still rising, and projected to continue doing so, in emerging economies. Demand therefore does not look set to collapse. The lack of exploration and investment in new fields will thus likely see supply and demand do the job of bringing prices back up again over the course of several years. If a major player takes it upon itself to cut production by 1 million barrels, things will turn over night. Whichever it is, I prefer arriving early, as opposed to not making it at all, to the party.

 

Read Next: Introduction to contrarian investing

  • Brianmark

    Again, a very interesting article. I will be buying some energy soon. I just don’t know which one yet.

    • Harald Baldr

      That’s the dilemma everyone’s faced with. Happy investing!

  • PeteyBrian

    I think it’s still early in the oil correction process. Layoffs and cost cutting in the oil industry are just now happening. Oil companies haven’t yet defaulted, consolidated, or filed bankruptcy. There’s still optimism of recovery within the industry.

    When Oil hit $15 around 2000 – there was definitely blood in the streets. There was plenty of time to get in oil, but no one wanted to touch oil company investments – no one wanted it. Oil was cheaper than bottled water. Educated, professional women were working the streets of Moscow to supplement their office jobs with their currency in freefall in oil dependent Russia.

    There’s pain starting now, but not yet blood.

    The bottoming process can take years, especially if there’s a world-wide recession in our near future. Patience will be rewarded.

    • Harald Baldr

      True that. There’s not much blood yet but there will be. Thank for sharing the 2000 experience. I think you’ve just invented a new contrarian indicator.

      When career women in oil producing countries hit the streets, the market has bottomed!

      • PeteyBrian

        I didn’t listen to the silver-haired guys in the office who advised me to sell my overpriced tech stocks and to load up on oil companies (and gold)! Lol! Many years later oil soared to $150 per barrel!!!

        • Harald Baldr

          Wouldn’t surprise me if oil is is $90 once again come 2018. Hard to tell but current price level is unsustainable long term so the bounce back will come sooner or later

  • Keith Clark

    I started work in the Oil industry in Feb 97, it was booming, companies in the North Sea could not hire both experienced and inexperienced guys fast enough…around 12-18 months later, i was lucky and took a 50% pay cut but kept my job, allot of guys higher up in the industry, were not so lucky. So fast forward and here we are again, only this time I was expensive and expendable:)

    Saudi, as far as i know, is the only country ramping up production and they have a constant recruitment drive on. All budgets in the west have been slashed, With exploration and drilling always being the first cuts to be made. This should eventually place demand on oil stock again. And then the scramble will begin again…and timing it correctly with the stocks will land you a pretty profit ..Im sure most oil companies love this Boom and Bust …I am hoping it comes round quicker than i presently expect it to, so that i have cash left in the bank to enjoy the recovery also.

    • Harald Baldr

      18 years in oil! What are your thoughts on the length of the downturn? Which companies do you rate the strongest (i.e. staying power) in anything oil related?

Password Reset
Please enter your e-mail address. You will receive a new password via e-mail.