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.
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.