No, Citigroup, We Won’t See $20 Per Barrel Crude Oil

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The last six or so months has been pretty rough in the oil patch to say the least. The world seems to be awash in bubbling crude. Production continues to grow rapidly as we frack ourselves into oblivion.

crude oilMeanwhile, near-term demand — thanks to various energy efficiency methods and slowing economic growth in key markets — has tapered off, causing oil prices to fall some 60% from their peaks. Shares of various energy stocks haven’t fared much better.

And yet, one prominent analyst thinks the things for the sector will get worse by year end — a lot worse.

Citigroup analyst Edward Morse is expecting oil prices to keep falling, perhaps hitting as low as $20 per barrel. But I’m not so sure.

For investors in energy stocks, there’s plenty of reasons to cheer and believe that crude oil’s recent move-up is the real thing and that the dour energy patch predictions may not come to fruition.

A 30% Decline in Crude Oil … Maybe

According to Morse, Citigroup’s global head of commodity research, West Texas Intermediate (WTI) crude oil could fall all the way downwards to the $20 per barrel mark. Crude oil hasn’t been that low since 2002.

The culprit behind the drop is the same problem that go us here in the first place: too much supply.

Morse states that several OPEC members — like Saudi Arabia & Iraq — have continued to pump out excess in order to keep their prices low for consumers in Asia and maintain their market shares. Meanwhile, nations like Brazil and Russia — who fund their governments completely via petrodollars — have ramped up production at these lower prices in order to keep their budgets inflated. Worldwide demand simply isn’t there, and storage facilities are at maximum capacity.

Morse suggests that all of these factors will contribute to a further price plunge, and he says that it’s “impossible to call a bottom point.” More importantly, the recent 9% increase in the price of crude oil over the last few trading sessions is supposedly more of a “head fake” that an actual rebound.

I’m not sure that rebound was a just a “head fake.”

Perhaps the biggest knock against Morse’s argument is the fact that no one can make any money off of $20 per barrel oil. And at $20, it does make some economic sense to begin shutting-in wells. Realistically, most energy firms — even giants like Exxon Mobil Corporation (NYSE:XOM) — struggle to make some serious cash with crude oil under $40 per barrel.

From fracking shale to drilling in the Gulf of Mexico, $20 is a death sentence. You need higher oil prices in order to justify drilling in these areas in the first place.

Falling oil prices are the reason for all the massive layoffs at energy firms as well as the huge reductions in capex spending by the various producers. Add in the significant drop in rig counts and you have a recipe to start reducing the supply glut that caused all of this in the first place.

That excess will still take time to work through the system, but given how quickly energy firms have already taken a guillotine to their capex budgets and workforces, it might be faster than Citigroup realizes.

Want an even faster way to raise prices? A hefty dose of geopolitical conflict always does the trick.

This time it’s Saudi Aribia and Russia that are getting into a bit of a scrap. Russia alleges that the Saudis have helped the U.S. in punishing Mother Russia for its involvement in the Ukraine. And the Russians aren’t very happy about it, considering just how much of their budget is funded by crude oil.

In response, Russia has basically said that they would be more than happy to help Iran attack Saudi Arabia, at which point “the prices for oil will skyrocket.” At the same time, Saudi Arabia has begun mulling the idea of curtailing its production to persuade Russia to stop supplying weapons to Syria.

Either of these scenarios will lead to pretty much an instant leap to crude oil.

And let’s not forget good old economics. When prices are low, demand tends to rise. We’ve already begun seeing that in several developed and emerging market nations. Even OPEC predicts that we’ll see increased crude oil demand by year end.

Crude Oil Probably Bottomed In the $40s

All of these factors — along with the dollar’s recent fall — make an interesting case for crude oil finally rising once again. Now, keep in mind, we most likely won’t see $150 per barrel oil anytime time soon, but $70 or $75 is certainly a reasonable estimate of where we could be in just a year’s time.

That means energy stocks should be on your radar. But not just any. As much as I like smaller players, they are still going to really feel the effects of lower prices, even at $60 or so per barrel. The best plays are the larger firms or integrated majors that can still make money at current prices and also have the cash flows to scoop up smaller oil firms on the cheap.

Companies like XOM, Apache Corp. (NYSE:APA) or Marathon Oil Corporation (NYSE:MRO) should be just fine in this environment. Perhaps even better than picking one or two energy stocks, is to buy them all.

The Vanguard Energy ETF (NYSEARCA:VDE) continues to be my favorite workhorse in the sector. Tracking nearly 165 different up- mid- and downstream energy players, VDE offers a great all-around play on the theme. And since it’s Vanguard, the ETF is dirt-cheap to own, costing only $12 per $10,000 invested.

For those investors looking for more bang for their buck with regards to rising crude oil prices, the SPDR S&P Oil & Gas Exploration & Production ETF (NYSEARCA:XOP) focuses only on firms that drill for crude oil. XOP has historically done better than VDE in shorter periods when oil is rising. If we’ve really bottomed, then XOP should see a huge bump upwards.

As of this writing, Aaron Levitt held a position in the VDE  

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Aaron Levitt is an investment journalist living in Ohio. With nearly two decades of experience, his work appears in several high-profile publications in both print and on the web. Also likes a good Reuben sandwich. Follow his picks and pans on Twitter at @AaronLevitt.


Article printed from InvestorPlace Media, https://investorplace.com/2015/02/crude-oil-energy-stocks/.

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