At this point, everyone knows how badly oil prices have cratered. Since reaching its highs back in the fall of 2014, it has been a straight shot downwards. And now oil prices are sitting at seven-year lows and have broken the critical $40 per barrel mark. This is the lowest oil prices have been since 2009 and the Great Recession.
That’s not great news for any stock that needs higher oil prices to pad its bottom line. That sub-$40 price is where many oil wells aren’t profitable at all.
The problem is, it might not get any better for the energy sector.
There are plenty of reasons why we won’t see that $60-per-barrel mark any time soon. But there are ways investors can find profit in the energy sector during this period of low oil prices.
We just have to switch around our game plan.
Lower Oil Prices for Five More Years
The key word for oil prices going forward is oversupply. And it looks like that overabundance is going to stick around for a very, very long time.
The combination of rising production in the U.S and Canada — thanks to fracking — and OPEC trying to keep its market share has created a nasty oversupply problem in the oil markets. There’s just too much of it to go around — especially when you consider that the demand picture is pretty stagnant as well.
As China’s economy continues to collapse and fuel efficiency measures in more developed nations have taken hold, we just don’t need as much oil as we are currently pumping.
The International Energy Agency’s (IEA) latest report paints just how bearish the picture for oil prices is going to be. The world currently has a 1.6 million-barrel-per-day surplus when it comes to production vs. demand. That’s the highest average daily surplus per quarter in the last decade. And let’s not forget about the 3 billion cushion of oil still in storage.
This is bad enough. But the real dour picture comes from the IEA’s demand figures.
The IEA estimates that the stalling global economy will cause oil demand in 2016 to fall to just 1.2 million barrels per day. That’s down from about 1.5 million today. The end result of this decreased demand in the face of still-rising production? Oil prices won’t recover for another five years. Under the current scenario, IEA estimates that crude oil prices will hit $80 a barrel by 2020.
That’s a long time to wait.
But it might actually be worse than the IEA expects. The agency’s projections didn’t take into account OPEC’s recent decision to keep pumping in the face of these rising supplies. Saudi Arabia has been very clear in its intention to keep market share at all costs.
Nor did the group count on the effects of the rising U.S. dollar on oil prices.
As the Fed gets ready to raise interest rates, the dollar is going to get to be a whole lot stronger. That’s bad news bears for oil prices and all matters of commodities.
So “lower for longer” is the new norm.
How to Invest With Low Oil Prices
The key to surviving and thriving in this new era of low oil prices comes down to switching up our game plans and focusing on those firms and sectors that can make it through.
For starters, the downstream players are a prime place to play. The group has been able to feast on the lower input costs thanks to basement-level oil prices. Crack spreads at top-notch refiners like Marathon (MPC) or Valero (VLO) haven’t been this good in years.
And the refiners haven’t been sitting on their laurels, they’ve been return that cash back to investors or expanding into nonrefining operations for diversification sake to cover when oil finally recovers.
The Market Vectors Oil Refiners ETF (CRAK) offers a chance to play the entire sector.
Secondly, strong shale and energy producers should be the only ones investors are really thinking about. A lot of smaller shale players aren’t going to make it, with their high debt loads and oil prices being where they are. This means shifting towards the large-cap integrated producers like Exxon (XOM) or Royal Dutch Shell (RDS-A, RDS-B). Even with their warts, they still have the goods to make it through this environment.
As do dominate shale players in the lowest-cost regions like the Bakken and Eagle Ford. Firms like EOG Resources (EOG) or Continental (CLR) are actually making more money per barrel today than they did with oil at $80.
Finally, much has been written about how the many midstream and master limited partnerships (MLPs) now have mondo commodity risk as they have expanded their operations to hold more processing assets. The vast bulk of them still operate as toll-ways and just move energy around the country. Strong MLPs like Magellan Midstream (MMP) or those that are tied to larger producers that are guaranteed to see continued volumes like Shell Midstream Partners, L.P. (SHLX) make a whole lot of sense.
Low Oil Prices Do Not Equal Low Profits
The above industries and sub-sectors of the energy markets should continue to churn out cash flows, profits and earnings even with oil prices in the dumps.
Many of these stocks and sub-sectors are now trading for peanuts, as they have fallen pretty hard during the oil rout.
Now could be the best time to realign a portfolio and overweight these stronger names for the new “lower for longer” oil price environment.
Further out, it’s still pretty rosy for energy stocks and higher oil prices. Investors just need to get through until that point.
As of this writing, Aaron Levitt is long MPC and the Vanguard Energy ETF (VDE), which contains some of the aforementioned securities.
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