The oil market is struggling.
The price of U.S. crude fell to $19.27 a barrel at one point yesterday, its lowest since 2002, while Brent crude dropped below $23 – levels not seen in 17 years.
Many analysts have slashed their 2020 oil price forecasts, with some saying that the commodity could reach as low as $10, if the coronavirus lockdown destroys demand further and Saudi Arabia fails to resolve its price war with Russia.
A few firms warn that $15 is on the horizon, while Goldman Sachs predicts that prices could drop ‘well below $20 a barrel’.
Let’s analyze the factors that have caused the price to sink below $20 a barrel and what could spark a recovery.
Why Do Oil Prices Keep Falling & Falling?
The fast-spreading novel coronavirus outbreak has triggered an unprecedented selloff in the commodity. In particular, with major cities under lockdown and travel restrictions in place, the consumption for crude is set to drop substantially. Global efforts to combat the pandemic’s impact and rev up economic activity have largely failed so far. The virus-inflicted demand slowdown has led to hefty oil selloff.
Pressure in the oil markets has been exacerbated by the no-holds-barred price war between Saudi Arabia and Russia. The carnage deepened after Saudi Arabia (the OPEC cartel’s biggest producer and exporter) and Russia (leader of the non-OPEC contingent) failed to agree on additional production cuts to boost oil market fundamentals and prop up prices. Subsequently, both countries decided to open the production floodgates, which combined with the demand destruction to send prices into a tailspin.
In a nutshell, it's basically too much supply but too little demand. This makes life harder for crude producers, especially shale operators.
Is Shale Oil Production Viable in the Low-$20s?
Oil between $45 and $50 a barrel is considered the break-even point for most shale operators, which means that they need crude prices of at least $45 to balance their operating cash flows with capital expenditure. At the prevailing crude prices of a little over $20 per barrel, these companies are unlikely to hit cash flow breakeven.
As a response to the bearish environment, the shale fraternity – especially the ones whose production mix are heavily tilted towards crude – has scaled back drilling activity and promised cuts to their capital budgets.
The likes of Diamondback Energy FANG, Concho Resources CXO, Marathon Oil MRO, among others, lowered their 2020 capital expenditure target to contend with depleted oil prices. Some like Occidental OXY — carrying a Zacks Rank #4 (Sell) — slashed their dividend payouts.
You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.
While the company boards adopt various strategies to survive the downturn, there is no denying that the latest oil market rout has rendered much of their production uneconomic. A pronged period of low oil will eat into their cash flows and several names might file for bankruptcy.
How About Big Oil?
Even the ‘Big Oil’ companies don’t seem to be immune to this price crash. Supermajors Chevron CVX, Royal Dutch Shell RDS.A and TOTAL S.A. TOT have all announced steps to "rationalize" their planned capital spending for the current year in response to the sudden oil price slump. The majors, while suspending share buyback programs, intend to generate sufficient free cash flow to maintain the dividend payouts, thereby preserving shareholder values.
Despite Big Oil’s struggles with returns, they are the ones that are best in adapting their business model to the prevailing momentum. Therefore, in this current turbulent market environment, the relatively low-risk energy conglomerate business structures of the large-cap integrateds — with their fortress-like balance sheets, ample free cash flows even in a low oil price environment and steady dividends — is advocated. The companies’ financial flexibility and strong balance sheet provide them with a larger war chest to draw upon in this highly-uncertain period for the economy.
Where is the Space to Store Excess Crude?
As producers keep pumping more oil into an oversupplied market, countries are running out of traditional inland storage facilities. This has prompted traders to buy giant tankers as floating storage, allowing them to move the (cheap) commodity onto ships and wait for an eventual recovery in prices.
In fact, with no place to put the crude amid the production binge and collapse in prices, tankers are increasingly being used to store excess oil. Increase in demand for such vessels over the past few days have led to surging rates for offshore oil tankers.
Are Prices Set to Rise Anytime Soon?
It's been a catastrophic year so far for crude oil, which has suffered a dramatic 67% collapse due to a massive supply glut. The price plunge has wreaked havoc on the industry claiming thousands of jobs, pushing the debt-heavy companies toward default and causing a steep drop in stock prices.
Yet, expect more pain ahead. Saudi Arabia’s refusal to tame output even in the face of continuously falling global consumption on account of the coronavirus pandemic will further delay the market’s rebalancing. As the world remains awash in crude oil, prices might go even lower before they start climbing higher.
How Does it Benefit Consumers?
To put it simply, all of this means plummeting gasoline prices for American drivers. Prices at the pump are at 20-year lows, with a gallon of gasoline at some U.S. states averaging less than $1. While this might be the best time in two decades to plan a road trip, there is hardly any rush to take advantage amid the coronavirus shutdown.
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TOTAL S.A. (TOT) : Free Stock Analysis Report
Marathon Oil Corporation (MRO) : Free Stock Analysis Report
Chevron Corporation (CVX) : Free Stock Analysis Report
Concho Resources Inc. (CXO) : Free Stock Analysis Report
Royal Dutch Shell PLC (RDS.A) : Free Stock Analysis Report
Occidental Petroleum Corporation (OXY) : Free Stock Analysis Report
Diamondback Energy, Inc. (FANG) : Free Stock Analysis Report
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