With Oil Prices Down, Why Not BUY Now?
- Thread starter ValueTravelerOZ
- Start date
henrygeorge
Level 2 Member
Matt do you have a previous thread or resource where you've posted your investment strategy research? That would be very helpful for beginners.
RRD
Level 2 Member
Yeah, I don't quite understand how that will play out. Delta has specific issues related to its refinery, but is still a cash machine, generating billions per year and doing buybacks and giving it back to the shareholders. The airline is the first airline in history to have $4B in profits in 2014 and projecting over $5B for 2015.
I don't have a specific repository but have talked about my approach various times.
Broadly speaking I think when you are younger you should focus more on earning and have a simple, index based strategy. As you progress through the stages of wealth it should become more sophisticated via strategic tilts.
IE start out very much in a total stock market fund. For many people I would recommend 100% allocation, only less for people with shakey salaries or weak emergency funds.
Then as you gain more wealth/salary increases etc start layering on focused ETFs, I personally tilt to Healthcare, Telecom and REITs in this market, but depending on cycle the levels and focus may adjust or alter.
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Dkelly1110
Level 2 Member
If they are refining oil, seems me they are buying the raw product -- crude -- which has a price that is volatile and then refining in into something they can use -- Jet-A, or some other "finished product." Currently in this market, their price for the raw product is lower, and their costs should be lower. Although I imagine, they, like many others pre-pay for their supply akin to a futures contract (they bought their Feb supply in November at x price, even though the current spot price is x-10), they will still make money selling the finished product (to themselves or others).
ushdadude
Level 2 Member
I guess it's similar to buying Apple stock when a new device comes out. It's figured into the stock price already.
SC Trojan
Level 2 Member
From a refinery standpoint, while it is true that their raw materials are lower, the markets are quite efficient and the price of finished product (jet, diesel, gasoline, etc) move in lock-step down with crude. Really the margins for refining haven't gotten better as crude has gone down.
As to whether they pre-pay for the crude it basically works like this. A lot of Delta's crude is from Bakken, which prices on a month-average basis. So for that crude you aren't getting much gain or loss. With imported crude you typically have a date that it is priced at, and then it takes time to ship it over. So in a falling market you actually lose quite a bit of money (in a rising market you gain money). Of course many of the smaller operators hedge their exposure to this in the futures market. When they buy the crude they sell an equivalent amount of products in the futures market at a later date and "lock-in" the margin.
The other interesting effect is that refineries typically have millions of barrels of working capital tied up in intermediate inventory. As the price of crude dropped by $50 / BBL this means they lost hundreds of millions of value. It doesn't show up as an earnings gain or loss though, unless you start dipping into the LIFO layers. Again, you can hedge around this, which I would bet Delta did.
SC Trojan
Level 2 Member
Looks like all the oil stocks are going through a new round of recent lows. XOM and CVX are both at multi-year lows and BP is pretty close as well. If you are looking to buy then now might be a good time. I actually think most majors will surprise on the upside on earnings reports as refining margins have been extremely high basically everywhere in the world. Pure E&P plays will probably continue getting hammered, but there could be some upside in buying COP if you think XOM is looking for someone to acquire at these prices.
Hanaleiradio
Level 2 Member
Brent broke 50 again--lowest in 6 months. Chart looks like it wants to test year's low.
SC Trojan
Level 2 Member
Does anyone know a good broker to buy options on Brent futures? I think now is the time to bet the farm on $100 oil in about 2-3 years.
Hanaleiradio
Level 2 Member
I used to trade them with Advantage Futures. I believe that both Interactive Brokers and Dorman Trading both offer BRN (symbol is COIL at IB). All offer the ICE e-minis, which are easier to digest for individual traders.
Good thing you didn't "bet the farm" on Monday or you'd be a sharecropper after today. There is no technical or fundamental reason to believe that a bottom is in place. Looks like its going to test the Dec 2008 lows. I'd wait to see if that holds after a couple of tests before even thinking about going long.
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SC Trojan
Level 2 Member
Options trading is basically a leveraged bet with higher risk and higher reward.
Just example numbers, but let's say it costs you $5 to buy a call at $60 that expires in 2 years. If Brent is at $60 in 2 years then you lost all $5. If Brent is at $100 then you made $35 ($100-$60-$5). So you made 7X profit.
Contrast that to if you bought a barrel of Brent. If you pay $50 and it goes to $100 then you get a 1X profit. Of course, if it goes to $60 then you make $10 or 20%. Heck, even if it drop $10 you don't loose 100% of your investment, you only lose 20%.
There's a lot of data that says in 2 years prices will be significantly higher, so why not leverage up what could possibly go wrong
As to whether we're in a bottom. I think the bottom is probably sometime this winter. Iran deal gets approved and continued overflow in US tanks leads to $30 oil. Of course, no one really knows what OPEC will do, they could very easily change course in November and oil could spike up to $70-80 in a month.
SC Trojan
Level 2 Member
Haha well, I don't actually have the cajones to "bet the farm". I just received a moderate sum of money (say ~5% of my net worth) from selling a property. I'm seriously considering putting it all on crude options because the upside could be enough to put me near my goal for early retirement. The downside will basically set me back by 1 year, so not great but not a life changer either.
SC Trojan
Level 2 Member
Right now Shell (RDS-B) and BP are both yielding ~8%. This is completely insane!
BP definitely has some issues, but the dividend should be safe for a while thanks to them building a war chest of ~$35 BN by selling tons of assets at $100 crude in the past 5 years. They did cut the dividend shortly after Macondo, so there's not a rich history of dividend payouts unfortunately. There is some upside though, as XOM could decide to buy them at a premium.
Shell is a much more stable company, that hasn't cut its dividend since 1943. They are going to do everything they can to keep that streak alive because they know pensioners depend on them. The market might be punishing them for the BG merger, as right now LNG economics are looking pretty poor.
BP definitely has some issues, but the dividend should be safe for a while thanks to them building a war chest of ~$35 BN by selling tons of assets at $100 crude in the past 5 years. They did cut the dividend shortly after Macondo, so there's not a rich history of dividend payouts unfortunately. There is some upside though, as XOM could decide to buy them at a premium.
Shell is a much more stable company, that hasn't cut its dividend since 1943. They are going to do everything they can to keep that streak alive because they know pensioners depend on them. The market might be punishing them for the BG merger, as right now LNG economics are looking pretty poor.
SC Trojan
Level 2 Member
Man, I wanted to buy more RDS-B this week after they announced they were dropping the arctic stuff. They were over 8.1% yield, which is amazing. I had to move my money from one account to another and by the time I did, they were already up 10%. Oh well, I'll wait until quarterly earnings come out, as this quarter is going to be a blood bath for all the IOCs.
kodiak jack
Level 2 Member
Oil is back near multi-year lows again. "Record storage" headlines are spooking a lot of folks, and our massive supply and weak-ish demand are an overhang that won't easily be worked off. But rig counts are down and the high-decline wells associated with unconventional drilling will contain supply for the next 12 months. US production is already beginning to drop. So at some point the prices moves a bit higher. Not going to see $80 WTI for a long time again without a shock though (like Israel bombing Iran or somesuch; certainly a possibility there.) I'd accumulate here. If you can short stocks in your brokerage account, shorting DWTI is a great way to take a long position in oil. Make it a SMALL position though.
Hanaleiradio
Level 2 Member
Another good test of the Dec 08 low in process. If it holds, then next test could well be the refinery maintenance shutdowns in the spring.
Other than cheaper capital and trading costs (and at times, greater liquidity), the primary reason to use futures is TAXES. Futures are taxed at 60% LT gains and 40% ST gains.
It is interesting that this discussion of "efficient markets" and the oil market in particular is almost a year old. Markets are only efficient at moving quickly (not pricing correctly). Take the advice of a retired floor trader and member of the CBoT, markets can stay wrong/irrational longer than you can stay solvent.
SC Trojan
Level 2 Member
One stock to watch right now is BG Group (BRGYY is the US ADR). It's basically being priced by Shell at this point due to their pending merger but has a distinct discount to its value post merger still. That's the market's way of saying the merger is not 100% guaranteed. Personally, I think it will go through because most of the owners of BG also own Shell stock and if the deal falls through it would be pretty disastorous for BG (and likely Shell would have to pay an exit clause too).
The post-merger value of BG I calculated is at a ~9% yield today. I wanted to buy about a week ago when it was closer to 10%, but couldn't get my funds in place quick enough and both BG and Shell jumped just before Xmas. Still a good value though, if you believe Shell can keep the dividend flowing. Personally, I think they can because they can always sell downstream assets to fund the dividend and they have a HUGE downstream presence worldwide.
The post-merger value of BG I calculated is at a ~9% yield today. I wanted to buy about a week ago when it was closer to 10%, but couldn't get my funds in place quick enough and both BG and Shell jumped just before Xmas. Still a good value though, if you believe Shell can keep the dividend flowing. Personally, I think they can because they can always sell downstream assets to fund the dividend and they have a HUGE downstream presence worldwide.
Free-quent Flyer
Blogger
I don't pick stocks but SC Trojan has got me thinking. Rather than betting that Shell will keep its dividend constant/increasing, which is simply gambling, another way to look at it is how much would Shell have to CUT its dividend in order to make it a bad investment. If you have access to 6% APY accounts, it would have to cut the dividend 29.7% to make the stock purchase a wash. If 5% is your wash point, 41.5%. So rather than thinking about the chance of the dividend being cut, you can assume it will be cut and think about the risk of different levels of cuts.
I'm in for one.
I'm in for one.
You do understand that a stock is not like a savings account in that the price is variable, right?
Free-quent Flyer
Blogger
The market price of the security is variable, but that's irrelevant to my point since you lock in YOUR price when you buy the stock.
A share of stock is a legal claim on a future income stream (dividends), that incidentally also confers some rights over the governance of the underlying company. What I'm talking about is comparing that income stream to the income stream you'd be entitled to if you invested the same money in a high-interest account.
High-interest accounts have the advantage of your upfront principal being FDIC/NCUA-insured, as you point out. To compensate for lacking that advantage, you'd want a higher income stream from non-insured investments, which are the dividends we're talking about.
But both investments have one risk: the risk of the income stream changing. Indeed, Consumers CU just lowered their highest interest to 4.59% from 5.09%. The same risk is why SC Trojan brought up the question of the "reliability" of the income stream of BP versus Shell. The history of those payments is actually publicly available:
BP: http://www.nasdaq.com/symbol/bp/dividend-history
Shell: http://www.nasdaq.com/symbol/rds.a/dividend-history
I'm not trying to be condescending, I'm pointing out that we're talking about two different things. You're talking about the first risk (return of principal) and I'm talking about the second risk (changes to future income stream).
If you have $20,000 in a Consumers CU rewards checking account earning 4.59% APY, that money is just as "locked in" as purchase of a stock — assuming you're interested in the income stream, which is in fact what I'm interested in — because withdrawing from the account is "selling" your claim to that income stream, albeit at the original price paid.
All of which brings me back to my calculation: how much would the income stream from the Shell stock have to drop for it to be a wash with your other, insured, liquid investments?
[Edit: as a relevant aside, the drop in BP's dividend from its peak pre-Deepwater Horizon to its low afterwards was 50%. It's since recovered to 28.5% below peak. So steep drops are definitely possible — I didn't mean to dismiss that risk in my original post.]
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Today, in my real life job, I'm trying to help a client who had an investment in an energy trust, taxed in a similarly confusing manner to a MLP. He initially invested a sum of money to 'buy an income stream'.
Let's pretend that the position was initially $20,000 that was drawn from Consumers CU. It would be worth about $200 today.
Now, you could start 'stock picking' by citing how you simply know that BP and Shell are 'reliable'. If you were a stock picker that is.. and not at all like this other company. But then one wonders, in an efficient (and its pretty efficient with algo and HFT at the least) why are you guys able to find a position that offers an anomalous amount of yield, that also happen to be in some of the best known oil and gas companies in the world?
The focus on yield and buying an income stream is misleading. In the case that I'm working on, you can see this. The price spirals down, the dividend is subsequently reduced, yield drops, people sell.. and so on.
Now, we could stock pick and say that will never happen to a big oil company because they are too big to fail. But the price of the company can drop. Which brings us to your question, how much would the dividend need to drop?
I'd like to refocus the question:
Let's pretend that the position was initially $20,000 that was drawn from Consumers CU. It would be worth about $200 today.
Now, you could start 'stock picking' by citing how you simply know that BP and Shell are 'reliable'. If you were a stock picker that is.. and not at all like this other company. But then one wonders, in an efficient (and its pretty efficient with algo and HFT at the least) why are you guys able to find a position that offers an anomalous amount of yield, that also happen to be in some of the best known oil and gas companies in the world?
The focus on yield and buying an income stream is misleading. In the case that I'm working on, you can see this. The price spirals down, the dividend is subsequently reduced, yield drops, people sell.. and so on.
Now, we could stock pick and say that will never happen to a big oil company because they are too big to fail. But the price of the company can drop. Which brings us to your question, how much would the dividend need to drop?
I'd like to refocus the question:
- Why would a company sustain a yield at 9%?
- Even if they could sustain it, where is the money coming from when revenues are down and the company is focused on reducing Capex?
- If they cannot sustain it, what happens to the price if dividend is reduced?
- At what point in the cycle has the yield and principal declined to the point where the income flow is underperforming a fixed income investment with guaranteed principal?
Free-quent Flyer
Blogger
We are 100% agreed on one thing: the current 9% yield is unsustainable, and will definitely go away. The question is HOW will it go away:
Option 1: Oil price recovers/investors get greedy and the stock price is bid up 2-3x. Dividend yield lowers from 9% to 3%-4.5%. Yay! Income stream continues (remember you bought in at 9%), after death shares are passed to children who sell it immediately and pay no capital gains tax thanks to step up basis rule.
Option 2: Oil price continues to plunge, profit margins are squeezed, dividend is cut, investors get nervous and sell, stock price plunges, dividend is cut again. Boo! Income stream drops below fixed income investment with guaranteed principal, and principal is wiped out in bankruptcy.
This is gambling, as is all stock picking, which is why I don't do it. But this is a bet (i.e., unknown, uncontrollable outcome) where you do have some information: Shell's dividend has only gone up in nominal, per-share terms since 2005 (i.e., before the financial crisis and great recession). Deciding how much weight to put on that fact is, again, gambling. But it is certainly an interesting fact.
Option 1: Oil price recovers/investors get greedy and the stock price is bid up 2-3x. Dividend yield lowers from 9% to 3%-4.5%. Yay! Income stream continues (remember you bought in at 9%), after death shares are passed to children who sell it immediately and pay no capital gains tax thanks to step up basis rule.
Option 2: Oil price continues to plunge, profit margins are squeezed, dividend is cut, investors get nervous and sell, stock price plunges, dividend is cut again. Boo! Income stream drops below fixed income investment with guaranteed principal, and principal is wiped out in bankruptcy.
This is gambling, as is all stock picking, which is why I don't do it. But this is a bet (i.e., unknown, uncontrollable outcome) where you do have some information: Shell's dividend has only gone up in nominal, per-share terms since 2005 (i.e., before the financial crisis and great recession). Deciding how much weight to put on that fact is, again, gambling. But it is certainly an interesting fact.
If the price goes up you are always going to be OK - but you are looking for Dividend movement right now.. which is likely to reduce, or maybe they cling onto it for a Q or two, but its on the ropes without a recovery in the oil industry.
So - what happens if the dividend drives the stock, as it is a measure of the health of the company? Dividend drops - if the stock drops with it, then the yield is too high again, so it drops again.
Option 3
Oil is volatile, but fairly flat over the year - you lose, because the price and dividend death spiral of doom™ continue.
So - what happens if the dividend drives the stock, as it is a measure of the health of the company? Dividend drops - if the stock drops with it, then the yield is too high again, so it drops again.
Option 3
Oil is volatile, but fairly flat over the year - you lose, because the price and dividend death spiral of doom™ continue.
Hanaleiradio
Level 2 Member
In addition to Matt's excellent point about the likelihood of a nasty downward spiral that butchers the hell out of the dividend, I have to ask why one would risk a multi-year reduction in wealth in order to squeeze out at most an extra couple hundred basis points in yield over an investment that has no risk to principle? I might use casino money to take the risk for an extra 1000 bp, but not for anything less.
BTW, in late Dec. the third test of the 2008 lows failed, and we're now testing 2005 lows. Trend following oil futures downhill was the play of 2015.
BTW, in late Dec. the third test of the 2008 lows failed, and we're now testing 2005 lows. Trend following oil futures downhill was the play of 2015.
AndyP
Level 2 Member
So I'm going to admit I lost pretty big trying to catch the falling knife in oil last year. I still hold the positions (two positions, one I have had for 3.5 years and is nearly flat, the other I've had for about a year and is way down). Will I be able to claim the capital losses on my tax return? If not, can I sell now and claim them or would this go on 2016s return?
You can only claim realized losses (occurs when you sell) and of course, from regular (non tax advantaged) accounts. So since you didn't sell last year you can't use them for last year.
AndyP
Level 2 Member
Thank you Matt. Thanks to your other thread it appears I need to remember to harvest gains in 2016 as it may be the last year I am in the 15% bracket with the 0% cap gains rate. I'm assuming capital losses subtract from capital gains before ordinary income? Which makes it impossible to harvest gains and losses at the same time.
If that's the case, the question at the end of 2016 will be which is larger, my capital gains or losses. The gains will likely be taxed at 15% if I realize them after 2016, and the losses save me 15% tax on ordinary income. So I should harvest whichever is larger. Or I could hold the losses into 2017 and harvest them then when I am in a higher tax bracket.
This is all very interesting although I should try not to worry too much since most of my money is in tax advantaged accounts.
If that's the case, the question at the end of 2016 will be which is larger, my capital gains or losses. The gains will likely be taxed at 15% if I realize them after 2016, and the losses save me 15% tax on ordinary income. So I should harvest whichever is larger. Or I could hold the losses into 2017 and harvest them then when I am in a higher tax bracket.
This is all very interesting although I should try not to worry too much since most of my money is in tax advantaged accounts.
Yes, from a tax perspective it would be ideal to harvest gains at 0% in the year prior to popping up a bracket, and then losses the following year. If you do it at the same time (same year) they would net one another out.
SC Trojan
Level 2 Member
Missed a lot of this conversation, so I'll chime in.
Definitely agree this is speculative. If you look at the yield which is over 9% right now, that's really the market's way of saying they don't believe it is sustainable. At today's oil prices, there is no question it is unsustainable. Really the question is, will it be sustainable in the long term due to increases in oil prices and/or other factors?
But, there are still a few points that make me think this is a good investment:
Definitely agree this is speculative. If you look at the yield which is over 9% right now, that's really the market's way of saying they don't believe it is sustainable. At today's oil prices, there is no question it is unsustainable. Really the question is, will it be sustainable in the long term due to increases in oil prices and/or other factors?
But, there are still a few points that make me think this is a good investment:
- I agree with Free-Quent Flyer that IF they cut the dividend, it is unlikely they cut it to zero. I think realistically they would cut it to ~3-4%. Management would want to be "one and done" on dividend cuts.
- With that being said, management will do EVERYTHING they can to keep the dividend streak going. The annual dividend is ~12 billion. They have already announced $30 billion in asset sales and I'm sure they are going to the cheap European debt markets to raise capital as well. Their downstream has a capital employed of ~$60 billion, frankly I think they would sell the downstream rather than cut the dividend.
- The fundamentals of the oil industry suggest the price won't remain low for several years. I'm not talking about the futures market, I'm talking about actual supply / demand and cost of production. If you believe that drillers won't drill unless they get a profit, then you probably need ~$70 oil to replace what is going to naturally decline in the next few years. I can't speculate on whether this means 1 year or 5 years, but I don't think this is a new normal.
Doesn't the current price take into account the likelihood that supply will decline in a few years?