With Oil Prices Down, Why Not BUY Now?

[ValueTravelerOZ]

Since the U.S. govt has declared (currency) war with Russia, and brought down the price of oil, in an effort to bring down the ruble to it's knees....my question is.. why not buy oil stocks now? These $2.xx prices at the pump are defly short-termed, and if you think you can fill up the ol' thirsty H3 right now for $45 will last forever, think again. I'm actually thinking of buying some oil stocks, but I ain't exactly the expert.....anyone have some insight?

 

[Matt]

Since the U.S. govt has declared (currency) war with Russia, and brought down the price of oil, in an effort to bring down the ruble to it's knees....my question is.. why not buy oil stocks now? These $2.xx prices at the pump are defly short-termed, and if you think you can fill up the ol' thirsty H3 right now for $45 will last forever, think again. I'm actually thinking of buying some oil stocks, but I ain't exactly the expert.....anyone have some insight?

Classic question here- we see something low, don't really understand it, and think it is an opportunity. Happens all the time. Reminds me of an interview question I had with the MD of CLSA back in the day (which I fluffed) he told me a story about the price of a pair of Church's shoes, and how his buddy always knew where to get them and what they cost. I thought he was just rambling, but later realized he was talking about understanding core value of a product.

So, onto Oil - will it go up? Probably. The question is when, and what happens to your money in the meantime. For reference I placed a similar bet on the Yen devaluing when it was at 80. However it sat there for I guess a year making no money for me.

Back to Oil - why is it low now? Personally I don't think Russia is the real reason for the oil price drop, while it is a very complex beast, I think that a core component of it is the relationship between OPEC and US Shale. OPEC elected to maintain the production flow of oil from the OPEC countries, http://www.opec.org/opec_web/en/press_room/2938.htm

So from a supply and demand perspective, we now have Shale oil, and the same amount of OPEC oil being created (plus we now have 2 Libyan oil fields back online) and as such supply has increased. In conjunction with supply increasing it seems that demand is decreasing at this moment, leading to a surplus, and pressuring prices downwards.

In order for the price of oil to increase, I believe that OPEC must reduce the supply, however if they do that, the price of US Shale increases. So in essence they would be not selling so much and in doing so adding wealth to the competition. Instead, it seems that they would rather eat the loss on the barrel now in order to force the price of US Shale lower, and as such put pressure on US Shale operations.

I imagine what they will do is keep the pressure on until several more operations fail, and then slowly increase the price when the US shale pipeline has been 'slapped back down'.

Who knows when that will happen? And what will you lose out on waiting for it?

 

[My1stMile]

I have thought about investing at these prices, but I agree with Matt's take on the fundamentals of what is going on. I don't want to catch the falling knife if the bottom is in the $20-$30 a barrel range. I think I will just be happy with my fuel savings for now.

 

[ushdadude]

And if the keystone pipeline ever happens, it can keep prices down
But I do have to admit, I am still tempted to buy even though I know absolutely nothing about oil futures.

 

[Kendon]

I've been tempted to jump in as well. One thing I'm looking at is the dividend for some of the big oil stocks is around 4% (CVX in particular). If, and it's a big if, the dividend doesn't get slashed might be good for a buy and hold.

 

[El Ingeniero]

Bought STO cheap, but that was extending a position I already had.

Agree w/ the analysis about OPE putting pressure on US shale producers. IMO, it won't work. They've already started refracturing the original fracked wells, way cheaper than the original wells.

 

[Differentplanet]

Bottom picking makes your fingers smell.
What do you call a stock that’s down 90%? A stock that was down 80% and then got cut in half.

 

[Panache]

I did lose quite a bit in energy stocks, would it be best to hold on to them or sell now before they go even lower? Admittedly, I'm letting my FA do most moves as I don't want to do a knee-jerk move, but I waited as she recommended in early Dec and prices kept falling. I am wondering if I should step in or has this hit bottom?

 

[ValueTravelerOZ]

thank you all for your useful input. Like I said, I don't know much about the crude market, but I do know geopolitics unfortunately is a factor in prices.

 

[Matt]

I did lose quite a bit in energy stocks, would it be best to hold on to them or sell now before they go even lower? Admittedly, I'm letting my FA do most moves as I don't want to do a knee-jerk move, but I waited as she recommended in early Dec and prices kept falling. I am wondering if I should step in or has this hit bottom?

You should sell them and replace with a substantially not similar position. This would allow you to harvest capital losses.

You'd be best to look at ETF replacements, and stay out of the stock for more than 31 days as a minimum.

 

[Matt S NYC]

Be careful about where you buy. American energy companies are not going to be able to sustain themselves at these prices for the long haul. Saudi can afford to keep prices low for a much longer time than American companies can stomach. Agree with @Matt that it is a complicated issue.

 

[El Ingeniero]

A shale well costs something like $8 million. Re-fracking costs 25% of the original costs and gets production back to nearly the original levels, and often turns money losers into money makers. My guess is that in 5 years, the oldest and biggest players in shale oil will still be around. Other issue is that low prices will stimulate the economy, leading to a rise in demand.

 

[Hanaleiradio]

If you want to bottom feed, keep your eye on the oil service sector rather than big oil. That's where the volatility is, and is where the bargains will be. (Look at a 3 or 5 yr chart of XOM v RIG, for example.)
In full disclosure I'm a firm adherent to trend following. Nevertheless, I had many of the same thoughts as the OP and spent part of the weekend deciding if I should close out shorts in oil service field (RIG & SLB). I came to firm decision to continue riding the trend down. In addition to the factors outlined by Matt (and remember the falling demand in China and Europe) , the research reminded just how much of the oil service sector is significantly reliant on debt to fund very high costs of extraction activity (particularly the drillers.) The rapid steep decline in prices means that new production, and thus revenue, is getting cut far quicker than anyone anticipated. Some of these guys are going to have trouble with their debt. That's the next shoe to fall, and the ripples will lead to another wave of m&a, and a lot of uncertainty.

 

[gmenrule]

start by selling puts and get paid for your entry point...xle is liquid

 

[Hanaleiradio]

The other point on this concerns timing. Its very rare for a sector to quickly bounce back after it's been exposed to the kind of bloodletting that the oil patch has recently endured.

Just noticed that today's NYTimes has article re: lending to oil patch:
http://dealbook.nytimes (dotcom)/2015/01/11/as-oil-prices-fall-banks-serving-the-energy-industry-brace-for-a-jolt/?action=click&pgtype=Homepage&module=first-column-region&region=top-news&WT.nav=top-news&hp

 

[Hanaleiradio]

And if you want a simplified bullish case for RIG--a company that has been hit harder than most:
http://www.bidnessetc (dotcom)/32325-is-it-the-right-time-to-buy-transocean-rig-stock/
Barron's also had a piece over the weekend presenting the bullish case.

Although I think most of the bullish arguments are in fact bull, I took 2 tidbits from this article that helped my research into other oil service companies:
1. cash-on-hand position
2. schedule of debt rollovers.

If you look at some of the smaller oil service companies (RIG is one of the giants), you'll find some facing a rollover schedule with a much weaker cash on hand position.

 

[jmw]

I am no good at timing stocks. I've been looking at oil too.

If I catch a falling knife, I will likely get a nasty cut.

But if I wait too long, the price can go up fast.

Thank goodness for zero commission trades at Merrill Lynch so I can dollar cost average in (and harvest losses) for free.

 

[El Ingeniero]

I think you guys are forgetting the refracking trend. You can refrack a fracked well for 1/12th to 1/6th the original cost of drilling and completing it the first time, often restoring production nearly back to the original levels.

What will happen is that all the people with 6 or 7 year old wells will refrack them for much less than they paid originally, and make money at even lower oil prices than today.

So if you think the oil services guys are going to be sitting on their hands waiting for notes to come due, I think they will be refracking at cost just to pay off their notes. They'll have lean times for a while, but I don't think they will die off like flies by any means.

 

[Hanaleiradio]

I think you guys are forgetting the refracking trend. You can refrack a fracked well for 1/12th to 1/6th the original cost of drilling and completing it the first time, often restoring production nearly back to the original levels.

What will happen is that all the people with 6 or 7 year old wells will refrack them for much less than they paid originally, and make money at even lower oil prices than today.

So if you think the oil services guys are going to be sitting on their hands waiting for notes to come due, I think they will be refracking at cost just to pay off their notes. They'll have lean times for a while, but I don't think they will die off like flies by any means.

Would appreciate a link to a source for that info, as I'm not aware of any source claiming that re-fracking is that cheap, or can come anywhere close to replacing the lost production from offshore and fracking extraction that is getting mothballed at a record pace. Here's a pretty good overview of costs from an industry trade journal (apart from some of the political speculation at the end):
http://oil-price(dotnet)/en/articles/falling-oil-price-slows-us-fracking.php

 

[Matt]

Good discussion - reminder it is OK to link out of here if you like as it is vanilla stuff, until we crack the next 10 bagger in Oil

 

[El Ingeniero]

Would appreciate a link to a source for that info, as I'm not aware of any source claiming that re-fracking is that cheap, or can come anywhere close to replacing the lost production from offshore and fracking extraction that is getting mothballed at a record pace. Here's a pretty good overview of costs from an industry trade journal (apart from some of the political speculation at the end):
http://oil-price (dotnet) /en/articles/falling-oil-price-slows-us-fracking.php

The industry has learned a lot in the last 6 years. I won't say it's dirt cheap, but I do believe it's significantly cheaper than the original job:

http: //www.spe (dot) org/news/article/renewing-mature-shale-wells-through-refracturing
http: //powersource.post-gazette (dot) com/powersource/companies-powersource/2014/08/19/Refracking-breathing-new-life-into-aging-wells/stories/201408190006

Much of the optimism stems from the experience with gas, where prices have been very low for much longer.

 

[El Ingeniero]

Good discussion - reminder it is OK to link out of here if you like as it is vanilla stuff, until we crack the next 10 bagger in Oil

Better to have the habit of never linking out and not make a mistake.

 

[Hanaleiradio]

The industry has learned a lot in the last 6 years. I won't say it's dirt cheap, but I do believe it's significantly cheaper than the original job:

http: //www.spe (dot) org/news/article/renewing-mature-shale-wells-through-refracturing
http: //powersource.post-gazette (dot) com/powersource/companies-powersource/2014/08/19/Refracking-breathing-new-life-into-aging-wells/stories/201408190006

Much of the optimism stems from the experience with gas, where prices have been very low for much longer.

Thanks for the link--very interesting. Worth following to see if they can ramp up in oil and how much production from new fracking it can be a substitute for. In the short run my money says it won't be fast enough, and it's not going to help companies like RIG that are focused on offshore. But refracking certainly cuts the cost when they can use existing permits, pads, and roads, and we've already seen with fracking how it's far cheaper and quicker to mothball a well.

 

[SC Trojan]

If you are looking to buy an oil stock, I'd recommend BP. I'd wait until their earnings call though, as I believe they are going to be decimated due to the combination of Russian sanctions and low oil prices. Right now they're yielding over 6.5%, and they have said the dividend is the #1 priority for them. Of the majors they are the most likely to be acquired, which would come at a premium to today's price.

While no one really knows that is going to happen to oil prices I wouldn't be surprised to see a huge spike in the next couple years. There is actually VERY low spare production capacity in historical terms (~3% now vs >10% in the 80s and 90s). What this means is that relatively minor disruptions can take the market from being long to being short. With Iran and Venezuela being on the brink of insolvency and a lot of issues in the Mid East and West Africa, disruptions could occur unexpectedly...

On another note, one interesting thing about this market is some players (Shell, Vitol, etc.) have used the precipitous drop in oil prices to lock in risk free profits using the futures market. Basically, the futures market allows you to sell oil for a price at a future date at a higher price than today. This is normal, since oil is an inflationary product in general. However, right now the expected increase is relatively large. So large that it would pay for your storage costs between now and that future date. You can then buy crude oil today, put it on a rented VLCC (aka floating storage) and then sell it later at that guaranteed price. These arbitrage opportunities only last so long because people take advantage of them, but I always thought it was an intriguing way to make risk free profits.

 

[goals^n^dreams]

Gas is very cheap right now. It is around $2.25/gallon in Orange County, CA. I am thinking to buy BP gas. Is it a good idea to buy gas stock now or wait?

 

[Matt]

Gas is very cheap right now. It is around $2.25/gallon in Orange County, CA. I am thinking to buy BP gas. Is it a good idea to buy gas stock now or wait?

You shouldn't buy individual stocks. Just get a target date fund.

 

[El Ingeniero]

You shouldn't buy individual stocks. Just get a target date fund.

They even have target date ETFs these days.

 

[Hanaleiradio]

Gas is very cheap right now. It is around $2.25/gallon in Orange County, CA. I am thinking to buy BP gas. Is it a good idea to buy gas stock now or wait?

You might want to look at historical data. Every time that oil has taken a severe plunge the bear has sustained itself for years--not months. Of course, you might believe in those famous four words: "Its different this time."

 

[El Ingeniero]

You might want to look at historical data. Every time that oil has taken a severe plunge the bear has sustained itself for years--not months. Of course, you might believe in those famous four words: "Its different this time."

The interesting thing is, the longer an asset class stays down, the bigger the resurgence.

 

[f0xx]

Back to Oil - why is it low now? Personally I don't think Russia is the real reason for the oil price drop, while it is a very complex beast, I think that a core component of it is the relationship between OPEC and US Shale. OPEC elected to maintain the production flow of oil from the OPEC countries, http://www.opec.org/opec_web/en/press_room/2938.htm

It's not just Russia we're putting the squeeze on. But Iran, Venezuela and many other countries.

 

[RRD]

With oil prices down, it is more prudent to buy airline stocks, imho. I did buy a bunch of oil/rig stocks early December and have lost 50% on my 7k investment already. Thankfully, it is in my IRA a/c and I can afford to hold onto these stocks for a long time till the prices recover, though it is a fair chunk of money tied down which I'd rather have invested in better names. I am still averaging down on these beaten oil names (BP/COP/DVN/SN/CBI). On the bright side, my airline stock (AAL) is 70% up (which I should have bought way more of).

 

[Matt]

With oil prices down, it is more prudent to buy airline stocks, imho. I did buy a bunch of oil/rig stocks early December and have lost 50% on my 7k investment already. Thankfully, it is in my IRA a/c and I can afford to hold onto these stocks for a long time till the prices recover, though it is a fair chunk of money tied down which I'd rather have invested in better names. I am still averaging down on these beaten oil names (BP/COP/DVN/SN/CBI). On the bright side, my airline stock (AAL) is 70% up (which I should have bought way more of).

On the surface, that sounds like a logical decision. How familiar with the futures market are you?

 

[RRD]

On the surface, that sounds like a logical decision. How familiar with the futures market are you?

Not familiar at all. Just read about it on Wikipedia and my head hurts now. Why do you ask?

 

[Matt]

Not familiar at all. Just read about it on Wikipedia and my head hurts now. Why do you ask?

Very high level:

It allows a buyer (or seller) to fix a price in the future in order to exchange a commodity. As such, the existence of the Futures Exchange allows airlines to lock in prices today for future oil needs. I think this is relevant to your thought to buy airlines.​

The logic you had is sound, lower oil = smaller costs = greater profit. However, because they have already locked in future pricing, an efficient market would have adjusted the current price to bake in the forecasted future profit.

In other words, because everyone knows they will be getting cheap oil they are already worth more today, and as such you will be paying a premium today that already factors in future enhanced profits.

Having said that, a good earning report will still attract some 'dumb money' so you could see a nice bump from people who buy in based on the surprisingly high profit just announced.

 

[RRD]

Very high level:

It allows a buyer (or seller) to fix a price in the future in order to exchange a commodity. As such, the existence of the Futures Exchange allows airlines to lock in prices today for future oil needs. I think this is relevant to your thought to buy airlines.​

The logic you had is sound, lower oil = smaller costs = greater profit. However, because they have already locked in future pricing, an efficient market would have adjusted the current price to bake in the forecasted future profit.

In other words, because everyone knows they will be getting cheap oil they are already worth more today, and as such you will be paying a premium today that already factors in future enhanced profits.

Having said that, a good earning report will still attract some 'dumb money' so you could see a nice bump from people who buy in based on the surprisingly high profit just announced.

Ah! Thank you for simplifying it - makes much more sense now. I have been reading analysis of these airline stocks on Seeking Alpha where analysts talked about locking in cheaper oil rates now and therefore more profits in the future but there is another component to airline stocks doing well - more than ever before airline traffic and few big competitors left with the merging of the big airlines (American & US Airways this year, United and Continental couple of years ago), which means ticket prices are still high (very few percentage of people are MSing out their travel expenses). So, if you see the airline stocks' charts for the last few years, they have been zooming compared to the rest of the market. A Delta stock which I bought at $9 just two years ago is at $50 today (because they got into their own refinery business). They have been posting record profits and this oil crash is just a boon!
Market is hardly ever efficient when it comes to adjusting current prices with regards to future profits. If it were that, Apple would not have gone to the lows that it went to last year and now it is the only stock holding the market together.