Is Carnage in the Oil Patch an Opportunity?
Ahh, black gold and Texas tea. There’s just something about crude oil that stirs the soul of those seeking profits—or maybe I’m just a fan of The Beverly Hillbillies.
But like any other asset class, crude oil has its share of risks that come with the territory. Those risks have been magnified several-fold over the last month.
The convergence of the economic consequences of the virus with an epic battle between oil producing giants, Saudi Arabia and Russia, has resulted in decimation for oil industry stock investors.
We are not talking about a bear market here with losses of a mere 20% or a bit more. No, the losses in oil and gas stocks exceed 50%.
The SPDR S&P Oil and Gas ETF (NYSE:XOP) is down 56% over the last month as of mid-day Friday.
Within the sector some individual names are faring far worse. Shares of integrated oil company, Occidental Petroleum (NYSE:OXY) plummeted a whopping 70% as OPEC entered into a price war that had crude prices falling into the $30 range.
Many companies like Occidental require prices that are well above that range to be profitable.
When one considers that many oil companies like Occidental are capitalized with debt, the risk of default rises when oil prices decline.
Being last in line in the pay chain, equity shares collapsed as oil prices plunged.
The question now is should investors dip their toes in the crude sector at current levels?
For those that love carnage, the answer may be yes. It also may mean catching a falling knife.
Conventional wisdom suggests that there will be bankruptcies in the oil patch. That’s a huge risk of loss no matter how big of a discount the market is offering today on oil stocks.
Simply put, it all comes down to economic conditions and oil prices.
If we do enter a recession but emerge quickly, oil prices could recover quickly. Add in some sort of agreement on curbing production by OPEC and you could see a V-shaped recovery in crude prices.
Assuming oil prices stabilize at prices safely above breakeven, one oil asset class that may be worthy of considering would be the Master Limited Partnership. These stocks are structured to pay cash flow to investors in the form of a dividend.
That model works when crude prices are safely above breakeven levels and stay that way with minimal volatility. It doesn’t work so well if there is a protracted stay at these very low levels.
Like individual oil stocks, oil based MLP’s are down hard, too.
Shares of Hess Midstream (NYSE:HESM) are down 56% over the last month. That loss, assuming the company maintains its dividend (a big if with oil prices in the $30 range) pushes an already high dividend yield to more than 15%.
The dynamics in oil are intriguing and names in the sector are on my radar.
They should be on yours, too.
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