30 BARRON’S March 16, 2020
Brent crude, fell 24% on Monday, the
steepest drop since 1991, and then
another 11% over Wednesday and
Thursday. All told, the price for Brent
has been cut in half this year.
This “war” is ostensibly between
Russia and Saudi Arabia. Russia re-
jected a plan from OPEC (the Organi-
zation of the Petroleum Exporting
Countries) to cut production, given the
likelihood of lower global demand.
Saudi Arabia increased its oil output
in retaliation. The real target, however,
has been the U.S., and the dozens of
American companies that have been
drilling feverishly in U.S. shale plays,
stealing market share from the inter-
national giants. The shale drillers de-
pend on capital markets for financing,
and no one will give them loans when
oil prices are below $40. Several will
have to go out of business or be swal-
lowed by competitors.
“It’s really the end of so many com-
panies,” David Heikkinen said on
Monday. “You couldn’t imagine a sup-
ply war in the middle of an economic
recession.” Heikkinen, the CEO of
Houston-based equity research firm
Heikkinen Energy Advisors, said he
was having trouble reaching the oil
companies he usually talks with, be-
cause they were rewriting their drill-
ing plans.
Analysts expect the number of rigs
drilling on U.S. soil to drop by at least
a quarter. Evercore’s James West pre-
dicts the rig count will fall to 690 this
year from an average of 920 in 2019.
U.S. production could decline from a
high of 13 million barrels a day—the
highest level in the world—in Novem-
ber to 12.6 million, on average, in 2020
and 11.1 million in 2021, according to
Stifel.
That could still prove too optimis-
tic. OPEC and its allies are likely to
flood the market with 3.5 million extra
barrels of cheap crude a day, crowding
out competitors. The world uses 100
million barrels a day, give or take a
few million; a shift in demand or sup-
ply of a few hundred thousand barrels
can causes double-digit price swings
in normal times.
And the flood of supply comes just
as the coronavirus pandemic is likely
to destroy demand for several million
barrels of oil a day. Jet travel alone
uses about eight million barrels daily,
and many planes are now grounded
worldwide.
Investors have three options.
One is to ignore the industry en-
tirely. That has been a smart choice for
almost the entire past decade, during
which energy stocks regularly trailed
the market by double-digits. The in-
dustry’s debt position is ominous—oil
and gas producers have piled on more
than $120 billion in the past five years,
and they still can’t consistently pro-
duce cash. In its latest report, the non-
profit Institute for Energy Economics
and Financial Analysis found that
producers had spent $5 billion more
on drilling for oil in the previous four
quarters than they had made from
selling it.
Another option for investors is to
buy energy stocks that could perse-
vere amid low oil prices. Natural gas
producers, for instance, outperformed
last week after months of weakness.
Gas producers should benefit as over-
all oil drilling slows, because that pro-
duces “associated gas” that has led to
oversupply in the gas market. Take
away that associated gas, and the price
should rise.Cabot Oil & Gas(ticker:
COG) is one of the safest gas plays.
Oil shipping companies can also
persevere in this environment, at least
in the short term. Oil is in contango,
meaning that futures prices are trad-
ing above spot prices. It pays for com-
panies to buy oil and hold it on tank-
ers for later sale. “We believe the
entire tanker sector should benefit,”
Stifel analyst Derrick Whitfield wrote.
His favorite of the bunch isInterna-
tional Seaways(INSW), which rose
on the week. Other shipping compa-
nies that could benefit includeScor-
pio Tankers(STNG) andEuronav
(EURN), according to Whitfield.
Refiners, too, would presumably
benefit if oil prices are low for a long
time, because crude is an input for
them. Cowen analyst Jason Gabelman
likesPhillips 66(PSX), which has a
strong balance sheet and can profit by
refining crude produced overseas,
even if U.S. production slumps. Gabel-
man likesValero Energy(VLO), an-
other large U.S. refiner that should see
gains from some of the same dynam-
ics as Phillips.
Still, the refiners’ stocks bounced
around last week, with all the big
American names crashing by double-
digits on Thursday. Low prices may be
good for them, but a global recession
hurts demand for their products.
A third option—the riskiest but
perhaps the most rewarding—is to
bottom-fish for oil producers that
have been beaten down and could
snap back smartly.
One stock that several analysts
have recommended in recent days is
Concho Resources(CXO), a Texas
driller that has hedged most of its pro-
duction this year at higher prices.
Even at $35 a barrel, it is one of the
least leveraged members of the indus-
try and could rebound once prices
recover, analysts say. Trading at $39, it
is miles away from the average ana-
lyst’s target price of $96. Still, Con-
cho—like most other producers—has
rarely generated positive free cash
flow, even at higher oil prices.
And there is no particular reason to
think petroleum will rebound in the
The Oil Shock
Brent Crude
(per barrel)’12 ’16 ’2020406080100$120Source: BloombergF
or more than 150 years,
drilling for oil meant un-
derstanding the science of
geology.
Last week, as oil prices
crashed on simultaneous
supply and demand shocks,
industry experts turned to mythology
(“The pillars of Hercules crashed to-
gether”), and even polemology, the
study of war. “Armageddon,” one ana-
lyst warned.
The international oil benchmark,
By AVI SALZMAN
Struggling
To Survive Oil’s
Global Price War
The energy industry faces a shakeout and difficult times ahead.
Analysts point to seven stocks that could persevere amid low prices.