We're a Long Way From 'Peak Oil'

The threat of major war can't move oil prices higher... What oil markets fear the most... We're a long way from 'Peak Oil'... Coronavirus fears drive prices lower... Oil and gas debts coming due soon... Companies can't afford the bills... One company that's likely to go bust...

The threat of a major war can't even keep oil prices moving higher for more than a few days...

In the January 3 Digest, my colleague Corey McLaughlin covered the U.S. airstrike that killed Iran's top military leader – Maj. Gen. Qassem Soleimani, the head of the country's Quds special forces.

Corey discussed the tensions in the Middle East in the hours following the airstrike, and the real possibility of a major war breaking out between the U.S. and Iran. He also touched on how oil prices were reacting to the breaking news.

In today's Digest, I (Bill McGilton) want to revisit this incident and discuss in greater detail the state of oil right now... and where prices are likely to head at least through the first half of this year.

In short, we're a long way from the "Peak Oil" days of 2008...

Last month's conflict between the U.S. and Iran was a key tell for investors when it comes to oil...

As I explained to my Stansberry's Big Trade subscribers last month, the way things played out showed us that the oil market isn't too concerned about geopolitical risks.

That might sound counterintuitive. After all, to this day, many folks still believe that all the latest tensions in the Middle East play a major role in the world's oil supply.

And there's no doubt this was one of the most serious geopolitical flare-ups in decades... with the threat of a major conflict involving a world power.

It had implications for the entire Middle East region. For two decades, Soleimani was responsible for arming, training, and commanding Iranian "proxy" militias in countries like Iraq, Syria, Lebanon, and Yemen.

More recently, Soleimani helped Iraq regain control of its oil-rich city of Kirkuk in 2017... And he was allegedly the mastermind behind the attack at the U.S. embassy in Iraq in December, which eventually led the U.S. and Iran to the brink of all-out war...

With Soleimani's death, people in Iran felt like they had lost an important symbol of resistance. Many Iranians called for revenge as their hero became a martyr.

More than a month later, the Middle East remains on edge. And follow-up attacks could always occur...

But all the uncertainty and fear to start the year wasn't enough to keep oil prices moving higher.

Brent crude oil (the international benchmark) rose only 4% to $69 per barrel through all the heightened tension...

Here's what happened after the U.S. drone killed Soleimani and Iran retaliated a few days later with a missile barrage on U.S. troops stationed at a pair of Iraqi airbases...

After the retaliation from Iran, prices continued to fall and are now trading around $57 per barrel – 16% lower than before the strike was carried out.

This wasn't the first time this sort of price movement happened, either...

The same thing happened after an Iranian "proxy" drone attack on the world's largest oil-processing facility, Abqaiq in Saudi Arabia, in September. Two-thirds of Saudi Arabia's oil is processed there... 7 million barrels per day.

Saudi Arabia said the attack knocked out more than 5% of daily global output (5.7 million barrels of production a day). The price of Brent crude spiked to $69 on that attack, too.

Then, two weeks later, after the facility was back running (though still not at full capacity), the price of Brent crude had dropped back down to $58, as though nothing ever happened.

And the way I see it, prices will likely head even lower in the long term... and it goes back to a key fundamental that doesn't draw nearly as many headlines warning of a potential armed conflict.

Right now, oil markets fear something more than geopolitical risk...

Oversupply.

As I wrote last month in Big Trade...

Global oil supply is expected to outpace demand for the foreseeable future, thanks mostly to North American shale producers...

The Organization of the Petroleum Exporting Countries ("OPEC") plans to cut its oil production by 6% from 35 million barrels per day in 2019 to 33 million barrels per day by 2024. But it won't matter...

The Middle East (represented by OPEC) is no longer the world's swing oil producer. The United States is.

As President Donald Trump said amid the conflict in January, "We do not need Middle East oil." The U.S. is the top oil-producing country in the world, and we have less need to import oil from other countries than ever before...

Global oil production outside of OPEC is projected to increase 12% over the next five years – from 64 million barrels per day in 2019 to more than 72 million barrels per day in 2025... dwarfing the OPEC cuts.

Because of the increased production (coupled with stable demand), the U.S. Energy Information Administration ("EIA") expects an oil surplus in 2020. EIA forecasts global oil supply to increase by 1.6 million barrels per day and global demand to increase by just 1.3 million barrels per day.

That's a surplus of 300,000 barrels per day.

Fatih Birol, the executive director of the Paris-based International Energy Agency, expects even bigger oil surpluses... At the Reuters Global Markets Forum in Davos, Switzerland, on January 23, Birol said he believes we'll see a surplus of 1 million barrels of oil per day, at least through the first half of 2020.

And that includes OPEC's oil cuts. "That's the comfortable market outlook," he said.

Whether it's a surplus of 300,000 barrels per day or 1 million barrels per day, the point is... Excess oil supply will lead to more inventory and lower prices.

This looming and large global supply imbalance almost completely mutes the threat of higher prices... from geopolitical risk or anything else short of a major war.

So there's a good chance the EIA's current forecast for Brent crude to average $65 per barrel in 2020 and $68 per barrel in 2021 is optimistic – and even more so when you consider that the forecast depends on the economy staying strong.

If the world economy starts to slow...

The demand for oil will fall even more – creating an even greater disparity between supply and demand. In turn, we'll see even lower prices.

Already, China National Petroleum projects that demand-led growth for oil in China will fall from 5.2% in 2019 to 2.4% in 2020. And those projections were made before the coronavirus outbreak... which recently sent oil prices to 13-month lows on fears of declining demand.

China was estimated to get 38% of its oil from the Middle East this year.

Meanwhile, German manufacturing has been in a slump – causing the German economy to grow at 0.6% in 2019 – the slowest pace since the eurozone debt crisis in 2013. (Though as my colleague C. Scott Garliss wrote in the Digest last month, things in Germany are just now starting to rebound.)

Either way, the International Monetary Fund projects that U.S. growth will fall from 2.3% in 2019... to 2% in 2020... to 1.7% in 2021.

So we're seeing several signs of slowing demand that will also put pressure on oil prices.

At current prices, many oil companies remain uncompetitive...

They have cost structures that can't keep up in the world of $60-something oil... let alone $50-something oil.

In the boom years of 2011 to 2014, these companies took on huge amounts of debt that made sense in the world of $100-plus oil. Now they're burdened with heavy debt and projects with high break-even costs.

According to Norwegian energy-research firm Rystad Energy, new oil projects, on average, require a minimum of $60 per barrel just to break even.

Of course, there are different variables across each oil-drilling project. Each project requires a certain oil price to break even over the life of the project.

The higher oil prices go, the more projects become feasible. Conversely, the lower oil prices go, the fewer projects make economic sense.

Here's Rystad's average breakeven price for the new oil projects...

But no one starts a new drilling project to lose money. There has to be upside with a margin of error, meaning oil has to be sustainable at prices higher than breakeven long enough to give investors confidence that a new project is worthwhile.

U.S. onshore shale projects – which don't need ships or more specialized equipment – are the world's second-cheapest source of oil, behind projects in the Middle East.

But they don't come with geopolitical risk. That's where money for new projects will go.

This will likely lead to a new round of oil and gas bankruptcies...

Leveraged companies with huge debt on their books to fund more expensive oil projects with high breakeven costs (like offshore and deepwater drilling) are in real trouble.

Companies like Chesapeake Energy (CHK) and Antero Resources (AR) are struggling to hang on... hoping for higher oil prices.

Many of these companies not only can't make a profit... They can't even service their debts. Many are running out of money and can't borrow more. And one by one, they're going bankrupt.

According to law firm Haynes and Boone, 208 oil and gas producers with a combined $122 billion in debt filed for bankruptcy from the beginning of 2015 through the end of 2019. In the same period, another 196 oilfield-services companies with a combined $66 billion in debt declared bankruptcy.

After a lull in 2017 and 2018, energy bankruptcies started picking up again in 2019 – with 42 energy producers and 21 energy-service companies filing bankruptcy.

It's about to get even worse...

Back in the days of $100-plus barrels of oil from 2011 through much of 2014, many U.S. oil and gas companies gambled... Fueled by cheap credit, they took on huge amounts of debt – more than they could ever handle – hoping that oil prices would keep going up.

They were victims of their own success... Now, the bills have piled up. And they're coming due within a short period of time...

According to credit-ratings agency Moody's, $203 billion of oil and gas debt is set to mature from 2020 through 2023...

Many oil and gas companies can't afford to pay.

If you own oil and gas stocks, take a run through their financial reports and check their breakeven costs. (Our director of research Austin Root gave a great primer on how to do this in a recent Masters Series essay.)

If most of their production has breakeven scenarios that rely on oil staying near today's prices... be careful.

And pay close attention to their debt, too. If these companies have high debt levels, make sure they can generate enough cash from operations to cover it...

I'm willing to bet you'll find a lot of companies are in trouble if oil prices go lower, as I expect... That means we'll likely see many more oil and gas bankruptcies from here.

In my latest issue of Big Trade, I recommended a short play on one company in particular that could go bust soon.

It's one of the largest offshore drilling contractors, but its problem is that with oil prices hovering in the $60s or even less, it doesn't make sense anymore to keep its whole fleet working.

The company has $4.2 billion in debt coming due through 2023, and right now it can't even afford to pay the interest on it.

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New 52-week highs (as of 2/13/20): Blackstone Mortgage Trust (BXMT), DocuSign (DOCU), Hannon Armstrong Sustainable Infrastructure Capital (HASI), Home Depot (HD), Ingersoll Rand (IR), iShares U.S. Home Construction Fund (ITB), JD.com (JD), Kinder Morgan (KMI), New Residential Investment (NRZ), NetEase (NTES), New York Times (NYT), PepsiCo (PEP), ResMed (RMD), Service Corporation International (SCI), Sea Limited (SE), Splunk Technology (SPLK), The Trade Desk (TTD), ProShares Ultra Utilities Fund (UPW), ProShares Ultra Semiconductors Fund (USD), ProShares Ultra Financials Fund (UYG), Vanguard Real Estate Index Fund (VNQ), and W.R. Berkley (WRB).

A quiet mailbag today, but we do have one brief housekeeping note to share instead... The U.S. markets and our Stansberry Research offices are closed on Monday for Presidents' Day. After this weekend's Masters Series essays, we'll resume our normal Digest coverage on Tuesday.

We hope you have a great holiday weekend... In the meantime, as always, send your comments and questions to feedback@stansberryresearch.com.

Regards,

Bill McGilton
Kiev, Ukraine
February 14, 2020