We're a Long Way From 'Peak Oil'
Editor's note: It's time to say goodbye to the longest bull market ever...
After 11 years without a 20% drop from a previous high, all three major U.S. indexes officially entered bear market territory over the past week. And although stocks moved higher yesterday, the coronavirus will likely cause more headaches in the weeks ahead.
Things were just as bad in the oil and gas space... After an agreement between oil-industry powerhouses OPEC and Russia fell apart last weekend, the price of oil plunged roughly 25%.
And as Stansberry's Big Trade editor Bill McGilton explains in today's Masters Series – adapted from the February 14 Digest – the pain in the oil sector likely isn't over yet...
We're a Long Way From 'Peak Oil'
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.
Today, I 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...
The 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 in January, the way things played out showed us that the oil market wasn'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.
Iran retaliated a few days later with a missile barrage on U.S. troops stationed at a pair of Iraqi airbases...
And now, more than two and a half months later, the Middle East remains on edge.
Follow-up attacks could always occur... For example, on Wednesday, two American service members and one British service person sadly lost their lives in a rocket attack launched by Iraqi proxy militias.
But all the geopolitical uncertainty and fear that started the year – and remains – hasn't been enough to keep oil prices moving higher.
Brent crude oil (the international benchmark) rose only 4% to roughly $70 per barrel through all the heightened tension. And in the weeks after the U.S. drone killed Soleimani and Iran's retaliation, oil prices continued to fall...
By mid-February, a barrel of Brent crude traded for about $57 per barrel – 16% lower than before the strike.
And that's before "OPEC+" – a three-year pact between oil cartel OPEC and Russia – fell apart on March 6, when Russia refused to cut its oil production any further. OPEC wanted deeper oil cuts to support higher oil prices, but Russia wouldn't play along.
Saudi Arabia became infuriated and launched a full-fledged oil "price war"... saying it would boost production by 25% – around 2.6 million barrels per day – to a record 12.3 million barrels per day in April. And then, Russia said it will also boost production by 500,000 barrels per day. As you can see in the previous chart, that sent oil prices into a freefall...
The increased supply of oil comes at the same time demand is falling as people reduce travel due to the recent outbreak of coronavirus. This combination has pushed Brent crude all the way down to about $35.50 per barrel today.
This wasn't the first time oil shrugged off geopolitical tension, 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 2019. 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 could 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 oversupply more than geopolitical risk...
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 4% over the next two years – from 65 million barrels per day in 2019 to 68 million barrels per day in 2021.
Because of the increased production (coupled with stable demand), the U.S. Energy Information Administration ("EIA") expects an oil surplus in 2020. The EIA forecasts global oil supply to increase by 1.5 million barrels per day and global demand to increase by just 370,000 barrels per day.
That's a surplus of around 1 million barrels per day.
Keep in mind that the EIA was forecasting 2% global growth to arrive at that surplus. The Organization for Economic Cooperation and Development ("OECD") is calling for 2020 global growth to fall as low as 1.5% because of the coronavirus.
So in all likelihood, the oil surplus will be much larger...
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.
The supply and demand imbalance has prompted the EIA to cut its forecast...
At the beginning of the year, the EIA was calling for Brent crude to average $65 per barrel in 2020 and $68 per barrel in 2021. Because of the price war and the outbreak of coronavirus, the EIA now expects Brent crude to average $43 in 2020 and $55 in 2021.
The OECD still expects the world's economy to grow, just at a slower rate. But the coronavirus could change that...
In that case, the demand for oil will fall even more – creating an even greater disparity between supply and demand. In turn, we'll see even lower oil prices.
Already, the coronavirus has disrupted the supply chain for nearly 75% of U.S. companies, according to news website Axios. The disruption is worldwide and ongoing... Germany's exports to China were down 6.5% in January compared to the year earlier.
With tens of millions of people on lockdown in China and similar lockdowns happening in other countries like Italy, we still don't know how much this situation will hurt the global economy. But one thing is certain... slowing economic activity will decrease demand for oil and will continue to pressure prices.
And even 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... or the current environment of $30-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 breakeven 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, each oil-drilling project has different variables. 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 are Rystad's average breakeven prices for 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 that are 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 – when it makes sense.
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 costing much more than it does today... 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 the January 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 with oil prices hovering in the $60s or even less, it doesn't make sense anymore for this company 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. And with oil prices falling off a cliff, its future looks bleak.
Subscribers who took my advice back in January are currently sitting on a 228% gain with this position. But if it goes belly-up as I expect, the company's stock will be worthless... And yet, folks holding onto this short play stand to make even more profits.
Regards,
Bill McGilton
Editor's note: If you're like most folks, you might be moving to the sidelines right now. Or you might worry that a prolonged crash could wipe out a big chunk of your earnings from the long bull market. But you don't have to be a victim...
In fact, Bill believes the ongoing panic creates a massive moneymaking opportunity. As stocks plunged over the past three weeks, he used a radical investment strategy to book gains of 227%... 137%... and 126%. And he's holding four other triple-digit winners today.
Next Thursday, March 19, at 8 p.m. Eastern time, Bill will take part in an online emergency briefing about where the market will go next... and reveal all the details about his strategy. If you hold stocks, you can't afford to miss this FREE event. Reserve your spot right here.