Black Gold

"If you are going through hell, keep going"

-Winston Churchill


Welcome to The Golden Sense!  Odds are pretty good that you’ve never heard of, let alone tried, Pemberton’s French Wine Coca. This was an extremely popular beverage of the mid-1800s. I am willing to bet, however, that you have tried the beverage it evolved into. Made from a combination of the South American coca plant, the kola nut and Bordeaux wine, an Atlanta-based pharmacist named John Pemberton created his coca wine. He eventually replaced wine with carbonated water and renamed his drink Coca-Cola.

Speaking of different names and dark substances, oil is known by many names including black gold, Texas tea, dino juice and a host of others. Beyond the colorful language, it is indeed an important commodity in the modern day world. As you probably know, the oil market is a disaster. The price of oil has plunged 75% since 2014. In February, oil hit its lowest level since 2003. Some say that these lower oil prices are good for the economy, while others say that is a bad thing. 

First the good - lower oil prices mean lower gasoline prices and that means consumers have more money in their pocket to spend. I know I like going to the gas station much more today than I did a few years ago. Everyone is relieved to have a few extra bucks in their pocket.

Now the bad - lower oil prices can lead to weakness in bank loans related to bankruptcies in the energy sector. Since the start of 2015, 130 North American oil and gas producers and service companies have filed for bankruptcy owing almost $44 billion, according to law firm Haynes & Boone. Two weeks ago, Linn Energy filed for bankruptcy, making it the largest shale oil bankruptcy since 2014. It owes lenders $8.3 billion. A week later, SandRidge Energy declared bankruptcy. It became the second-biggest shale oil company to go bankrupt. The company owes its lenders about $4.1 billion. Ultra Petroleum, Penn Virginia, Breitburn Energy, and Halcón Resources also filed for bankruptcy in the past couple weeks. 

In addition, there has also been industry layoffs when prices tank and it can lead to spillover weakness in other businesses located in oil driven states. Before we get too pessimistic, please remember that not all oil companies will fail.

Recently, oil was trading at about $48 per barrel. That was up from the $32 low level of 2016 and also above the average of about $40. Still low overall, but slightly better.  Next, consider how that price of $48 compares to where we were just 1 year ago. Back then oil hit a high of about $64 per barrel, so the decline in 12 months from that point is about 25%. In any industry that is a big decline. To gain a broader perspective, we look at the $48 price and compare it to where things have been over the past 5 years. During that time, the high water mark reached about $143 per barrel and the average was about $84.  

The key drivers to the decline are higher production, a decline in global demand, a change at OPEC that allows for its members to keep pumping and selling oil on the market, a flood of production from Iran from the lifting of the global embargo there, a strong US Dollar and ongoing weakness in China and other countries. These factors seem to be medium to longer term issues, so the best guess at this point is that prices will remain subdued for now. 

So what can we take from all this? Remember, in times of crisis, there is opportunity. Not all oil companies are going bankrupt and oil companies will restructure their businesses. If you survey the damage, opportunities to buy quality oil stocks may exist. I consider a stock a buy if these oil companies are still able to turn a profit, have a price to earnings ratio below 18, and offer a dividend of 3% or more. These opportunities don't come around often, so take the time to do the research and make the play. 

Owning shares of a quality oil company is a good asset to have. Oil companies produce a prized necessary commodity that has staying power. They deal with real wealth. A real asset. It is not ‘wealth’ in the conventional sense. I’m not talking about paper money that’s conjured out of thin air by central bankers. They sell a commodity that is vital to the foundation of modern economies. These points are what make oil companies such a prized asset to own.

Now that oil has stabilized, the stronger companies are separating themselves from the weaker companies. This year, Exxon is up 15%. Chevron is up 11%.

The crash in oil prices has given us a chance to buy world-class oil companies at deep bargains. I'm not saying these companies are a bargain right now...but bargains do exist out there. It's time to start sniffing around... and perhaps you will find exactly what you are looking for.

Over and Out

-T. Norman

References:

Brown, Steve.  Bank Investment Daily 2016

Spittler, Justin. Casey Daily Dispatch 2016