Even If Oil Has Bottomed, Oil Stocks Are Still in for Difficult Times

Oil is recovering, and markets are asking what’s in store for the major oil producers. Exxon Mobil Corp. (NYSE: XOM), Chevron Corp. (NYSE: CVX) and ConocoPhillips (NYSE: COP) all suffered as crude declined, as it became less and less profitable to pull barrels out of the ground. With things seemingly turning around, at least near term, common sense suggests we should see a similar turnaround in the fortunes of big oil. Will common sense prevail? Probably not.

Oil is up, yes, but a variety of factors are coalescing to ensure it won’t be up for long — or at least that it won’t rise much further. The primary driver behind the current bullish momentum is the expectation that OPEC will come to an agreement on output caps. This might happen, but continued production at current levels will do very little to dent the current oversupply.

The United States alone has more than 1.2 billion barrels of oil stockpiled, and global production is outstripping demand by 2 million barrels a day. Global daily demand comes in at around 94 million barrels daily. Without the production surplus, U.S. stockpiles stagnate at their current levels. If production falls below demand based on an OPEC freeze agreement, chances are it won’t do so by more than 2 million to 3 million barrels a day. At a 2-million-barrel production shortfall, it would take nearly two years to work through U.S. stockpiles alone.

Obviously this is an extreme example and the United States wouldn’t let its stockpiles reduce considerably, but this only serves to support the point.
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Perhaps even more important near term, oil companies of all sizes are hedging in the $35 to $45 dollar range for 2016. The longer oil remains below these hedge contracts, producers will want to sell as much oil as they can. This will put pressure on near-term prices and caps any potential longer term upside at the upper hedge range through 2017.

In short, oil may be up, but take a step back, and it’s still very much down. The major oil companies may see a slight recovery on the back of mainstream media expectations and reporting of a near-term oil boost, but the bottom line is that these companies will likely be forced to sell oil at or near current prices for the next 24 months or so.

Of course, there is an opportunity for some of the better capitalized companies to acquire the cheap assets of smaller, less well-managed oil companies when they go bankrupt. A company with a low debt-to-equity ratio could make cheap investments going forward. Of the three mentioned, Exxon Mobil comes out on top, with a ratio of 21.88.

By Matt Winkler