If you are someone who was long equities in mid-February, the last month was probably quite a rough ride. The S&P 500 is down around 20% from its high. The FTSE 100 (the stock market index of the United Kingdom) is down around 35% from its pre-coronavirus high and has hit its lowest point since 2011. Amid all of this chaos, some parts of the market have been hit worse than others, with the energy sector being a prime example.
Companies like Exxon Mobil (XOM) and Royal Dutch Shell (RDS.A, RDS.B) have seen their share prices plummet as they have been hit by the double blow of lower projected demand due to the coronavirus and the price war between Russia and Saudi Arabia (and, by extension, all other major oil-producing nations). The price per barrel of Brent Crude (the global benchmark) has collapsed from around $70 in early January to around $30 as of the writing of this article.
Much has been made of the geopolitics of the Russia-Saudi Arabia fallout. Some are seeing it as a struggle for market dominance between these two top oil producers, while others think it could be a coordinated attempt to take down debt-ridden U.S. shale companies. The truth is that it’s probably all of the above. Regardless, the net result is that energy as a whole has taken a serious fall, and I think that brave bargain hunters can find value in some of these blue chip names.
The main question is whether the current price of oil is sustainable for the parties pushing the price war. The answer, most likely, is no. According to the International Monetary Fund, Saudi Arabia’s breakeven oil price - the price at which they can balance their budget - is $80 per barrel. By contrast, Russia’s breakeven point is estimated to be around $42 a barrel - still higher than the current price, but comparatively much more manageable. U.S. sanctions imposed on Russia since 2014 forced the Kremlin to toughen up its budget against declines in global oil prices, resulting in this much lower breakeven point.
U.S. shale producers break even at around $45 a barrel, just above Russia. However, unlike Russia or Saudi Arabia, U.S. oil companies do not have the benefit of official state support. President Vladimir Putin can defend the essentially state-controlled Russia oil producers by dipping into the country’s sovereign wealth fund, but private U.S. producers cannot (although President Trump has floated the idea of organising a bailout for U.S. shale).
I think the most likely outcome is that Saudi Arabia will cave first. Crown Prince Mohamed Bin Salman’s position within the Saudi royal family has become increasingly more precarious, and bleeding billions of dollars from the state’s coffers to fight an uphill battle against cheaper U.S. shale and more efficient Russian production practices is unlikely to win him any more popularity.
History supports this hypothesis. Between 2014- and 2016, OPEC drove down the price of oil in a similar attempt to break shale, with disastrous consequences for the cartel. The shale industry was able to consolidate and lower its breakeven below what the Saudis thought possible, leading OPEC states to lose hundreds of billions of dollars in revenues.
Disclosure: The author owns no stocks mentioned.
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