Brent crude oil closed at US$44.06 per barrel last night, the lowest daily close this year. If we can hold this level tonight, it’s near to certain that Brent crude will head to significantly lower lows very soon.
I say ‘near to certain’ because markets rise and fall on confidence.
If punters are positive on the prospects of crude, they’ll buy shares in oil companies. If not, they’ll sell those shares and go short. Shorting is a way to profit from falling asset prices.
Looking at this story, going short at the moment isn’t actually a bad idea. The news in the oil industry stinks.
And the prospects seem dismal…
As a contrarian, at this point in the cycle I would normally recommend buying oil stocks. After all, you need to buy low and sell high if you want to make the big money.
Unfortunately, this time is different.
It’s not time to buy oil yet
The fact is that supply far outweighs demand.
On the demand side, economies are overleveraged — to the point that borrowing more debt is not creating real economic growth. When economies were growing, they needed more oil to feed their economic engines. But growth in the major economies is stagnant. Furthermore, rising taxes and regulation are hitting the demand side of the equation hard.
Rather than seeing businesses expand and investing in capital, we are seeing them cut costs, slash jobs, and buy back their own shares. This comes at a time when consumers are demanding fewer discretionary goods because their real incomes have fallen dramatically. This ‘deflationary’ phase is crippling the need for crude oil.
On the supply side we’re seeing significantly more oil brought to market. This won’t change any time soon.
The end result: crude should fall to significantly lower lows in the near future.
But more specifically, crude oil should fall to US$34 per barrel or lower before oil bottoms. As such, if you buy crude oil stocks today, you’ll stand to lose A LOT of money in the months ahead.
I suggest being cautious and keeping your powder dry. There are definitely bargains out there, but crude may not be as cheap as it seems. When crude starts to fall lower, oil stocks will get hammered — regardless of their breakeven price.
When this happens, the question will be: what’s a bargain and what’s just cheap junk?
The investment dilemma
It’s an investing dilemma to many…
Fortunately for Resource Speculator readers, I’ve been analysing and investing in oil companies for many years. During this time, I’ve learnt firsthand what it takes for them to thrive, survive or fail.
Recently, I analysed every single crude oil stock on the ASX. And believe it or not…there’s plenty of cheap junk out there and overvalued oil stocks.
In fact, nothing has really changed all year…
On 3 March, I warned Resource Speculator readers that many oilers were significantly overvalued. Their share prices hadn’t been factored into the lower oil price environment. I said,
‘The P/E multiple is a common valuation tool. It measures how much you’d pay for shares in a company given its future earnings.
‘Using history as a guide, a PE multiple of 15x is considered to be fairly valued — i.e. you’re paying for 15 years’ worth of future profits today.
‘[Looking at the oil sector], you can see that energy valuations spiked to nearly 30x in recent months. Paying this price would be justified only if you believe that earnings will grow sustainably for 30 years. This might be the case for a major healthcare company that discovered a cancer cure, but definitely isn’t the case for major oil and gas plays.
‘A multiple of 30x is more than double the energy sector’s historical average. This suggests that energy stocks are significantly overvalued. We’re looking at valuations at similar levels to the Dot Com bubble of 1999.
‘The reason for the higher valuations is simple…
‘The destruction in the oil price from roughly US$80 per barrel to US$50 per barrel today didn’t truly kick off until mid-November of 2014. In this case, energy company cash flow quarterly statements haven’t truly shown the destruction in oil prices.
‘The next energy quarterlies are due out roughly towards the end of April 2015 (for the January – March period). In this case, it’s highly likely that the lower oil prices will flow through to valuations.
Indeed, this call was spot on.
If you look at any major oiler’s share price, you’ll see that it pulled back from the end of April into late August. The price then rallied marginally higher with the stock market into October.
The investment dilemma…continued
As I said, things are again looking bleak for the oilers. After the last pump and jump in crude oil prices, many companies have become — again— extremely overvalued.
It appears that the market is starting to catch on to this fact.
Smaller oilers are getting smashed. They’re close to being priced at the point of failure. Looking at the mid-tiers, life isn’t great either. Their share prices are trading, on average, 30–60% lower than the start of this year.
While, the larger and medium oilers are bleeding cash and cutting dividends. And because their balance sheets are so weak, they’ve been raising capital — something they said earlier this year that they wouldn’t need to do.
For example, after announcing a capital raising it said it wouldn’t need to do earlier this year, Santos Ltd [ASX:STO] dropped 27.24% yesterday. It’s down more than half the price it was at the start of the year. Origin Energy [ASX:ORG], Woodside Petroleum [ASX:WPL], Oil Search [ASX:OSH] are also down this year.
No doubt about it, it’s been a bad year for their shareholders…
And if you own any of these stocks, I’ve got more bad news. There’s a lot more pain to come. If you want to know when it will stop, check out Resource Speculator here.
So where is the value?
To be honest, there isn’t much good value right now.
That said, I am value hunting in the oil sector. And have about 20 stocks on my radar. I’m preparing to recommend a bunch of these oilers to Resource Speculator readers in the months ahead. When the crude crashes to US$34 per barrel, I’ll show them the best oilers, which should explode higher next year when geopolitical conflict goes off the charts.
The quagmire in the Middle East won’t just disappear overnight. In fact, according to Sputnik news last night (with my emphasis):
‘Speaking at the US Institute of Peace in Washington, DC, US Secretary of State John Kerry discussed Washington’s foreign policy in Syria.
‘“The stakes could not be higher,” Kerry said on Thursday, before insisting that the United States is “on the right track and we are making gains and we are clear on the road ahead.”
‘He also stressed Washington’s belief that Assad must be removed from power to ensure stability.
‘“Without a real transition, the fighting will continue and the war will never end,” Kerry said. “If the war is to end, we must find an alternative [to Assad].”’
Indeed, this isn’t a war against ISIS, it’s a war against Syrian president Bashar Al-Assad.
The US will do whatever it takes to instil their own ‘puppet’ politician in Syria — they want to build their own pipeline from Qatar to Europe. This would effectively block out Russian energy dominance in the region. It is all geopolitical. If you want to know more about this story, check out your free report here.
I’ve been preparing Resource Speculator readers for this for some time now. While we wait for the Middle East geopolitical game to escalate, there will be a smarter time to buy. That time hasn’t come yet. And this is why I‘ve recommended that readers wait before buying their oil stocks.
If you want to buy the best oil bargain on the ASX at the right time, check out your free report on the Middle East here.
Editor, Resource Speculator