Oil companies, perhaps more than any other industry, always see their fortunes move in line with the price of their underlying asset – crude oil. While the coronavirus scare is causing a general sell-off in stocks, the oil sector is suffering from a more fundamental problem, one that has been on the horizon for most of the past 12 months.
This problem of course, is oversupply. Crude oil prices are currently trading below $30 a barrel. The coronavirus has been perhaps the straw that broke the camel’s back, but it is the glut of crude that has allowed it to plummet so far, so fast.
The problem with making oil…
The reason oil companies are so linked with the price of crude is that so many facets of their business are dependent on crude prices being at or above certain levels. From downstream to upstream, different aspects of the business are only viable when crude prices are a certain level.
For example, let’s say it costs $50 to get each barrel of crude from deep wells or from shale fields. You need to be able to sell it for more than $50 to make a profit.
Of course the big oil companies have been doing this for a long time, and they know how to act when oil tanks – they cut capital expenditure, halt production at expensive fields, and generally batten down the hatches until crude goes back up. Historically, it always has gone back up.
Can oil recover?
I believe that oil will, once again, go back up…at some point.
In the meantime though, the coronavirus is having a broad impact on fuel consumption, and thus crude consumption. This is likely to continue for some time. I suspect that once the world finally gets a handle on the situation and life returns to normal, then travel will again become an everyday thing. This may not be for another year, but it will eventually happen.
OPEC and its member countries have been particularly obstinate in their refusal to cut quotas. I think long-term greed will eventually outweigh the short-term variety, and the group will begin to cut production in order to bolster prices.
Given my belief that crude prices will recover, I see the current situation as an opportunity rather than a cause for panic. There is risk, however, and I would only consider investing in the large blue chips.
For me, this means BP (LSE: BP) and Royal Dutch Shell (LSE: RDSB). I have long been a fan of these two oil companies. Both are well placed in size, scope, and cash to withstand the pressures of low crude prices, certainly for a year or so.
At the moment, both companies are maintaining their respective dividends, though I suspect this may change if crude prices stay at these levels for the next few months.
Both companies are as diverse as an oil company can be, and Shell particularly has shown a willingness to try out new things – exactly what is required in these kinds of times.
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Karl has shares in BP and Royal Dutch Shell. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.