Crude Oil: Opportunities & Value Traps

By Colin Twiggs
April 21, 2020

First, please read the Disclaimer.

On the weekend we wrote that the bottom had fallen out of the oil market after Nymex crude broke support at $20 per barrel.

Now, the previously unimaginable has occurred, with Nymex Light Crude falling below zero for the first time in history, closing at -$13.10 per barrel with reports of intra-day lows at -$37.63.

From The Age:

"Traders are still paying $US20.43 for a barrel of US oil to be delivered in June, which analysts consider to be closer to the "true" price of oil. Crude to be delivered next month, meanwhile, is running up against a stark problem: traders are running out of places to keep it, with storage tanks close to full amid a collapse in demand as factories, automobiles and airplanes sit idled around the world.

Tanks at a key energy hub in Oklahoma could hit their limits within three weeks, according to Chris Midgley, head of analytics at S&P Global Platts. Because of that, traders are willing to pay others to take that oil for delivery in May off their hands, so long as they also take the burden of figuring out where to keep it."

Brent Crude is trading at $25.57 per barrel but a Trend Index peak deep below zero warns of similar strong selling pressure.

Outlook

Crude oil production is still in a long-term up-trend. Low prices may present opportunities to buy cyclical stocks at historically low prices.

The Oil & Gas sector has plunged as expected.

Oil infrastructure is also suffering from low activity levels.

Energy-consuming industries, however, may benefit from lower oil prices.

Transport

Transport is the biggest consumer of crude oil products.

If we break usage down by fuel types, the largest is diesel/gas, followed closely by motor gasoline, with jet kerosene significantly smaller.

Airlines which have suffered from a massive drop in air travel.

While delivery services (formerly air freight) are suffering from the collapse of global trade.

So is marine transport.

But trucking is holding up well.

Construction Materials

Crude oil runs a distant second to coal as the chief energy source for cement production.

But the industry is a heavy transport user and should benefit from lower oil prices.

Mining

Mining is also likely to benefit from lower extraction and transport costs.

Forestry & Paper

Forestry is another heavy fuel user.

Chemicals & Plastics

Basic chemicals (including fertilizers) are the largest industrial consumer of crude oil.

Specialty chemicals are also largely oil-based.

Aerospace & Automobiles

Aerospace, laid low by problems at Boeing (BA), has been floored by a massive downturn in the airline industry and will take a long time to recover.

Automobiles have so far stood up well because of stellar performance from the likes of Tesla (TSLA).

But the sting is in the tail. Light vehicle sales have plummeted.

Low vehicle sales and less travel also means lower tire sales.

Oil Producers in Affected Regions

The IEA graph below shows producing regions that are uneconomic at varying prices/barrel (x-axis). If we take $25/barrel as the average over the next two years, North American producers would suffer the most, followed by Asia-Pacific and Latin America.

Middle-Eastern producers enjoy the lowest extraction costs and are mostly still profitable at lower prices.

Avoiding Value Traps

Value opportunities abound in industries that are badly affected by the economic contraction and falling crude prices — as well as by those industries that stand to benefit from low oil prices. Some affected industries, however, are going to struggle to survive without state assistance.

The problem with value stocks is that, although they may seem cheap, prices can fall a lot further. That is why we use both technical and fundamental analysis to evaluate opportunities.

There are many stocks that are trading well below our assessment of fair value at present but we will not buy until the technical outlook turns bullish. It takes plenty of patience. But helps to avoid value traps.

The stock market remains an exceptionally efficient mechanism
for the transfer of wealth from the impatient to the patient.

~ Warren Buffett