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Are Oil Stocks a Good Buy Now?

The oil market is awash in a flood of extra crude oil that will take lots of months to resolve, but there are some twinkles of chance for client investors.

Jason Hall

While many other sectors of the stock market have recuperated much of their losses, oil stocks as a group stay extremely beaten down. And that makes sense, considering that international oil demand is still down by double digits, with global travel all but stopped.

However there are some signs the economy is starting to open up in some places, and at some point in the future, oil need should begin growing. So the next step in this chain of thought is, this is good for the oil market, right? With the potential for an economic recovery as spring turns to summertime, are beaten-down oil stocks where financiers should be looking now?

Man looking at diagram showing sell and buy.

Image source: Getty Images.

One only has to look at just how much further the Energy Select Sector SPDR ETF ( NYSEMKT: XLE) and SPDR S&P Oil & Gas Explor & Prodtn ETF ( NYSEMKT: XOP) have fallen as compared to the more comprehensive stock market as measured by the SPDR S&P 500 ETF Trust ( NYSEMKT: SPY) At the end of the week on May 1, the broader market is down about 17%from the 2020 high, while the 2 major oil and gas ETFs are down 42%and 50%respectively.

So, are oil stocks a buy now? Should you purchase oil stocks?

How the oil market fell apart in 10 weeks

The first clear signals that 2020 was going to be a tough year for the oil industry came in February, when the International Energy Agency reset its full-year expectation for oil demand as COVID-19 ground China to a halt. In late-February Saudi Arabia and Russia went full-on cost war, with strategies to flood international oil markets and drive out affordable supplies.

But while everybody in the oil patch was gazing down the competition, no one understood simply how huge the COVID-19 pandemic had actually become, and international oil demand cratered even more than anybody anticipated, and on April 20, U.S. petroleum rates went unfavorable.

April 20 probably wasn’t the bottom

Numerous observers look at oil costs, and see that U.S. crude prices have rebounded greatly given that the day West Texas Intermediate futures went negative. The analysis for a great deal of folks is naturally, that was the bottom. It can’t get much worse than traders paying the buyers $38 per barrel to take shipments, right?

Man forcing a red line that's going down to go up.

Image source: Getty Images.

There’s a problem with that interpretation: It disregards the truth in the real oil market. In the 10 days considering that oil invested most of a trading session with the sellers paying the purchasers, the supply/demand imbalance has actually only gotten worse.

Global oil production has gone beyond need for essentially all of 2020, and over the previous month, it’s heightened. Saudi Arabia and several of its OPEC partners, together with Russia, spent the whole month of April pumping much more oil than in the very first quarter of 2020, while international oil need crashed hard. It was only on Friday, May 1, that the record offer to cut output by about 10 million barrels per day began.

Yet even with that deal in location, in addition to extra output decreases in The United States and Canada as shale production lastly begins falling, the expectation is that global oil output will exceed consumption well into the summertime. In a lot of cases– particularly in the U.S.– the only thing that will cause wells to be shut in (physically switched off) will be no place to send the oil.

All that oil pushes the recovery further out

The past a number of weeks have actually seen some of the biggest unrefined oil inventory constructs in U.S. history, and it’s only going to get even worse. There are more than 100 tankers either heading towards or currently off U.S. ports providing crude oil.

This excess is expected to grow even bigger. A large portion of the world’s fleet of oil tankers are being rented as floating storage vessels, and that could include another 200 million barrels to the storage mix.

Stacks of oil barrels.

Image source: Getty Images.

And the implications of all this oil kept above ground and on the water is massive. Depending upon the speed of healing in oil need, and when the healing begins, it might easily be a year before supply and demand are back in balance.

The insolvencies have actually currently begun, and banks aren’t going to save anyone

We have actually already seen significant shale manufacturer Whiting Petroleum ( NYSE: WLL) and offshore drilling professional Diamond Offshore ( NYSE: DO) file for personal bankruptcy defense, while Chesapeake Energy ( NYSE: CHK) simply had its debt devalued to the lowest “scrap” rating that’s just one notch above remaining in default. More business are anticipated to declare bankruptcy in the months ahead.

And unlike in other past energy declines where banks extended lifelines to indebted oil stocks to prop up their other loans, big loan providers like Wells Fargo ( NYSE: WFC) and JPMorgan Chase ( NYSE: JPM) have actually supposedly begun setting up operations to deal with defaulting borrowers in the oil spot, including taking and operating possessions instead of taking cents on the dollar to liquidate them in this environment.

Still want to invest in oil stocks? Search for strength, not inexpensive prices

The U.S. oil market is in terrible shape, and in the majority of cases there’s just too much threat and unpredictability to make it worth investing in.

Of the 3, just Overall operates oil production, and very little of its production is in North America so it’s not as exposed to the shale bomb that’s affecting so many U.S. manufacturers. Moreover, all 3 have strong midstream operations that ought to hold up relatively well throughout the slump, and Phillips 66 and Total have big gas sectors that aren’t dealing with anywhere near the pressure that the oil market is suffering from.

Lastly, all 3 have really strong balance sheets, with either huge quantities of money, easy access to inexpensive financial obligation liquidity, or a mix of both.

Lastly, do not anticipate to make a fast dollar. We are still in the early stages of a huge economic collapse, and it’s likely to be months before we even begin resolving the excess oil. These 3 business are set to be a few of the first to see the advantages of increased need, however it might take a lot longer for the oil healing to happen than you believe. Invest appropriately.

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