Stocks of major oil companies are better ways to play oil than commodity futures.
The low price of oil will create a cash crunch in shale oil companies.
Exxon Mobil and Chevron will purchase shale companies to acquire their assets.
Nothing in the financial markets ever moves in a straight line, either up or down.
Oil traders optimistically think they have found a price bottom. However, if the last six months are any indication, the recent bounce in oil could soon disappear. Instead of buying at inflection points, traders may find themselves trying to catch the proverbial knife.
The price of oil will go up again. However, I have no idea when. But I do know a safer way to make money in oil. It’s not by buying the commodity, but rather the stocks of the major oil companies.
Futures come with a lot of leverage. That’s great when the price rises, but it’s very dangerous when the price drops. However, the shares of oil companies make much smaller moves, up and down, on changes in the price of oil. You can survive the price decline on the stocks, but it takes a lot of capital to survive a big drop on the futures. It could wipe you out.
Since last summer, the price of U.S. crude oil has fallen about 50%. However, the decline in Royal Dutch Shell (NYSE:RDS.A) is half that. Since their 52-week highs, Chevron (NYSE:CVX) is down just 19% and Exxon Mobil (NYSE:XOM) has declined only 17%. The last time oil stocks saw prices this low was in 2012.
But there’s more to the story for buying big oil companies than just being a less risky way to capture the eventual rise in oil prices. The second part involves the U.S. shale oil companies.
As the price of oil stays low, shale companies, which have not been very profitable despite their phenomenal growth, will soon be hitting a cash crunch. As profitability dries up, they are becoming unable to finance their investment programs. And Bloomberg predicted that oil could drop to $20 a barrel if America runs out of places to store all the excess crude that continues to be pumped out of the ground.
Already, the price cut is making it too expensive for the shale companies to remain fully staffed. With the outcome bleak and uncertain for small- to medium-sized firms, shale companies have started drastic furloughs and layoffs. In addition, the interest rates on loans taken out to fund development and other projects require oil to sell for between $65 and $100 a barrel just to break even.
When the cash crunch hits, I predict the major oil companies will sweep in and purchase some of these shale companies, much like they did in 2010. Around that time, the leading producers of shale gas were acquired by the top ten oil producers. Currently, Exxon and Chevron have no debt and no bonds. They run on cash, and have a lot sitting around.
Three large shale companies I expect to be bought are EOG Resources (NYSE:EOG), Anadarko Petroleum (NYSE:APC) and BP Plc’s (NYSE:BP) shale operations. Recent reports have said Royal Dutch Shell is buying rival oil firm BG Group (OTCPK:BRGXF), and the British government will oppose any takeover of BP. In light of that, because BP will need to sell off some assets, I believe it will sell its shale gas assets to Shell.
EOG is an oil & gas player in Houston. It’s one of the largest players in shale, and is currently being pursued by oil companies looking to gain a larger U.S. imprint overall, and specifically, a bigger presence in Texas.
As for Anadarko, I believe that either Exxon or Chevron will soon make a play to take over the debt of this exploration, development and marketer of oil from The Woodlands, Texas.
In addition, many of the tiny players in the shale sector will have their assets purchased after they fall into bankruptcy. This will boost the production of the major oil firms that buy them. Unless you’re tuned into this sector, you won’t read about these bankruptcies, as few will land in the big business publications. Nor will you hear of the subsequent purchases. But although you won’t hear of every purchase, that doesn’t mean it’s not happening. If you look at the first quarter guidance for the majors – Chevron, Exxon and Shell – production and exploration are where their expenses are earmarked to be spent over the next three years.
Right now, the major oil companies don’t produce much oil in this hemisphere. They’ve sold a lot of their oil drilling assets, which is why they contract with everyone else. Purchasing the shale companies will put them back in North America, letting them control more territory, which will make them more dominant, and hence, more profitable.
It’s my firm opinion that a company wants more market share, even if it’s the biggest company. This is an opportunity for them to become more monopolistic. They didn’t buy the shale companies when oil was $100 a barrel and fracking was the talk of the land. They were valued too high. Exxon is super-conservative, and it’s not overpaying for anything. But as the shale companies become very attractive, I believe the majors are going to snap them up.
Additional disclosure: I also own APC bonds.