Frank Curzio's WALL STREET UNPLUGGED Podcast

Don’t Buy Oil Stocks Without Looking at These Charts First

crude oil prices

There was big news surrounding the oil industry last week …

I’m not talking about the meeting among 18 oil nations in Doha. Most insiders knew there was little chance Saudi Arabia, Russia and Iran would agree to “freeze” production to prop up oil prices.

The much bigger news was the bankruptcy announcement from Goodrich Petroleum. Goodrich was a large oil & gas producer with assets in big shale areas like Haynesville and the Eagle Ford.

The company’s market cap was once over $2 billion. Its share price traded above $80 in 2008. Institutional firms like JPMorgan and Deutsche Bank had strong “Buy” ratings on the stock, as its future looked promising.

However, Goodrich was sitting on a huge amount of debt. Once oil prices crashed to 12-year lows this year, the company could no longer generate enough cash flow to service its debt. It was just a matter of time before it filed for bankruptcy.

According to oil bankruptcy firm Haynes and Boone, more than 60 North American companies have now filed for bankruptcy since 2015. That amounts to roughly $22 billion in cumulative debt.

These numbers are small compared to the 175 publicly traded companies consulting firm Deloitte predicts could file for bankruptcy. These companies are sitting on $150 billion in debt and could file for bankruptcy by the end of the year.

Let me explain …

Over the past few months, we’ve seen a surge in most oil stocks.

That’s because oil prices popped more than 30% from their lows. The price of crude is hovering around $40 a barrel today. But the woes in the oil industry are not even close to being over …

Below is a chart from Citigroup. It highlights the breakeven costs for all the major global oil projects expected by 2020. Since there are hundreds of projects on this chart, it’s difficult to read the actual names.

That’s OK. Your focus should be on the uptrending blue line …

oil stocks breakeven price

You see, the blue line is the actual breakeven price for each project. And at $40 a barrel, about 15% of the projects are economical.

In other words, 85% of the projects on this chart will not make money if oil prices stay at $40 a barrel.

Even at $50 a barrel, more than half of these projects will not make money. Keep in mind, Goldman Sachs is predicting $50 oil prices through 2020. And heavyweights like ExxonMobil and Chevron are budgeting for sub-$50 oil prices at least through 2017.

Some analysts predict that the massive cuts in spending (to drill for oil) will result in much lower production. That means oil prices should go higher as more and more production comes off the market.

Yet, the price of oil declined from over $110 a barrel in January 2015 to $40 today. That’s a 64% decline in oil prices in 16 months. Despite this huge long-term pullback, there is still a ton of supply on the market.

This is evident from the chart below …

It’s the latest oil inventory numbers (from mid-April), which increased by 6.6 million barrels (to 537 million barrels) from the previous week.

As you can see, inventories are still at historically high levels (note that here’s another uptrending blue line). This is despite much lower oil prices and the massive cuts in spending.

united states crude oil five year price estimate
Image credit: Energy Information Administration

This tells us that the recent push higher in oil prices is not because the fundamental landscape is getting better. The move higher is likely due to short-covering.

If you are looking to invest in oil companies as a long-term investment, I suggest holding off.

Sure, names like Pioneer Natural Resources (PXD) and EOG Resources (EOG) have strong balance sheets and solid hedges in place through 2017. However, most oil companies will see huge declines in earnings for at least the next few quarters.

In fact, most are likely to see big earnings declines for several years. This includes the major oil companies who are not generating enough cash flow to cover their dividend payments, buybacks and drilling programs with oil prices at current levels.

If you hold off long enough … I’m sure you will get the chance to invest in some of your favorite oil stocks at much cheaper prices in the future.